Are Hoteliers Losing Control of their Inventory?

This was the question that hotel owners came to Cindy Estes Green from The Estes Group, and Mark Lomanno, member of the board of directors of newBrandAnalytics and former President and CEO of Smith Travel Research, amid growing concern about the penetration of the OTAs, and the cost of doing business through these channels.  This question developed into a research paper which you can access here.  I had a chance to speak with Mark about the study and its implications recently.  Before I get into the details of our conversation, I must say that the issues uncovered by the study simply cannot be ignored by the hotel industry, managers, owners, OTAs, vendors alike.  (which is why we’re  kicking off the blog series by exploring this timely topic).  The study quantified what experts have long suspected, that the way we’ve been operating in terms of pricing and distribution, must change if hotels want to continue to operate profitably.

The study utilizes three basic methods: a data analysis of 24,000 participating US hotels who contributed monthly rooms booked by channel and associated revenue to STR from January of 2009 – June of 2011; an econometric modeling of price and demand elasticity done by Tourism Economics; and a broad survey of trends in distribution management conducted by Cindy Estes Green.   In our discussion of the results, several important data points really struck me:

Imbalance between channel mix and pricing efforts

Results indicate that 35% of demand in 2010 came through electronic channels (including brand.com, GDS and third party). Of this demand, only about 10% as from the OTAs – and that only accounted for 7% of revenue (because of the commissions).   Surprisingly, voice channels accounted for 13% of demand and 17% of  revenue, yet the industry seems to have forgotten about this as a sales channel.  Mark made the comment, in fact, that he perceives that most hotel companies tend to think of voice more for customer care than as a sales channel.  What is scary to me is that, given the amount of attention given to OTAs, when it comes to pricing decisions, we’re letting 10% of our demand affect pricing for 90% of our demand!  Whenever the decision is made to drop a price on an OTA (which, because of rate parity, means discounting for brand.com too), there are follow on impacts to any linked prices (from negotiated contracts) and the pricing for groups as well.  I understand that the OTA price is not only controllable, but also highly visible, and therefore warrants the extra attention.  However, if you aren’t considering the impact of the OTA pricing on the other 90% of demand (and let’s not forget, actually 93% of revenue), and vice versa, you are definitely leaving money on the table.  The problem is that legacy revenue management systems tend to deal with these demand streams independently.  That must (and will) change soon, or we’ll continue to lose out on revenue opportunities.

We’re giving money away to the OTAs

This is kind of a controversial statement.  The OTAs would point out that they generated $7.7B in revenue for hotels in 2010 – but they made $10.4B in revenue – so the gap, or much of it anyway – could be thought of as a missed opportunity.  Part of the problem, Mark thinks, is that while the industry is aware of the costs of operating through this channel, it’s not really brought to the forefront in the tools that we use to measure performance – namely the hotel P&L.  Mark made the point that because the OTAs pay the hotels the rate minus the commission, the 25% that the OTAs take doesn’t appear on the P&L – but the GDS commission does.  He suspects (and I agree) that if hotels actually saw that OTA commission figure, they’d pay much more attention to how much volume they drive through the third parties.

There is no doubt that the OTAs invest a good deal of resources on marketing.  Their argument (and that of the research on the Billboard effect) is that they are able to give hotels more exposure than the hotels could generate on their own, and that the commission on one reservation should rightfully be partially considered a marketing expense.  Mark says that there is certainly some validity to the Billboard argument, but his study would suggest not to put all of your eggs in the Billboard basket.  The analysis showed that the OTAs generated a only a negligible amount of incremental demand into a market, which means any
demand a hotel gets is a share shift from another property.  If this is the case, hotels might be better off trying to shift the share through other channels where the net room rate is higher.  Mark also mentioned that if you compare the advertising the OTAs do through major media outlets with the advertising that hotel brands do, you’ll notice two things. First, the OTAs are drastically outspending the hotels; in TV it’s 2 to 1, in online paid search advertising between 3 and 4 to 1.  Second, while the hotels focus on service experience elements, the OTAs are all about the deal “come to us to get a screaming deal on hotel rooms”.  Even though rate parity means the consumer should get the same “deal” through brand.com, the OTAs are training the market that the best deals are to be found on the OTAs.   It appears that even though the OTAs are spending on advertising for hotels, the message is not to the best advantage of the hotels. (and of course the OTAs should be pushing messages out to their advantage, no one can blame them for that – I’m only suggesting that hoteliers should be aware of this)

Trying to win business by lowering rate is NOT GOING TO WORK!

Forgiving the dramatic capitalization, the most important finding in this research is that demand in the US is a zero sum game. There is essentially no  icremental demand in the market, so any movement ends up being a share shift.  This means that demand is generally speaking, inelastic.  You aren't generating incremental demand by lowering prices.  Any demand growth is a function of economics or demographics, not pricing changes.  Mark said that the STR data from 2008-2010 indicates that the only companies that showed any improvement over the comp set long term were the outliers-those that implemented drastic (and crazy) low rates and those that decided to raise rates despite the recession.  Those with high rates showed a bit of drop in occupancy, but not enough to damage performance. Obviously the drastically low rates were made up in volume. Everyone else tended towards the average.  His takeaway “why do we insist on dropping rates when demand is most inelastic.” Hmmm…

So what do we do about it?

Mark says the overwhelming reaction to the study from hoteliers is exactly this question.  Unfortunately, the answer isn’t a simple one.  Their preliminary work indicates that the answer will really depend on the characteristics of the individual properties.  While this may be disappointing to the industry, I think it’s OK.  This reinforces to me the importance of not acting on auto-pilot – or even worse, being led by your competitors decisions (see above about competitive set performance).  My advice: maintain your analytic discipline. Run the numbers on every decision.  Don’t be overly influenced by “prevailing wisdom”.  Keep your eyes open and understand why you’ve made every decision – simply saying “because the hotel across the street did it” isn’t a good enough answer.

In the end, I don’t think that operators should read these results as a condemnation of the OTAs (and neither does Mark), but rather as a call to action.  Cindy has pointed out in interviews, that if the OTAs never existed, something else would have filled the gap they left.  Mark says that, most importantly, the study results tell him that hotels better think very carefully about any deals they enter into next.  Companies like Google and Facebook will (and did) look at the $10.4B in revenue that the OTAs earned in 2010 as an opportunity, and they’ll be knocking on doors soon.  I couldn’t agree more.  We have a history of being lead, rather than leading, and  it’s time we took the reins!