The Price Positioning Trap
Setting prices is always a challenge, but never more so than right now, given the weakness in demand. The theory in the current situation is that hotel operators have little choice but to cut their rates, with the idea that lower rates will encourage more business, or help them grab market share. Certainly many hotels take that approach, but others attempt to maintain their position in relation to their competitive set. What operators need to focus on here is price positioning, especially as it relates to direct competitors.
Gas station comparison
Although the two may not seem to have much in common, the hotel business is much like the gas station business. Gasoline is a commodity, but various companies put their brand on it and some sell it at a premium price. Other stations maintain the "discount" position of underselling their competitors. Often, a consumer's trip to the gas station may start at a premium station and end at a discount station, though not necessarily because of price. Why would this happen? Sometimes there is a long line at the premium station, or perhaps the premium station is closed at that time. Whatever the reason, assume that the customer moves on to the next closest station, which happens to be a discount station, and pays a few cents less per gallon. Those few cents saved per gallon can add up to whole dollars in the end.
Why would the discount station conduct this "sale?" Perhaps it was matching the price of another discount station further across town. No matter. The point here is that the discount station operator left money on the table that day. The customer is going to fill that gas tank at whatever price they find, within reason, and was in fact prepared to pay the higher price at the premium brand up the street. Plus, it is doubtful that the discount station operator made up the difference in the volume of gas sold (if there was any profit at that price).
This scenario circles back to the point about carefully pricing rates in relation to your hotel's competitive set. A study performed by a research team at Cornell's School of Hotel Administration ("Competitive Pricing in Uncertain Times") found that hotels that undercut their competitors on price have a comparatively lower revenue per available room. The researchers, Cornell professors Cathy Enz and Linda Canina, along with the president of Smith Travel Research, Mark Lomanno, analyzed the RevPAR effects of setting prices either below or above those of your competitors.
This study compares hotels and their competitive sets with regard to rate, occupancy, and RevPAR. The study ran for seven years, and it covered the recession of 2001 through 2003 and the boom of 2004 through 2007. Regardless of the economic situation, hotels that kept their rates below those of their close competitors made comparatively less money, even though their occupancy was greater than that of competitors. The opposite was true also. Hotels that maintained their prices even just a few percentage points above those of competitors saw lower occupancy than those competitors did, but had a greater RevPAR than the competitive set did.
Hold your price position
Nothing in this study indicates that your hotel should abandon its price positioning or that you should fail to use your revenue management system. The point is to understand the results of a strategy of maintaining room rates that are lower or higher than those of your competitors. This is a matter of positioning, not one of discounting. From an industry point-of-view, the gas station in our scenario was discounting to an unnecessary extent. But from their point of view, they might have been matching a Sunday-afternoon price promotion by competitors.
The gas station scenario underlines the focus on price position in a weak economy. It's hard to maintain a price position above that of your competition, especially when customers feel empowered to negotiate you down and then go elsewhere. At the same time, we know that hotel guests build expectations about your future prices based on your current prices. Customers will surely be disappointed when rates revert back to their normal price. Gas prices are notably volatile, but if the economic recovery is as slow as some observers forecast, it may be difficult for hotel operators to restore their rates once they have cut them substantially.
Gas station comparison
Although the two may not seem to have much in common, the hotel business is much like the gas station business. Gasoline is a commodity, but various companies put their brand on it and some sell it at a premium price. Other stations maintain the "discount" position of underselling their competitors. Often, a consumer's trip to the gas station may start at a premium station and end at a discount station, though not necessarily because of price. Why would this happen? Sometimes there is a long line at the premium station, or perhaps the premium station is closed at that time. Whatever the reason, assume that the customer moves on to the next closest station, which happens to be a discount station, and pays a few cents less per gallon. Those few cents saved per gallon can add up to whole dollars in the end.
Why would the discount station conduct this "sale?" Perhaps it was matching the price of another discount station further across town. No matter. The point here is that the discount station operator left money on the table that day. The customer is going to fill that gas tank at whatever price they find, within reason, and was in fact prepared to pay the higher price at the premium brand up the street. Plus, it is doubtful that the discount station operator made up the difference in the volume of gas sold (if there was any profit at that price).
This scenario circles back to the point about carefully pricing rates in relation to your hotel's competitive set. A study performed by a research team at Cornell's School of Hotel Administration ("Competitive Pricing in Uncertain Times") found that hotels that undercut their competitors on price have a comparatively lower revenue per available room. The researchers, Cornell professors Cathy Enz and Linda Canina, along with the president of Smith Travel Research, Mark Lomanno, analyzed the RevPAR effects of setting prices either below or above those of your competitors.
This study compares hotels and their competitive sets with regard to rate, occupancy, and RevPAR. The study ran for seven years, and it covered the recession of 2001 through 2003 and the boom of 2004 through 2007. Regardless of the economic situation, hotels that kept their rates below those of their close competitors made comparatively less money, even though their occupancy was greater than that of competitors. The opposite was true also. Hotels that maintained their prices even just a few percentage points above those of competitors saw lower occupancy than those competitors did, but had a greater RevPAR than the competitive set did.
Hold your price position
Nothing in this study indicates that your hotel should abandon its price positioning or that you should fail to use your revenue management system. The point is to understand the results of a strategy of maintaining room rates that are lower or higher than those of your competitors. This is a matter of positioning, not one of discounting. From an industry point-of-view, the gas station in our scenario was discounting to an unnecessary extent. But from their point of view, they might have been matching a Sunday-afternoon price promotion by competitors.
The gas station scenario underlines the focus on price position in a weak economy. It's hard to maintain a price position above that of your competition, especially when customers feel empowered to negotiate you down and then go elsewhere. At the same time, we know that hotel guests build expectations about your future prices based on your current prices. Customers will surely be disappointed when rates revert back to their normal price. Gas prices are notably volatile, but if the economic recovery is as slow as some observers forecast, it may be difficult for hotel operators to restore their rates once they have cut them substantially.
