Peak profitability: Finding balance of occupancy, rate
 
Peak profitability: Finding balance of occupancy, rate
01 DECEMBER 2016 10:00 AM

Sellout nights aren’t as helpful if hoteliers are not correctly managing rates and acquisition costs.

REPORT FROM THE U.S.—It’s easy to assume that a sellout night is the best possible outcome for a hotel, but revenue management experts say that finding the right level of occupancy and rate to maximize profitability is more of a delicate balance.

That view coincides with a recent study by STR, parent company of Hotel News Now, which shows that the level of occupancy where hotels hit peak gross operating profit varies based on different factors, including chain scale and segment.

A 2015 HOST data analysis of performance metrics from more than 5,000 hotels concluded that the level at which gross operating profit hits its peak is higher than some would have expected—hovering between 75% and 85% for full-service hotels, and between 71% and slightly more than 80% for limited service. Analysts said operational costs put a burden on profitability after that point, unless hoteliers are able to use the high occupancy to drive up rate.

“As hotel operators are able to increase occupancies, at a certain point, peak profitability efficiency is realized,” Joseph Rael, STR’s director of financial performance, wrote in the study. “At this point, the data shows that there are diminishing returns beyond this level of occupancy, where profit margins actually decrease with additional rooms sold. At this occupancy, profit margins can only be improved by increased average rates.”

Courtney Russell, regional director of revenue management for Atrium Hospitality, said that’s true in his experience as a revenue manager. He said part of his job is convincing some GMs from pulling out all the stops to sell as many rooms as possible without first considering how their moves will affect the hotel’s overall profitability.

“You have to break it down to explain to some GMs that running at 80% occupancy is not a bad thing,” Russell said. “If you’re trying to get to 85% to 90%, you have to take into consideration the cost per occupied room and if to get there you have to lower rates. If you’re selling for $100 and drop to $80 to get that occupied room, it might not be that profitable.”

The right balance
Sources said the right mix will vary from property to property. That was supported by STR data, which showed upper-upscale hotels hit their profitability peak around 84.6% occupancy while upper-midscale hotels hit peak profitability at 71.4%. Part of the difference is due to factors like food-and-beverage revenue.

On the other end of that equation, hoteliers must factor in costs, such as how brands “calculate their reward program stay incentives based on the occupancy level,” noted James Bethany, corporate director of revenue management for Peachtree Hotel Group.

For example, he said, at a hotel where a rewards member wants to redeem points for a roomnight, “the brand sets the reimbursement level based on criteria and historical data for the hotel.”

Bethany cited Marriott International’s system of reimbursement, which sees a big jump when hitting plateaus like 90% occupancy, where the company reimburses at 40% of the average daily rate, and 96% occupancy, when reimbursement jumps to 90% of ADR.

“So with all of that in mind, if the hotel doesn’t hit those gates, it can cost the property a lot of revenue on the rate side, which directly impacts the profitability of the hotel,” Bethany said. “It’s heartbreaking to see a hotel have, say, 20 reward stays in-house at $13 and only miss that threshold by one or two rooms.”

Bethany said that’s a strong driver for hotels to discount rooms in the 11th hour. But Russell cautioned that hoteliers need to be careful about how and when they discount rooms and what channels they’re offering rooms on.

“The challenge is if you didn’t get the volume to offset the cheap discount, there’s an issue,” Russell said.

What fuels profitability
Mike Marshall, president and CEO of Marshall Hotels & Resorts, said it’s important not to get overly fixated on the occupancy level when considering profitability, because that is still primarily determined by the hotel’s ability to drive rate.

“I would argue that occupancy is not the key driver here, as occupancy is often what the market will give you,” he said. “Instead, I believe ADR becomes much more important and is the real profitability key.”

He said seasonal properties are a good example of this kind of thinking.

“If you are in a seasonal beach market with optimal demand for only two months out of the year, we will fee those two months at a very high rate,” Marshall said. “The hotel may do less than 50% occupancy for the entire year, but it can still be profitable. In a corporate market where everyone is highly booked during midweek, I may have to be more competitive on rate, but I am selling more rooms.”

Russell noted there is a flipside to that kind of thinking at unique properties like resorts and casinos. He said those types of hotels offer lower rates—and go further out of their way to find room availability—to guests who have proven to be big spenders on property.

“Even with that cheaper rate, it’s more profit to the bottom line,” he said.

What erodes profitability
Russell said timing of discounts is key. Hoteliers who are not careful about when they offer low rates on high-cost channels, like online travel agencies, will lose the ability to sell high-rate rooms on compression nights or when demand is high regardless of the discounts.

He said leaving discount channels open can lead to hotels charging significantly less than they otherwise could for large swaths, sometimes even 20%, of their rooms.

To combat that, he said, hoteliers should be willing to lean on brands’ revenue management systems, which help track compression nights and high-demand periods far in advance. He also said GMs need to embrace the idea that being the last to sell out, or maybe falling just short of selling out, on high-demand nights is actually a good thing.

That’s because being the last hotel with available rooms in the area presents the opportunity to significantly improve rates.

“Say it’s a high-demand weekend and, come Monday morning, everyone else was at 100% and we were at 98%. We didn’t care because we could charge so much more for our last rooms,” he said. “We fell slightly short on occupancy, but our ADR was so much higher.”

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