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The Role of the Room Rate

Chapter Nine
PowerPoints developed by
Bharath M. Josiam, Ph. D.
Professor, Hospitality Management
University of North Texas, Denton, TX, USA

And
Edited by Gary K. Vallen, Ed. D.
Professor, School of Hotel and Restaurant Management
Northern Arizona University, Flagstaff, AZ, USA
Check-In Check-Out: Managing Hotel Operations, 9e
Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Objectives of Chapter 9
Understanding why hotels are unable to get the rack rate
Understanding the negative impact on revenues from
discounting
Understanding the Hubbart Room Rate formula
Understanding the Building Cost Room Rate formula
Understanding the Ideal Average Room Rate
Understanding terms/jargon specific to room rate factors
and calculations

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

The Room Rates Impact on Guest Demand


Hotel Room Rate and the Economy (Exhibit 9-1)
Demand for hotel rooms generally reflect the economy.
When economy is booming, demand shoots up, and hotels
charge more.
When economy is weak, demand drops, as do occupancy,
ADR, and REVPAR.
There is a lag between high demand and construction of new
hotel rooms.
Booming economy leads to increased new construction, while
weak economy leads to bankruptcies and closures.
Over time, this is equilibrium between supply and demand.
But, capacity has also increased with over-built markets
Room rate are price-elastic, but that varies with the market
segment targeted.

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

The Room Rates Impact on Guest Demand


Bottom-Line
You need to charge enough to make money, but not more than
your competitors, or you will kill the market
Role of Lodging Taxes on Rates
Politicians would rather tax visitors than locals!
High taxes on hotel rooms world-wide as a result
High taxes do impact business, particularly groups

Online Travel Agencies (OTAs) and Room Taxes


OTAs buy rooms at cheap wholesale rates and sell at higher
retail that is how they make profits
OTAs are only paying taxes on the lower wholesale rates
Cities want them to pay taxes on the higher retail rates
Individual hoteliers feel that there is unfair competition from
OTAs as hotels have to pay taxes at a higher rate to the cities
for their direct sales.
Currently, there are many court cases across the country to
resolve this issue
Check-In Check-Out: Managing Hotel Operations, 9e
Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

The Room Rates Impact on Guest Demand


Rack Rate: The standard posted rate
Discounts off Rack Rate

Most customers do not pay rack rate, so why bother?


Some will pay, so lets get it from them!
Rack rate sets the image/market position of the hotel
This is a luxury hotel with $200 room rates

The impact of rate cutting (Exhibit 9-2)


Discounting Profitability
You need to sell 11% more rooms if you cut your rate by 10%
Is the market that price elastic?

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

The Room Rates Impact on Guest Demand


Discounts off Rack Rate (Continued)

Examples of Discounted Rates


Seasonal rates, weather-related discounts, weekly rates,
corporate rates, commercial rates, employee courtesy rates,
senior citizens rate, AAA or other travel club rates etc.
Government per diems The government will pay only a
fixed amount to its employee per day, so hotels charge less
for government employees to get that business
It pays to pay rack rate Give no discounts, but give special
benefits to those paying rack rate
Auction Travel Sites Deep discount on-line sites, where
customers bid for rates and hotels accept if they think the
room will be empty otherwise.
Often opaque, where name of hotel is revealed only after bid is
final and credit card is charged. (Exhibit 9-9)

Complimentary Rooms No rate! Room is given free


Have strict control systems in place to prevent abuse
Check-In Check-Out: Managing Hotel Operations, 9e
Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

The Room Rates Impact on Guest Demand


Additional Rate Factors
Energy and Other Non-room surcharges
Charging per room
Energy surcharges
Resort fees
Hotels can conveniently provide a range of complimentary
services, such as morning newspapers, local telephone
calls, in-room coffee, the health club, spa, etc.

These fees appear to be on the decline


A nuisance and source of complaints rather than a true
revenue source
The growing potential for lawsuits

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

The Room Rates Impact on Guest Demand


Additional Rate Factors (Continued)

Premium Periods
Ability to charge more than rack rate during special
events
May be illegal and prosecuted as price gouging

Double Occupancy
Charging per person, rather than per room

Trend in USA is to charge for the room, rather than per-person

American Plan Day


Guests on American plan (AP) or modified American plan
(MAP) must be given their full quota of meals
Day Rate Rooms
Special rates for stays of less than overnight
Perceived as only for shady business and/or prone to
employee fraud and/or general accounting hassles
Need to re-examine these perceptions
Check-In Check-Out: Managing Hotel Operations, 9e
Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Determining the Proper Room Rate

The Hubbart Room Rate Formula

1.
2.
3.
4.
5.
6.

(Exhibit 9-14)
Operating Expenses
1,102,800
Taxes and Insurance
273,000
Depreciation
294,750
Reasonable ROA
414,000
Total
2,084,550
Less Income from other sources
139,200
Amount needed from room sales
$ 1,945,350
Revenue from room sales needed
$1,945,350
Number of rooms available (Per Day)
88
Rooms available per year (item 2x 365)
32,120
Less allowance for vacancies (@ 30%)
9,636
Number of rooms to be sold (@70%)
22,484
ADR per room to get ROA (item1/item5)
$ 86.52

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Determining the Proper Room Rate

The Hubbart Room Rate Formula

(Exhibit 9-14)
Short comings of the formula
It is inward looking at what we need, rather than outward
looking at market conditions
Many assumptions are problematic
What is reasonable ROA?
What occupancy rate is attainable?
Occupancy is a function of room rate!!
What about role of other departments like F & B?
Should low estimates force us to increase rates?
Should high estimates force us to lower rates?

Summary
It is a worthwhile formula to use as a guideline, after
recognizing the problems inherent in it.

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Determining the Proper Room Rate

Square Foot Calculation

Use numbers from Hubbart Formula, but use square footage of


room, not number of rooms
1.
2.
3.
4.
5.

Hotel has 27,250 square feet in 88 rooms


@ 70% occupancy only 19,075 sq,ft will be occupied
Daily required return is $ 5329.73
(Room revenue/365)
Each square foot must generate $0.27941 per day
(3/2)
A 300 sq.ft room would sell for $ 83.82
(4X5)

The Building Cost Room Rate Formula

The average room rate should equal $1 per $1,000 of


construction cost

A 200 room hotel, costing $14 million, should have a room rate of $70
($14 million /200 rooms/ $1,000) = $ 70

Despite being a very old rule of thumb it is surprisingly valid


even today!

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Determining the Proper Room Rate

The Ideal Average Room Rate


Assumes that at say 70% occupancy, each room category is occupied
at 70%
Revenue is calculated based on this assumption
If actual revenue is greater, there is demand for higher priced rooms,
so increase rates, or convert rooms to higher priced ones
If actual revenue is lower, more lower priced rooms are being
occupied, so try up-selling, marketing etc to increase revenues

In general, rooms fill from bottom-up, so we may need to construct


that way, with greater availability of cheaper rooms

Up-selling Premium Accommodations


Use incentives to up-sell
Higher ADRs are a win-win-win situation
The clerk wins by receiving increased payroll
Management wins because up-selling contributes proportionately
higher profits to the P&L Statement
The guest wins by receiving exactly the room desired

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Ideal Average Room Rate -Scenario 1


Room Type

Occupancy%

Single Room

80%

Double Room

80%

Junior Suite

60%

Luxury Suite

60%

Average

70%

Cheaper rooms have greater occupancy

Rooms tend to be sold from bottom-up


Train staff to upsell
Consider converting larger rooms/suites to multiple single rooms

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Ideal Average Room Rate - Scenario 2


Room Type

Occupancy%

Single Room

60%

Double Room

60%

Junior Suite

80%

Luxury Suite

80%

Average

70%

More expensive rooms have better occupancy

Rooms are selling from top down


Potential to increase rates
Potential to convert lower rated rooms into suites

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Objectives of Chapter 9
Understanding why hotels are unable to get the rack rate
Understanding the negative impact on revenues from
discounting
Understanding the Hubbart Room Rate formula
Understanding the Building Cost Room Rate formula
Understanding the Ideal Average Room Rate
Understand terms/jargon specific to room rate factors and
calculations

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Determining the Proper Room Rate In-class Assignment

The Hubbart Room Rate Formula

1.
2.
3.
4.
5.
6.

(Exhibit 9-14, pgs. 356, 357)


Operating Expenses
2,000,800
Taxes and Insurance
400,000
Depreciation
350,750
Reasonable ROA
900,000
Total
Less Income from other sources
340,000
Amount needed from room sales
$
Revenue from room sales needed $
Number of rooms available (Per Day) 275
Rooms available per year (item 2x 365)
Less allowance for vacancies (@ 25%)
Number of rooms to be sold (@75%)
ADR per room to get ROA (item1/item5) $

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved

Determining the Proper Room Rate In-class Assignment

Square Foot Calculation

Use numbers from Hubbart Formula, but use square footage


of room, not number of rooms
1.
2.
3.
4.
5.

Hotel has 80,500 square feet in 275 rooms


@ 75% occupancy only
Sq.ft are occupied
Daily required return is $
(Room Revenue/365)
Each square foot must generate $
per day (3/2)
A 300 sq.ft room would sell for $
(4X5)

The Building Cost Room Rate Formula

The average room rate should equal $1 per $1,000 of


construction cost

A 300 room hotel, costing $25 million, should have a room rate of $
($
million /
rooms/ $1,000) = $

Similar calculations can be done to arrive at a return on


investment for a major renovation project

Check-In Check-Out: Managing Hotel Operations, 9e


Gary Vallen, Jerome Vallen

2013 by Pearson Higher Education, Inc


Upper Saddle River, New Jersey 07458 All Rights Reserved