The Role of the Room Rate

1. The Role of the Room Rate Chapter Nine PowerPoints developed by Bharath M. Josiam, Ph. D. Professor, Hospitality Management University of North Texas, Denton, TX, USA And Edited by Gary K. Vallen, Ed. D. Professor, School of Hotel and Restaurant Management Northern Arizona University, Flagstaff, AZ, USA

2. Objectives of Chapter 9 Understanding why hotels are unable to get the rack rate Understanding the negative impact on revenues from discounting Understanding the Hubbart Room Rate formula Understanding the Building Cost Room Rate formula Understanding the Ideal Average Room Rate Understanding terms/jargon specific to room rate factors and calculations

3. The Room Rate’s Impact on Guest Demand Hotel Room Rate and the Economy (Exhibit 9-1) Demand for hotel rooms generally reflect the economy. When economy is booming, demand shoots up, and hotels charge more. When economy is weak, demand drops, as do occupancy, ADR, and REVPAR. There is a lag between high demand and construction of new hotel rooms. Booming economy leads to increased new construction, while weak economy leads to bankruptcies and closures. Over time, this is equilibrium between supply and demand. But, capacity has also increased with over-built markets Room rate are price-elastic, but that varies with the market segment targeted.

4. The Room Rate’s Impact on Guest Demand Bottom-Line You need to charge enough to make money, but not more than your competitors, or you will “kill” the market Role of Lodging Taxes on Rates Politicians would rather tax visitors than locals! High taxes on hotel rooms world-wide as a result High taxes do impact business, particularly groups Online Travel Agencies (OTAs) and Room Taxes OTAs buy rooms at cheap wholesale rates and sell at higher retail – that is how they make profits OTAs are only paying taxes on the lower wholesale rates Cities want them to pay taxes on the higher retail rates Individual hoteliers feel that there is unfair competition from OTAs as hotels have to pay taxes at a higher rate to the cities for their direct sales. Currently, there are many court cases across the country to resolve this issue

5. The Room Rate’s Impact on Guest Demand Rack Rate: The standard posted rate Discounts off Rack Rate Most customers do not pay rack rate, so why bother? Some will pay, so lets get it from them! Rack rate sets the image/market position of the hotel This is a luxury hotel with “$200” room rates The impact of rate cutting (Exhibit 9-2) Discounting Profitability You need to sell 11% more rooms if you cut your rate by 10% Is the market that price elastic?

6. The Room Rate’s Impact on Guest Demand Discounts off Rack Rate (Continued) Examples of Discounted Rates Seasonal rates, weather-related discounts, weekly rates, corporate rates, commercial rates, employee courtesy rates, senior citizens rate, AAA or other travel club rates etc. Government per diems – The government will pay only a fixed amount to its employee per day, so hotels charge less for government employees to get that business It pays to pay rack rate – Give no discounts, but give special benefits to those paying rack rate Auction Travel Sites – Deep discount on-line sites, where customers bid for rates and hotels accept if they think the room will be empty otherwise. Often “opaque,” where name of hotel is revealed only after bid is final and credit card is charged. (Exhibit 9-9) Complimentary Rooms – No rate! Room is given free Have strict control systems in place to prevent abuse

7. The Room Rate’s Impact on Guest Demand Additional Rate Factors Energy and Other Non-room surcharges Charging per room Energy surcharges Resort fees Hotels can conveniently provide a range of “complimentary” services, such as morning newspapers, local telephone calls, in-room coffee, the health club, spa, etc. These fees appear to be on the decline A nuisance and source of complaints rather than a true revenue source The growing potential for lawsuits

8. The Room Rate’s Impact on Guest Demand Additional Rate Factors (Continued) Premium Periods Ability to charge more than rack rate during “special” events May be illegal and prosecuted as “price gouging” Double Occupancy Charging per person, rather than per room Trend in USA is to charge for the room, rather than per-person American Plan Day Guests on American plan (AP) or modified American plan (MAP) must be given their full quota of meals Day Rate Rooms Special rates for stays of less than overnight Perceived as only for shady business and/or prone to employee fraud and/or general accounting hassles Need to re-examine these perceptions

9. Determining the Proper Room Rate The Hubbart Room Rate Formula (Exhibit 9-14) Operating Expenses 1,102,800 Taxes and Insurance 273,000 Depreciation 294,750 Reasonable ROA 414,000 Total 2,084,550 Less Income from other sources 139,200 Amount needed from room sales $ 1,945,350 Revenue from room sales needed $1,945,350 Number of rooms available (Per Day) 88 Rooms available per year (item 2x 365) 32,120 Less allowance for vacancies (@ 30%) 9,636 Number of rooms to be sold (@70%) 22,484 ADR per room to get ROA (item1/item5) $ 86.52

10. Determining the Proper Room Rate The Hubbart Room Rate Formula (Exhibit 9-14) Short comings of the formula It is inward looking at what we need, rather than outward looking at market conditions Many assumptions are problematic What is “reasonable” ROA? What occupancy rate is attainable? Occupancy is a function of room rate!! What about role of other departments like F & B? Should low estimates force us to increase rates? Should high estimates force us to lower rates? Summary It is a worthwhile formula to use as a guideline, after recognizing the problems inherent in it.

11. Determining the Proper Room Rate Square Foot Calculation Use numbers from Hubbart Formula, but use square footage of room, not number of rooms Hotel has 27,250 square feet in 88 rooms @ 70% occupancy only 19,075sq,ft will be occupied Dailyrequired return is $ 5329.73 (Room revenue/365) Each square foot must generate $0.27941 per day (3/2) A 300 sq.ft room would sell for $ 83.82 (4X5) The Building Cost Room Rate Formula The average room rate should equal $1 per $1,000 of construction cost A 200 room hotel, costing $14 million, should have a room rate of $70 ($14 million /200 rooms/ $1,000) = $ 70 Despite being a very old “rule of thumb” it is surprisingly valid even today!

12. Determining the Proper Room Rate The Ideal Average Room Rate Assumes that at say 70% occupancy, each room category is occupied at 70% Revenue is calculated based on this assumption If actual revenue is greater, there is demand for higher priced rooms, so increase rates, or convert rooms to higher priced ones If actual revenue is lower, more lower priced rooms are being occupied, so try up-selling, marketing etc to increase revenues In general, rooms fill from bottom-up, so we may need to construct that way, with greater availability of cheaper rooms Up-selling Premium Accommodations Use incentives to up-sell Higher ADRs are a win-win-win situation The clerk wins by receiving increased payroll Management wins because up-selling contributes proportionately higher profits to the P&L Statement The guest wins by receiving exactly the room desired

13. Ideal Average Room Rate -Scenario 1 Cheaper rooms have greater occupancy Rooms tend to be sold from “bottom-up” Train staff to upsell Consider converting larger rooms/suites to multiple single rooms

14. Ideal Average Room Rate - Scenario 2 More expensive rooms have better occupancy Rooms are selling from “top –down” Potential to increase rates Potential to convert lower rated rooms into suites

15. Objectives of Chapter 9 Understanding why hotels are unable to get the rack rate Understanding the negative impact on revenues from discounting Understanding the Hubbart Room Rate formula Understanding the Building Cost Room Rate formula Understanding the Ideal Average Room Rate Understand terms/jargon specific to room rate factors and calculations

16. Determining the Proper Room Rate – In-class Assignment The Hubbart Room Rate Formula (Exhibit 9-14, pgs. 356, 357) Operating Expenses 2,000,800 Taxes and Insurance 400,000 Depreciation 350,750 Reasonable ROA 900,000 Total Less Income from other sources 340,000 Amount needed from room sales $ Revenue from room sales needed $ Number of rooms available (Per Day) 275 Rooms available per year (item 2x 365) Less allowance for vacancies (@ 25%) Number of rooms to be sold (@75%) ADR per room to get ROA (item1/item5) $

17. Determining the Proper Room Rate – In-class Assignment Square Foot Calculation Use numbers from Hubbart Formula, but use square footage of room, not number of rooms Hotel has 80,500 square feet in 275 rooms @ 75% occupancy only Sq.ft are occupied Daily required return is $ (Room Revenue/365) Each square foot must generate $ per day (3/2) A 300 sq.ft room would sell for $ (4X5) The Building Cost Room Rate Formula The average room rate should equal $1 per $1,000 of construction cost A 300 room hotel, costing $25 million, should have a room rate of $ ($ million / rooms/ $1,000) = $ Similar calculations can be done to arrive at a return on investment for a major renovation project