The selling price should not be based on costs but should be more demand based.
This because we do not sell a physical product (pen, table, dress, etc.), which tends to have a small variable price, but services that can have a very different value depending on the customer, period and many other variables.
So, we can sell the same service (e.g. standard room + breakfast), for the same day, with the same channel but at different times and therefore, potentially, also at different prices.
Subscribe to our weekly newsletter and stay up to date
However, this change does not occur on the cost side: that service will always have the same cost at any price you decide to sell it.
It is important to know the cost of the room to never go on sale below this threshold but this indication should only be used in extreme cases and not as a basic rule on which to plan the pricing strategy.
The costs, briefly, are divided into two types:
– Fixed, do not depend on the quantity sold (e.g. Receptionist Salary for the Rooms Department, Chef for the Restaurant Department, Rents and / or Mortgages for the Non-Operating Department);
– Variables, they change according to the single quantity sold in addition (e.g. Courtesy Kit for the Rooms Department, Food for the Restaurant Department)
I have often seen nonsense price reductions, economically unsustainable. The theory behind it justifies this practice with the assumption: “If there are always fixed costs (regardless of the quantity sold), the goal of the sale is to try to recover at least the variable costs, rather than nothing”. So if the variable cost of my room is € 15, I can potentially sell it for € 16 – I recover the variable cost and a small part (€ 1) of the fixed one.
All this can make sense but if we put it into the reality of the accommodation facilities it reveals many inaccuracies.
It has always been known that the hospitality indutry is “rigid” – with high fixed costs – because it is very tied to a supporting structure that provides services, not goods: this difference is fundamental in the analysis.
The service provided to the customer is provided by labours who involve not only wages but all the costs associated with them (employee benefits, payroll taxes, bonuses and incentives, etc.).
The Italian economic structure (laws) and vigilant roles (trade unions) pays high attention to the rights of workers, also guaranteeing, rightly, minimum wages.
This, from the point of view of the entrepreneur, however, places the cost of labor in the category of fixed costs.
From statistics on a world scale, on average, fixed costs amount to around 70% of the total costs of each structure. Of course, it depends on the individual case: managers “owners of the walls” and without mortgages or highly automated hotels can see this percentage reduced.
So if for a room I have costs of € 50, these, on average, are divided into € 35 (70%) fixed and € 15 (30%) variables.
I consider the goal of fully recovering the € 15 (selling for € 16) and in any case losing € 34 (€ 35 of fixed costs – € 1 remaining from the sale) economically “unsatisfactory”!
Let’s do a quick calculation / example: 50 € of costs per room X 10 rooms X 30 days = 15.000 € of costs in April (500 € per day).
To recover € 15,000 in costs, with a sale price of € 16, I would have to sell about 937 rooms but I only have 300 (10 rooms X 30 days).
With this technique, in this example, even by selling all the rooms every day for € 16, I would get: € 16 X 10 rooms X 30 days = € 4,800 of revenues (€ 160 per day) … compared to € 15,000 of costs with a loss of 68%, even if you did it only for one day (160 € of Revenues – 500 € of Costs).
With this strategy, to reach the BEP (Break Even Point), for each room sold for € 16, I would have to sell one for € 84: a great challenge, especially after positioning yourself in a market with a lower spending capacity.
The concept is the same as the RevPAR balance: is it better to sell 80% of the property for € 100 or 70% for € 150? In the first case the RevPAR is € 80, in the second € 105.
If I cut prices by 10% and occupancy rises by 15%, I have done a great job; if I cut the prices by 10%, occupancy goes up just 3% … I only lowered the prices to the same customers, I brought a bad economic result and it would have been more profitable not to cut down the prices!
Furthermore, the price is only one of the many levers that influence the sale. It is the simplest lever to modify but for this reason it is the most sensitive and the last one I recommend to use. Lowering the price does not create demand. Not having the right sales channels does not create demand. Having the right channels but not having the right positioning does not create demand.
Marketing, distribution, segmentation, the brand… these are all levers which, selling for € 16, have obviously been set aside.
Given the paragraphs premise, problem (with the loss observed) and solution … why do we still talk too often about numbers but without making the right analyses?
In any industry, loss-making strategies are carefully evaluated and weighted by macro strategies with higher objectives. In Las Vegas hotels, for example, the rooms department could be at a loss but only to be able to have much more profit in the Casino Department, which otherwise would be empty.
Instead, even as a customer, I am used to seeing entire destinations that, at any cost (“problem” paragraph), do everything they can to obtain quantity (demand), completely ignoring quality (price) and all the other levers that affect the sale – a premeditated mass suicide.