At a certain occupancy, profit margins are not likely to be improved without increasing average rates.
BROOMFIELD, Colorado—In 2015, hotel occupancies were at all-time highs throughout the industry. Since most hotels are still not struggling to fill rooms in 2016, we wondered: What is the optimal occupancy for hotels, with respect to profitability? Obviously, there is no magic occupancy for every hotel, but we can look at profitability for similar hotel segments at differing levels of occupancy using 2015 HOST data.
For this analysis, we used the more than 5,000 hotels that submitted HOST data for 2015, and divided them into segments based on full-service versus limited-service, class and relative average daily rate. For example, the chart below shows the full-service, upscale hotels and their average-daily-rate distribution. These are primarily select-service hotels, and you can see the most common ADR ranges are the $100-$120 and $120-$140 ranges.
We then compared occupancy and gross operating profit (GOP) margins for the most common ADR ranges within each class and service level. If we chart the median GOP margins by occupancy, we can see where profit margins peak for similar hotel products and ADR levels. The chart below illustrates the median GOP margins at different occupancies for the full-service, upscale segment.
The highlighted orange line shows the median GOP margin for each occupancy interval in the $100-$120 ADR range. If we add a second-degree polynomial trend line, it tells us that at 75.1% occupancy, GOP is maximized at 47.9%. Beyond the 75.1% occupancy, you can see that the profit margin actually begins to decrease. At the highest occupancy for this set (94%), we show an estimated GOP margin of only 24.8%. This is what we would expect here. At a certain occupancy, there are diminished returns on profit margin as variable expenses and incremental labor costs exceed the incremental revenue of the hotel being nearly full.
So using this method for each class and service level, we found the maximum profit margin for some of the most common ADR ranges (shown in the chart below).
Clearly, the occupancies at peak profit margins are surprisingly high for each of these classes. We can see that at the high-end in the luxury and upper upscale classes, peak profitability occurs for occupancies in the low to mid-80%s. This is seemingly high, but these are full-service hotels with roughly 40% of revenues coming from the food and beverage department, other operated departments, and miscellaneous income. As such, filling the hotel helps increase revenues from these other departments, as well as the rooms department.
In the upscale class, we see the difference between upscale full-service and upscale limited-service. As mentioned earlier, the upscale full-service segment is primarily comprised of select-service hotels such as Courtyard by Marriott, Hilton Garden Inn, Hyatt Place, etc. However, the upscale limited-service segment is primarily comprised of extended-stay hotels such as Residence Inn by Marriott, Homewood Suites by Hilton, and Staybridge Suites. Extended-stay hotels typically operate more efficiently since they don’t necessarily clean rooms daily for their long-term guests. As we would expect, the hotels in this segment experienced higher margins and maximize profitability at a higher level of occupancy.
We performed this analysis for many ADR ranges within each class and service level. In comparing different ADR ranges within the same class, we found that as you go up in ADR, the profit margin and optimal occupancy also increase. This can be seen in the previous graph, which shows three ADR ranges for the upscale full-service segment. The blue line is the $80-$100 ADR range, and each line above shows a greater ADR range with a larger maximum profit margin at a higher level of occupancy.
So then, as hotel operators are able to increase occupancies, at a certain point, peak profitability efficiency is realized. 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. Operators would be better served to achieve a high level of occupancy, and then increase rates to further boost their bottom line at higher margins. After all, the goal of hotel operators is to maximize profits, not achieve 100% occupancy.
This article represents an interpretation of data collected by STR, parent company of HNN. Please feel free to comment or contact an editor with any questions or concerns.