Lecture Managerial Accounting for the hospitality industry: Chapter 8 - Dopson, Hayes

Chapter 8 - Revenue management for hotels. In this chapter, you will learn how hoteliers decide what they will charge for the hotel rooms and the other products they sell. You will discover that hotels typically offer their guests a variety of room rates depending upon the specific characteristics of the rooms sold and the guests to whom the rooms are sold.

Chapter 8

Revenue Management

for Hotels

 Establishing Room Rates

 Revenue Management

 Non-Room Revenue

Chapter Outline

Learning Outcomes

 Utilize alternative methods when establishing a hotel’s

room rate structure

 Apply revenue management and analysis techniques to

the administration of a hotel’s room rate structure

 Recognize the importance to a hotel of properly

managing and controlling its non-room revenue

Establishing Room Rates

 Any serious exploration of hotel room rates and their

management must include basic information about

room rate economics

 Room rate economics recognizes that, when the supply

of hotel rooms is held constant, an increase in demand for those rooms will result in an increase in their selling price

 Conversely, when supply is held constant, a decrease

in demand leads to a decreased selling price

Establishing Room Rates

 Understanding the law of demand is critical because,

unlike managers in other industries, hoteliers cannot

increase their inventory levels of rooms (supply) in

response to increases in demand

 Hotel managers must also understand that their own

inventory of rooms is highly perishable

 If a hotel does not sell room 101 on Monday night, it will

never again be able to sell that room on that night, and the potential revenue that would be generated from the sale is lost forever

Establishing Room Rates

 A rack rate is the price at which a hotel sells its rooms

when no discounts of any kind are offered to the guests

 In some cases, it makes sense for hoteliers to create

special event rates Sometimes referred to as “super”

or “premium” rack, these rates are used when a hotel is assured of very high demand levels (e.g., Mardi Gras in New Orleans and New Year’s Eve in New York City)

 Hotels often negotiate special rates for selected guests

In most cases, these negotiated rates will vary by room type

 In addition to rack and negotiated rates, hotels typically

offer corporate rates, government rates, and group

rates

Establishing Room Rates

 Some hotels have great success “packaging” the guest

rooms they sell with other hotel services or local area

attractions

 When a hotel creates a package, the package rate

charged must be sufficient to ensure that all costs

associated with the package have been considered

 In addition, the use of one or more authorized fade

rates, a reduced rate authorized for use when a guest

seeking a reservation is hesitant to make the

reservation because the price is perceived as too high, can result in even more room rates to be managed

Establishing Room Rates

 A hotel’s revenue managers can also create discounts

at various percentage or dollar levels for each rate type

we have examined

 The result is that a hotel, with multiple room types and

multiple rate plans, may have literally hundreds of rates types programmed into its property management

system

 A property management system (PMS) is a computer

system used to manage guest bookings, online

reservations, check-in/check-out, and guest purchases

of amenities offered by the hotel

The Hubbart Room Rate Formula

 The Hubbart formula is used to determine what a hotel’s

average daily rate (ADR) should be to reach the hotel

owner’s financial goals

 The Hubbart formula is a “bottom-up” approach as

shown in Figure 8.2

 To illustrate the Hubbart formula, the Blue Lagoon

Water Park Resort’s Income Statement is shown in

Figure 8.3

 For a detailed analysis of the Hubbart formula, see Go

Figure! following Figure 8.3

 For a summary of the Hubbart formula calculations for

the Blue Lagoon Water Park Resort, see Figure 8.4

Figure 8.2 Comparison of Normal and Bottom-Up Formats

Normal Format for the Income Statement

Bottom-Up Format for the Hubbart Formula

Operated Department Income

+ Operated Departments Income (Excluding Rooms)

+ Taxes

- Undistributed Operating Expenses + Nonoperating Expenses

(Excluding Rooms)

(Rooms)  

Figure 8.3 Income Statement

Blue Lagoon Water Park Resort Income Statement For the Period: January 1 through December 31, 2010

Net Revenue Cost of Sales

Payroll and Related Expenses Expenses Other Income (Loss) Operated Departments

Food 7,200,000 2,138,400 2,188,800 532,800 2,340,000 Beverage 3,264,000 451,440 534,960 201,600 2,076,000 Telecommunications 72,000 169,200 54,000 28,800 -180,000 Other Operated Departments 540,000 79,200 180,000 64,800 216,000 Rentals and Other Income 109,800 15,840 48,960 10,800 34,200

Total Operated Departments 25,201,800 2,854,080 5,973,120 2,077,200 14,297,400

Gross Operating Profit 25,201,800 2,854,080 8,877,600 5,934,240 7,535,880

Rent, Property Taxes, and

g o fig ure!       

The steps required to compute the Hubbart formula in this example are:

1 Calculate the hotel’s target before-tax net income Multiply the required

rate of return (ROI) of the owner’s investment, and then adjust the answer for before-tax net income

Assume an investor considers paying $16,217,417 for the 240 room hotel at the Blue Lagoon and desires a 12% return on the investment

$16,217,417 x 0.12 = $1,946,090 ROI (hotel’s target net income)

Calculate before-tax net income Divide the after-tax net income (owner’s

ROI) by 1.00 minus the tax rate

After-Tax Net Income (ROI) 1.00 – Tax Rate = Before-Tax Net Income

or, assuming a tax rate of 40%

$1,946,090 1.00 – 0.40 = $3,243,483.30 ~ $3,243,480 (rounded down)

In order to be consistent with the Income Before Taxes number in Figure 8.3,

we will round the before-tax net income down to $3,243,480 Normally, you wouldn’t round this number down (the IRS would not like that!), but in order for the Blue Lagoon statements to work nicely for the entire book, the rounded down number works better

( g o fig ure! continued)       

2 Calculate estimated nonoperating expenses Calculate estimates of

nonoperating expenses including rent, property taxes and insurance plus depreciation and amortization plus interest expense

In this example, the total nonoperating expenses are as follows:

Rent, Property Taxes, and Insurance 1,760,400 Depreciation and Amortization 1,260,000 Interest Expense 1,272,000

Total Nonoperating Expenses $4,292,400

3 Calculate estimated undistributed operating expenses Calculate

estimates of undistributed operating expenses including administrative and general, information systems, human resources, security, franchise fees, transportation, marketing, property operations and maintenance, and utility costs

In this example, the total undistributed operating expenses are as follows:

Administrative and General 1,357,200 Information Systems 388,800 Human Resources 583,200 Security 277,200 Franchise Fees 0 Transportation 334,800 Marketing 1,552,320 Property Operations and Maintenance 1,197,000 Utility Costs 1,071,000

Total Undistributed Operating Expenses $6,761,520

( g o fig ure! continued)       

4 Calculate estimated operated departments income excluding rooms

Calculate estimates of revenues minus expenses to determine estimated income for all non-rooms departments These include income from food, beverage, telecommunications, other operated departments, and rentals and other income

In this example, estimated operating departments income excluding rooms is

as follows:

Total Operated Departments Income Excluding Rooms $4,486,200

5 Calculate the operated department income for rooms Using the results

from steps 2 through 4: add the owner's desired ROI (adjusted for before-tax net income), add total nonoperating expenses, add total undistributed operating expenses, subtract total operated departments income excluding

rooms (see Figure 8.2)

In this example, estimated operated department income for rooms is as follows:

Total Undistributed Operating Expenses + 6,761,520 Total Operated Departments Income Excluding Rooms - 4,486,200

Operated Department Income for Rooms $9,811,200

( g o fig ure! continued)       

6 Calculate the estimated rooms department revenues based on

estimated occupancy Add estimated operated department income for

rooms (from step 5) to estimated rooms expenses based on estimated occupancy to determine estimated rooms department revenues

From historical data, the rooms manager has calculated that payroll and related expenses and other expenses for rooms is $60 per room Also, the manager has determined that the hotel has an average occupancy % of 80%, and the hotel has 240 rooms (see Chapter 1)

Calculate the estimated number of rooms to be sold in the year:

240 rooms x 365 days in a year x 0.80 occupancy = 70,080 rooms

Calculate the estimated rooms expenses based on $60 per room:

70,080 rooms x $60 = $4,204,800

Calculate the estimated rooms department revenues:

Operated Department Income for Rooms 9,811,200

Estimated Rooms Department Revenues $14,016,000

( g o fig ure! continued)       

7 Calculate the hotel’s required ADR Divide the estimated rooms department

revenues (from step 6) by the estimated number of rooms to be sold (from step 6):

Estimated Rooms Department Revenues

or

$14,016,000

Thus, the ADR that should be charged for the Blue Lagoon’s rooms in order to

achieve the owner’s desired net income (ROI) is $200

Figure 8.4 Summary of Hubbart Formula Calculations for the Blue Lagoon Steps 1-5:

Bottom-Up Format for the Hubbart Formula Calculations

+ Undistributed Operating Expenses + 6,761,520

- Operated Departments Income (Excluding Rooms) - 4,486,200

= Operated Department Income (Rooms) $9,811,200 Step 6:

240 rooms x 365 days in a year x 0.80 occupancy = 70,080 rooms

70,080 rooms x $60 expense per room = $4,204,800 estimated rooms

expenses

Operated Department Income for Rooms 9,811,200

Step 7:

$14,016,000 70,080 = $200

The Hubbart Room Rate Formula

 The Hubbart formula is useful because it requires

managerial accountants and hoteliers to consider the

hotel owner's realistic investment goals and the costs of operating the hotel before determining the room rate

 The formula has been criticized for relying on

assumptions about the reasonableness of an owner’s

desired ROI and the need to know expenses that are

affected by the quality of the hotel’s management

 Another criticism is that the formula requires the room

rate to compensate for operating losses incurred by

other areas (such as from telecommunications)

The Hubbart Room Rate Formula

 Despite its limitations, the Hubbart formula remains an

important way to view the necessity of developing a

room rate that:

 Provides an adequate return to the hotel’s owner(s)

 Recovers the hotel’s non-operating expenses

 Considers the hotel’s undistributed operating expenses

 Accounts for all the hotel’s non-room operated departments income (or loss)

 Results in a definite and justifiable overall ADR goal

The $1.00 per $1,000 Rule

 One alternative way that hoteliers have historically

determined room rate is the $1.00 per $1,000 rule

 This rule states that, for every $1,000 invested in a

hotel, the property should charge $1.00 in ADR

 The dollar-per-thousand rule is most accurate for hotels

that have high occupancies, high ADRs for their area of operation, and are newly built

The $1.00 per $1,000 Rule

 Despite some limitations, the $1.00 per $1,000 rule

does reflect the tendency for hotel buyers to discuss

hotel selling prices in terms of a hotel’s cost per key

(average cost per room), which is the average purchase price of a hotel’s guestroom expressed in thousands of dollars

 It is important to recognize that the rate computed using

the $1.00 per $1,000 rule does not become the hotel’s

rack rate

 Instead, it is the overall ADR that the hotel must achieve

when its sells all of its various rooms at all of their

respective rates

Alternative Room Rate

Methodologies

 Non-traditional, non-cost methods to establish rates:

 Competitive Pricing Charge what the competition charges

 Follow the Leader Pricing Charge what the dominant hotel in the area charges

 Prestige Pricing Charge the highest rate in the area and justify it with better product and/or service levels

 Discount Pricing Reduce rates below that of the likely competitors

Web-Influenced Room Rate

Methodologies

 Today’s hotel room rate structures have been changed,

and changed forever, by the advent of the Internet as

the most popular method used for selling hotel rooms

 As a result of the Internet, consumers can easily

compare prices, but so can a hotel’s major competitors

 While the call-around was standard practice as late as

the early 2000s, consider modern hoteliers utilizing one

of the many websites similar to

http://www.Travelaxe.com and others that allow him/her

to easily see other hotels’ rates

Web-Influenced Room Rate

Methodologies

 Guests care very little how much it “costs” a hotel to

provide its rooms

 They care about the lodging value they receive

 As a result, a hotel’s rates are heavily influenced by the

laws of supply and demand

 A guest can make a hotel reservation at a given rate,

and, every day until the date of arrival, can go online to shop for an even lower price for the same room

 If a lower rate were to be found, the guest could

re-contact the hotel, cancel the original reservation, and

secure the new, lower rate

Revenue Management

 Revenue management, also called yield management,

is a set of techniques and procedures that use hotel

specific data to manipulate occupancy, ADR, or both for the purpose of maximizing the revenue yield achieved

by a hotel

 Yield is a term used to describe the percentage of total

potential revenue that is actually realized

 Revenue managers are responsible for making

decisions regarding the pricing and selling of guest

rooms in order to maximize yield

g o fig ure!       

For example, consider a property that has the potential of generating $50,000 with a fully booked hotel, but only generates revenues of $30,000 on a given Saturday The hotel’s yield would be calculated as follows:

Total Realized Revenue Total Potential Revenue = Yield

or

$30,000

Revenue Management

 RevPAR is a combination of ADR and occupancy %

 To increase yield simply means to increase the hotel’s

RevPAR

 Therefore, any change (decrease or increase) in either

or both of the factors comprising RevPAR will change

the yield of the hotel’s revenue

 RevPAR is calculated using the following formula:

ADR x Occupancy % = RevPAR

Revenue Management

 Revenue management techniques are used during

periods of low, as well as high, demand

 Although the actual revenue management techniques

used by hoteliers vary by property, in their simplest

form, all these techniques are employed to:

 Forecast demand

 Eliminate discounts in high demand periods

 Increase discounts during low demand periods

 Implement “Special Event” rates during periods of extremely heavy demand