Higher Occupancy at Lower Prices Isn’t Worth It
- Hotels with higher room prices reported higher profits than hotels with lower prices and higher occupancy rates.
- Guests can tolerate higher prices if they see added value behind them.
- In this way, operating costs associated with occupied rooms can be reduced.
In the hotel business, there is a theory, often put into practice, that says general price reductions will result in higher occupancy, and thus higher profits. Written down like this in one sentence, it sounds like a contradiction. So let’s look at this myth in detail and see why this is the case.
Focusing only on occupancy without taking other factors into consideration need not always lead to higher profits; in many cases, quite the contrary applies.
A recent study. in which over 4000 European hotels were analyzed over a period of ten years, showed that by maintaining a higher Average Daily Rate, hotels reported higher revenues than through artificial price reductions to achieve maximum occupancy.
There is therefore value in focusing on maximizing revenues from available rooms. Guests are on the whole ready to accept higher room prices if they see added value, or if they find themselves in a tight spot, in finding accommodations at all. In addition, operators reduce operating costs associated with occupied rooms, thus reporting higher profits.
Here’s a specific example:
Let’s compare two hotels with ten rooms each:
Hotel A operates at full occupancy by reducing the price per room per night to €60. Total daily revenue is €600.
Hotel B has an occupancy of only 90%, but rooms are priced at €80 per night. Total daily revenue is €720.
Hotel B is already ahead by €120. But there are other factors to be considered, for instance CPOR (Costs of Preparing an Occupied Room), which includes housecleaning and laundry, cosmetic products, utilities, etc. For our example we’ll fix these expenses at €20 per room.
Hotel A therefore has overhead of €200 that must be deducted from total revenue. The overall profit per night is thus €400.
In the case of Hotel B, overhead of €180 must be deducted from total revenue. The overall profit per night is thus €540. The difference between the revenue of Hotel A and Hotel B is €140 per night. Over the course a month Hotel B will show a profit that is €4,200 higher than that of Hotel A. And this is only an example of two small hotels with just ten rooms apiece.
Y-Axis: Price, X-Axis: Room Occupancy. Hotel A 100%, Hotel B 90%
A higher occupancy rate logically leads to higher overhead costs. Focusing on room ADR (Average Daily Rate) is clearly better than focusing on achieving the highest possible occupancy. The potential loss of revenue based on a lower occupancy rate must be balanced out by revenue from the ADR. Larger hotels are able to compensate this loss through additional services (restaurants, wellness, bars, etc.).
The efficiency of each accommodation facility can be calculated using the following parameters:
ADR — The Average Daily Rate is calculated by dividing total facility revenue by the number of rooms sold.
OCC — The Occupancy Rate is calculated by dividing the number of rooms sold by the total number of rooms in the facility. If the result is multiplied by 100, a percentage value is obtained.
CPOR—the Cost of Preparing an Occupied Room is calculated as the sum of all individual operating costs for all rooms divided by the number of rooms sold. These include wages, cleaning and maintenance supplies, upkeep, laundry, utilities, as well as marketing and depreciation due to wear and tear..
RevPAR– Revenue Per Available Room is very probably the most important factor. It is calculated by multiplying the ADR by the percentage value of OCC or as income from accommodations (for a period) divided by the number of vacant rooms (in the same period). The formula is therefore:
RevPAR = ADR * OCC%
Clearly an increase in occupancy due to low prices will lead to an increase in OCC, but simultaneously a reduction in ADR. Rather than increasing profits, the opposite tends to holds true.
The other variables can be calculated by rearranging the formula. (RevPAR / ADR = OCC%, RevPAR / OCC% = ADR)
RevPAR is currently the most frequently used measure of a hotel’s success, though not a perfect one. For example CPOR is not included as a factor, nor is revenue from services aside from accommodation. This leads us to the extensive topic of revenue management, which we’ll deal with in subsequent blog additions.