NB: This is an article by Robert Hernandez of Origin World Labs
I have had the good fortune to engage with hundreds of Hotel Revenue Managers from every corner of the hospitality industry. With no reservation I can honestly say that the vast majority are dedicated professionals who want nothing less than the best for their employers. They care about their personal performance and the value they create. Despite all that, it is hard to argue with the reality that the career trajectory of most hotel RMs has left a lot of holes in their mastery of some concepts from economics, finance, marketing, and mathematics that are critical to dominating the function. That’s not their fault, it’s just that the profession expanded so quickly that it did not give most enough time to properly train for the most challenging aspects of the job. As a result, I am often involved in conversations where an RM uses an RM-related term incorrectly or the definition of it is severely twisted. Now, I am not the kind of jerk that is a stickler for nomenclature, but there are three terms that are tossed out incorrectly so often that I feel compelled to list them and define them here. These are the three terms that I find Revenue Managers misusing the most.
Elasticity – This Does Not Just Happen On Peak Days.
Elasticity is term that comes from the field of Economics. The formal definition for elasticity is the change in quantity for products that you can sell when you change the price. Pricing for every business is based on the notion that if you increase your price you are likely to sell less of a product and when you decrease your prices, you are likely to sell more. Think of a rubber band. If it is “elastic” it means that you can stretch it. Likewise an elastic market is one where you can “stretch” the pricing and charge more for a product without losing a lot of demand. In an “inelastic” market a change in price will cause a significant change in demand. In brief, Elasticity is the measure of how much more or less you sell when you increase or decrease prices. The fact that elasticity exists is what allows you to lure customers away from competitors by lowering your prices and also to increase prices during high demand periods in order to sell your inventory only to those who are most willing to pay. Carefully calibrating the rates in order to take advantage of the elasticity of demand for certain time periods and for certain customers is what allows Revenue Managers to create more revenue.
Segmentation – These Are Not Just Channels.
RM works best when the consumers of a product have different motivations for purchasing it. When this is true, you can use pricing tactics to extract more value from those customers who have a strong need for the product and to entice those customers for whom the product is less critical. Segmentation is the ability to divide customers by their use or motivation for use for a product. The classic example is the traditional segmentation of customers in the airline industry by business and leisure. Business customers have very strict travel itineraries and therefore there are more likely to have to book a flight regardless of the price. Leisure travelers have less pressure to travel during a specific period therefore they are less likely to accept higher prices to travel during a specific period. Airlines have been able to segment their customers in order to be able to offer different prices depending on the guest motivation for travel. Even within the leisure category, there are different segments. During a holiday period, leisure travelers are more likely to accept higher fares because they need to travel within a specific time period. In the hotel business, segmentation is also typically centered around business vs. leisure. The ability to divide the customer base by need is essential to RM as it allows for specific pricing based on a specific segment’s demand for your product. A traveler who absolutely has to book a hotel room for a specific night in a specific hotel room is a lot more likely to accept a higher rate than a traveler who has flexibility in when they travel and where they stay. The RM’s job is to create pricing that will appeal to each segment. In the ideal world, segments would be divided by their elasticity profiles.
Optimization– This Is Not Just Having Good Distribution.
Revenue Optimization is the scientific part of Hotel Revenue Management. It involves using some advanced mathematical techniques to determine what is the rate or range of rates that is the most likely to deliver the highest revenue for any market segment. The techniques of Revenue Optimization were developed in the airline industry. The main approach to Mathematical Optimization was developed by a Pricing Analyst at British Airways over three decades ago. This approach is called capacity control and it involves determining for each room to be sold whether to accept a guest that will accept a lower room rate or hold out for a guest that is likely to pay a higher rate. This approach is the most common optimization algorithm used in the hotel business and is actually the basis for the calculations that drive most revenue management systems. The second approach to Optimization is called Dynamic Pricing. It involves the estimation of the elasticity for each market segment using these elasticities and the mathematical tools of operations research, one can determine the best rate to offer to any market given any available inventory. With dynamic pricing, one can also determine what rate changes to make when Inventory has been reduced due to Group Sales or Unexpected Demand. Mathematical Optimization does require a Revenue Manager to have a deeper analytical background and that is why it is the most sophisticated form of Revenue Management analysis.