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Best practices in pricing and price optimization
publication date: Jan 25, 2015
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author/source: Chris Anderson, HSMAI
Best practices in pricing and price optimizationBy Chris K. Anderson HotelNewsNow.com columnist Story
While pricing can be a great strategic lever for service firms, simple non-tactical decreases in posted prices are bound to encourage competitive reaction and provide a classic illustration of the Prisoner’s Dilemma.
An examination of industry pricing during our last two economic downturns indicates we as an industry still have lessons to learn. A look at U.S. average-daily-rate and demand declines (as summarized in Figure 1 below) shows that during the 2001/2002 downturn hotels quickly responded to weakening demand with price decreases. In 2007 and 2008, suppliers responded slower, but once prices started to decrease there was a race to the bottom as prices declined faster and further.
There are some simple best practices that can help hoteliers better respond when demand weakens and truly optimize their revenue when demand is strong: Make the price-change contribution positive When contemplating a price change, firms need to first assess the required demand response to make the price-change contribution positive. For example, consider Figure 2 where a firm is contemplating decreasing prices from P1 to P2. The firm would have sold Q1 at P1. By lowering prices to P2, they forgo the contribution outlined in area A [(P1-P2)* Q1] while they receive new contribution defined by B [(Q2-Q1)*(P2-VC)]. The price change will be contribution-positive as long as B>A. The price change breaks even if A=B.
We can express this break-even change in demand as:
where CM is the firm’s original contribution margin (P1-VC) and delta P is P1-P2. If you don’t think you can achieve the required break-even demand increase, then don’t decrease prices. (This works the same if considering a price increase.) The fundamental issue firms fail to consider when making price changes is that all consumers pay (or don’t pay) the new price—even those who would have paid more had prices not been decreased. Assess the implications when reacting to a competitive reaction
Unfortunately, many firms never assess the implications of competitor price changes and simply follow them down, largely because they don’t want to reward the competitor. We can generalize pricing changes with a few basic concepts: 1. Decrease prices (either proactively or reactively following a competitor’s price reduction) in price-sensitive (elastic) segments:
2. Raise prices (or follow a competitor’s price increase) in non-price sensitive (inelastic) segments:
The key term here is segments, indicating firms should not universally price dynamically but rather target price changes at specific market segments, as only targeted price changes will generate enough incremental demand to compensate for rate dilution. Think like marketers Manage discounts strategically Bundling is another method of offering private discounts whereby the hotel room is bundled with other hotel services (e.g., spa and food and beverage) with the hotel guest paying a (reduced) package price. More recently, membership selling or flash sales have become increasing popular. Membership selling, unlike posted-price-online selling, involves offers being sent to qualified members of a program. Individual hotels or airlines have performed these actions in the past by sending fliers or emails to registered customers in their databases. These membership selling groups (TravelZoo, JetSetter, LivingSocial, Groupon, etc.) are contacting their members on the supplier’s behalf often with dramatically reduced rates.
Leverage easy-to-implement and targeted approaches to generate demand Search engine marketing or search engine optimization refer to the use of search engines as marketing vehicles. Many consumers first research their potential travel destinations or hotels at a search engine prior to other travel sites. Ensuring your hotel has prime placement at the search engine will undoubtedly drive more demand further down the search funnel. Figure 5 is a display of a Google search on “hotels in red wing.” This search stems from a project with the St. James Hotel in Red Wing, Minnesota. As you can see, the search nets the hotel’s URL high on the list, with their pay-per-click ad fifth down the list of ads on the right hand side. When looking at this first page result we see both direct competitors to the St. James being listed (e.g., American Inn), as well as the OTAs (using PPC). Search engine marketing will increasingly become an important aspect of all revenue management activities at a property as it provides an easy to implement and targeted approach to generating demand.
Use OTAs for strategic marketing A related experimental study (“The Billboard Effect: Online Travel Agent Impact on Non-OTA Reservation Volume”) showed that not only do OTAs generate incremental reservations at the OTA, they also significantly increase reservation volume at non-OTA channels (hotel’s own website, call center, traditional travel agent, etc.). The study found that an approximate lift of 20% in reservations is obtained by listing on OTAs like Expedia, Orbitz or Travelocity. Together, these two studies illustrate the strategic role of OTAs in generating reservations for many hotels. As a note of caution, hotels must use these OTAs strategically—ensuring they are using these channels only when price-sensitive customers are shopping. Provide rooms, and potentially deals, to the OTA when the majority of reservations for the discount segment are booking but then remove these deals once the full price segment is in the market. Look at the OTA as a marketing expense targeted to price-sensitive consumers, using the OTA if you think it’s the most efficient use of your marketing dollars. Generally speaking, OTAs are relatively consistent in the products and services they offer consumers. What differentiates each is their ability to market to consumers and drive traffic to the specific OTA. Given the general move towards rate parity, the use of OTAs does not in itself provide an effective method of customer segmentation as customers see the same prices regardless of shopping/purchasing channel. The OTA does provide segmentation opportunities if suppliers understand the types of customers “in the market” at various days before arrival and engage the OTAs appropriately. For example if customers are researching travel early in the booking cycle (30 DBAs or greater), then they are probably price-focused leisure travelers. As a result, the supplier might want to engage in sponsored placement or banner adds to capture the consumer’s eye or engage in strikethrough pricing to indicate the presence of promotions. For customers shopping even earlier, the supplier might wish to participate with an OTA’s opaque packaging rate and provide a somewhat hidden discount given an air/hotel bundle. Conversely, for shopping dates closer to arrival, customers are more likely to be less price-sensitive. Given rate parity (and the need to offer similar rates at brand.com to more brand-loyal customers), suppliers should be less active in promotional activities at the OTA—perhaps attracting customers with value adds (e.g., parking, free breakfast, etc.) in an attempt to add value and still maintain decent page sort at the OTA. Ultimately, you should view OTAs and their associated elevated fees or commissions as a marketing vehicle. For many smaller properties, the OTAs represent an efficient use of marketing dollars to generate incremental demand, whereas larger properties or properties within a brand might have other opportunities to stimulate demand. Special Note: This topic will be explored in more detail on 22 November as part of the 10-part 2011 Revenue Management Webinar Series. The related webinar is titled “What Are the Best Practices in Pricing and Price Optimization?" Want to Learn More? About the Author The opinions expressed in this column do not necessarily reflect the opinions of HotelNewsNow.com or its parent company, Smith Travel Research and its affiliated companies. Columnists published on this site are given the freedom to express views that may be controversial, but our goal is to provoke thought and constructive discussion within our reader community. Please feel free to comment or contact an editor with any questions or concerns. About the HSMAI Revenue Management Advisory Board Members include:
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