The same debate is raging in offices and lobbies of hotels throughout the U.S. and probably around the world: Do you cut room rate in order to capture occupancy from competitors or do you hold rate and give away occupancy to other hotels that cut their rates? Here are two sets of conversations between a general manager and a revenue manager illustrating the dilemma:

January 2009

GENERAL MANAGER: Whatever you do, don’t cut our room rate. It always takes longer to rebuild room rate than to get back occupancy.

REVENUE MANAGER: Yes sir, I totally agree with your request. We will not discount our room rate.

March 2009

REVENUE MANAGER: Based on our Smith Travel Research daily STAR Report, it is obvious that our competitive set has drastically reduced their rates. In January our average rate was $150, which equated to a market penetration of 95 percent. According to our March STAR Report, our room rate is still $150, but the rate penetration has increased to 115 percent.

GENERAL MANAGER: What has happened to our occupancy during this period?

REVENUE MANAGER: Our occupancy has declined 15 points from 71 percent. The STAR Report shows our current occupancy penetration is 86 percent, down from 100 percent in January.

Let’s investigate this further. First of all, cutting room rate rarely induces overall market demand. In other words, if all hotels in Dallas reduce their rates, it is unlikely many people would quickly change their travel plans and make Dallas their destination. This is particularly true for commercial and meeting travelers who select destinations based on a business need rather than a travel bargain. Leisure travel might be somewhat influenced by reduced rates, but usually if other travel costs are reduced as well.

Focusing on a specific market, demand can be drawn to hotels offering bargains. With the advent of the Internet, it has become significantly easier for travelers to search out and identify these favorable opportunities. Unfortunately, when one or more hotels break ranks and decide to reduce rates in order to capture a greater share of local demand, others follow suit and soon the overall rate for the market drops. The logical solution is for all hotels to form a cartel and refuse to cut their room rates. Sadly, cartels are illegal in the U.S.

Looking back over time, there have been only two years in the last 40 when room rates for a typical U.S. hotel actually declined; in 2001 and 2002 rates fell approximately 1.5 percent each year. HVS is projecting U.S. rates will fall a gigantic 8.5 percent this year and one percent in 2010. Part of this current decline can be attributed to the severity of the recession, but some of the declines relate to the massive increase in data and information currently available to hotel operators. Hotel and revenue managers can use Smith Travel Research daily STAR Reports to almost instantly determine how their rates compare to their competitive set. When a competitor breaks rank and starts to reduce rate, users of the daily STAR Report immediately notice it.

Twenty years ago, before we had all this instant information, it could take a hotel 30 to 60 days to realize the competition had lowered rate. My guess is hotels reacting quickly to competitor discounting have exacerbated the current decline in average room rate. Hopefully, the reverse will happen; when the economy recovers and occupancy rises, hoteliers will quickly move rates upward when they see their competitors doing the same.

There are many pros and cons on whether a hotel facing a down market should hold rate at the expense of occupancy or hold on to occupancy by lowering rate. The following lists some of the outcomes that should be considered when evaluating each strategy:

Hold Rate and Lose Occupancy

• Lower occupancy allows for reduced staffing levels, less wear and tear on the property and opportunity to perform maintenance and renovations.

• For luxury properties, holding rate preserves the exclusive image of the brand. In New York City some luxury hotels have kept their rate level, but occupancy has plummeted more than 40 points.

Hold Occupancy by Lowering Rate

• Occupied rooms generate other revenue such as food, beverage, spa and other income, which can cover some fixed costs.

• Loyal customers will be less likely to leave and fall in love with one of your competitors.

• Staffing can be maintained, which enhances employee morale. 

• Lowering rate sometimes makes upscale properties more competitive with lower-scale hotels, which will drive more business to the better properties.

The great debate on whether to maintain or cut rates during a down cycle will continue.  The dialogue at the beginning of my column omitted one piece of important information: The hotel’s RevPAR penetration was identical for January and March: 95 percent. This shows the subject property did not suffer a decline in rooms revenue that was any greater than that experienced by its competitive set by employing its strategy of holding rate and allowing occupancy to fall.

Stephen Rushmore is president and founder of HVS, a global hospitality consulting organization with offices around the world. Steve has provided consultation services for more than 12,000 hotels throughout the world during his 35-year career and specializes in complex issues involving hotel feasibility, valuations and financing. He can be reached at srushmore@hvs.com or 516 248-8828 ext. 204.