This month in the Analytic Hospitality Executive, we are focusing on the future of pricing and revenue management. Last week you read Alex Dietz’s post about revenue management and competitive rates. This week, I reached out to Bill Caroll, senior lecturer at the School of Hotel Administration, Cornell University. I asked Bill what he thinks are the latest trends in pricing and revenue management. It was an interesting and lively discussion, which is exactly what you would expect between two people who get so excited about this topic.
So Bill, what is the latest in pricing?
Bill believes that while we are facing a relatively slow economic recovery, spreading out over the next 12-36 months, there still may be some pressure on pricing. “However, it is unlikely that we will get back to pre-recession levels in the near term,” he explained. “There is a significant opportunity in the growth of mobile,” he told me. When you couple the poor economy with pressure on price and increasing use of mobile, hoteliers can gain significant opportunities to drive more revenue. They can do this by making better use of their assets; whether it is upselling their customers into more expensive classes of room, better merchandizing, or promoting more of the services they offer. “With good mobile programs in place, hoteliers can make the most of these opportunities,” Bill said.
Mobile applications and option-pricing for hotel rooms
While both hotels and online travel agencies consistently report that at least half of mobile bookings are being made for same-day reservations, what is not known is how many times the customer is booking on the same day through mobile apps to change their reservation from another property. Bill was very interested in Priceline’s recently declared strategy to gather reservations from travellers who have already booked at another hotel, by offering better deals through its Booking.com Tonight mobile application. “Why shouldn’t I, even as a customer with a corporate account, post what my current reservation deal in order to get a better deal?” Bill asked, “I have nothing to lose, and I may even get a better room at a cheaper price.”
To combat this, Bill thinks that hoteliers should start to get serious about option-pricing approaches. In contrast to a best available rate guarantee, an option-pricing approach provides value to hotel customers by offering that customer the option of purchasing a price guarantee. Bill cites his colleagues, Steven A. Carvell and Daniel C. Quan and their paper: Low Price Guarantees: How hotel companies can get it right. An option-pricing approach means that hoteliers must understand the value of each reservation.
“There are two scenarios where an option-pricing approach could be a very effective price response for hotels,” Bill explained. The first scenario occurs when the reserved price is greater than the current price, which results in the booking being at risk. In this scenario, the expected value of the reservation also goes down, because there is an increased chance (and with increased use of mobile apps an increased probability) of that guest not showing or cancelling. The second, opposite scenario is when the reserved price is less than the current price. In this scenario, another customer may be willing to trade or there could be a secondary market opportunity to sell that reservation. Bill thinks that the second scenario is unlikely to occur, but that with the ease of searching for a better deal through a mobile application, the first is increasingly more likely.
“With the first scenario, hotels need to respond if they do not want to lose the reservation or, at least reduce the risk of that occurring,” Bill told me. “A response could come in the form of a guarantee that if a customer gets a better offer than their current reserved price, the hotel will match the offer,” he said. Hotels need to consider if they would be willing to give a guarantee, and if so, for which customer types?
Argh – isn’t that just agreeing to commoditize your product even further on price?
I challenged Bill on this, because it seems that if we start price-match guarantees for hotels that we are agreeing that we compete only on price and not on differentiated products. This went against every revenue management and price optimization bone in my body.
“Based on the market reaction to the Priceline launch of its Booking.com Tonight application, perhaps being different is not quite enough,” Bill explained. “Raising switching costs is another possible response to this scenario,” Bill said. Hoteliers can raise switching costs by introducing some opacity or differential promise for customers who keep their reservations. “You need to create some service feature or value- add for guests so that they are no longer able to compare between hotel offers as easily.”
“Another alternative to option-pricing approaches is to increase your switching costs through higher cancellation penalties,” Bill said, “although I don’t think that any hotel company would be willing to be the first company to change their cancellation penalties, because of the competitive advantage that would give to the others.” While I would like to think that the days of no penalty cancellations are fading, I tend to agree with Bill. That said, I suggested that it may work for hoteliers if they offer particularly low rates that come with cancellation policies, in the same way that budget chains have done in the past. Bill points out that without understanding the impact of dilution, and accounting for them in our pricing models, that this could be a dangerous practice. “If you lower your leisure rates, it is not just your leisure rates that get lowered,” Bill said, “it has a spill-over effect on your other segments.”
Conditional price elasticity
Bill thinks that current day models are limited because they do not take into account conditional price elasticity. Conditional price elasticity incorporates the probability of each customer segment will buy up to a more expensive class of room, or purchase more services. He shared the case of revenue management in car rental, where revenue per day transactions would be much lower, because they would take into account conditional price elasticity and what customers were willing to pay for additional car class upgrades and services, such as pre-paid refueling or liability insurance. This generated better decisions because we understood the linked probability of generating additional revenue. Today’s hotel revenue management systems just do not do that as well as they should.
Have hotels missed their biggest opportunity?
Bill and I both agreed that the hotel industry has a huge untapped opportunity to upsell and cross sell to its customers. And unlike the airline industry, which created the perception that they had taken something away with their upsell and cross-sell policies, the hotel industry has the opportunity to offer premium products that the customer has not purchased in the past and was rarely given free. Hotels are really missing an opportunity to get value from something that they have not sold.
“Couple that with the abilities of mobile applications”, Bill said, “and you can have it all done before the guest gets to the property.”
So, while option-pricing and price-match guarantees do not appeal to the revenue manager in me – how about you? Do you think that upselling and cross-selling generates more revenue than just price manipulation? Bill and I will be debating discussing this for some time, so please – weigh in and join the discussion.
For more information on trends in pricing, download the New Pricing Techniques for Hospitality and Gaming white paper. And don't forget to nominate your fellow Analytic Hospitality Executives for the Cornell Center for Hospitality Research and IDeaS Hospitality Research & Analytics Awards.
2 Comments
Option pricing for hotels absollutely makes sense. A cancellable reservation is nothing more than a call option that a hotel is giving away for free. A cancellation fee is nothing more than putting a price on that option. The thing is, a very moderate cancellation fee is all that's necessary. All you'd want is a fee that will put a customer "out of the money" for switching to a cheaper room. Since you typically don't have wild swings on hotel rates, a $25 fee may suffice, and that's not a number that a lot of guests will gag at. Once you consider the time and effort to actually switch a resrvation around, that will probably protect you from about a $50 price swing. I would guess that will cover you about 90% of the time, even with mobile apps. No commoditization.
Miguel – thank you for your thoughts. The moderate cancellation fee that you have suggested is an excellent way to raise switching costs for customers of hotels so that they are less likely to give up that option. And at the level you have suggested, it may be much less likely that other hotel companies would use this to their competitive advantage.