www.lrjj.cn establishing room rates 1yvonne yang - rdm lrjj

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Establishing RoomRates

1Yvonne Yang - RDM LRJJ

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Contents

Tariff construction

Positioning price

Establish room rates

Pricing rooms:

Market Condition approach

Rule-of-Thumb approach

Hubbart Formula approach


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Tariff construction

• How do hotels set their rates?

• A determination of:– Economic calculation

• To price & to understand how consumers react to the pricing strategy

– Marketing decision• Positioning

Yvonne Yang - RDM LRJJ

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Tariff construction

• What is “Price”?– An amount ($) as an exchange to acquire

goods or services– In order to understand:

• How much to charge for its accommodation

• How to be attractive and competitive with other hotels


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Positioning Your Price

• Approaches to Positioning Your Price1. Skim - to skim, set your prices higher than the

competition does so you can "skim off" the higher-paying customers. If the competition is charging $79, you might set your rates at $89 and $99, in hopes of getting the people who are willing to pay a bit more.

2. Match - to match, set one rate to match the competition and another rate slightly higher. For instance, if the competition is charging $79, you might also charge $79 for one type of room and have an $89 rate available for a better room or option.


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Positioning Your Price3. Surround - to surround, offer one price that's lower than

the competition's price and one price that's higher. If the competition is charging $79, offer a $69 rate to attract the bargain-seekers, and offer an $89 rate for a slightly better room or option.

4. Undercut - to undercut, offer a price that is the same as your competition and a lower one as well. If the competition is charging $79, offer a $79 rate and a $69 in hopes of attracting more customers.

5. Penetrate - to penetrate, set your rates lower than those of the competition. If the competition is charging $79, offer rates such as $69 and $59 in hopes of getting consumers to try your products.


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Positioning Your Price

The table above illustrates the five approaches to positioning your price against the competition's. In this example, the competition is charging $79.


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• Criteria's influencing room rates:• Size (square meters)

• Type of room and bed

• Location / View

• Grade (Stars *)

• Furnishing / Amenities (features)

• Level of Service

• Type of business

• Etc…

• What about?• Season ?

• Weekday or Weekend?

• Time of arrival?

• Inclusive or non inclusive?

• Per person or per room?

Establishing Room Rates


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Pricing Rooms

1.Market condition approach2.Rule of thumb approach3.Hubbart formula approach


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Market Condition Approach The simplest and the most commonly used

approach Management looks at comparable hotels in the

geographical market and sees what they are charging of the same product (normally 6 to 10 hotels)

These properties are called as “competitive set”

The competition can be based on location, property ratings, property type, brand identification, or other factors


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Market Condition Approach

This could be done by “blind calls” to competing hotels, the following questions will be considered:

- Are our rates lower or higher than the competing hotels?

- How are our rates affecting our revenue?

- What is our occupancy percentage? What are the ones of the competing hotels?

- If we increase or decrease our rates, will our total revenue improve?

- Have any trends emerged during the past 3 to 6 months?

This also could be done by “industry report”: IBHS


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Market Condition ApproachDisadvantages If the property is new, construction costs will most

likely be higher than those of the competition This approach does not take the value of the

property into consideration (newer facilities and amenities)

Reality Rates might also be obtained through price order

company such as certified accounting firm Revenue managers among hotels might have

direct discussion with competitors Rates may also be available from public sources:

Internet, GDS, CRS or published rate brochure


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Rule-of-Thumb approach Set the rate of a room at $1 for each $1000 of

construction and furnishings cost per room, assuming a 70% occupancy.

Example: a hotel with the average construction and furnishings cost per room is $125,000, the minimum average room rate would be $125.


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Rule-of-Thumb approach

A well-maintained hotel worth $100,000 per room today may have been constructed at $20,000 per room 40 years ago

The average selling price will be $20 per room A much higher rate would appear to be appropriate

since inflation, increased costs of labor, furnishings and supplies have not been taken into account (CPI)

This approach DOES NOT take inflation into account.• This approach DOES NOT consider other facilities

and services (e.g.: F&B, recreation, laundry)


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Rule-of-thumb ApproachAverage per-room cost for hotel development:

Segment Per-room cost Budget/Economy $52,800 Mid-range w/o F&B $85,600 Mid-range with F&B $103,100 Full Service $165,900 Luxury/Resorts $516,300

From Hotel & Motel; Jan. 12, 2012


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• A hotel costs investors a total of $15,465,000/-, and has 300 rooms. Calculate an ARR with this information

• A second hotel costs $9,895,000/- and has 60 rooms. Calculate an ARR

• A boutique hotel costs 2,500, 00/- and has 12 rooms. Calculate an ARR

Rule-of-thumb Approach


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Hubbart Formula Approach

“Bottom-up” approach

Method:1. Calculate desired profit

2. Calculate pre-tax profits3. Calculate fixed charges and management fees4. Calculate undistributed operating expenses5. Estimate non-room operated department profit/loss6. Calculate required rooms division income7. Determine rooms division revenue

8. Calculate average room rate


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Hubbart Formula

• Example:– Look at desired Profit– Add all costs

– Gives Average Price per Room

Return

Costs

=ARR


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Case 1

Holiday Inn Hotel, a proposed 30-room with a fully equipped restaurant, will cost $750,000 to construct. An estimated additional $50,000 will be invested in the business as working capital. Of the total $800,000 investment, $400,000 is to be secured from the Bank of China at the rate of 10% interest and cash $400,000 provided by the owners. The projected occupancy rate is 80% for the year. The owners desire a 15% annual return on their investment after the hotel pays income taxes of 25%. The estimated undistributed expenses, not including income taxes and interest expense total $480,000. The estimated direct operating expense of the room department are $7 for each room sold. Consider a year to have 365 days.


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Item Calculation Amount

Owner's investment 400,000

Desire net Income for the owner （ ROI: 15% ） 400,000*0.15=60,000 60,000

Income tax rate:25% Pretax income=60,000/1-0.25 80,000

Plus: Interest expense :10% annual interest 400,000*0.1=40,000 40,000

Income needed before interest expense and taxes 120,000

Plus: Estimated depreciation, property taxes, and insurance 0

Income before fixed charges 120,000

Plus: Undistributed operating expense 480,000

Required operated departments income 600,000

Less: Other departments' income 0

Rooms department income 600,000

Plus: Rooms direct expense 30*0.8*365*7=61,320 61,320

Rooms Revenue 661,320

Number of rooms sold 30*0.8*365= 8,760

Required average room rate 75.49315

Case 1: Holiday Inn Answer


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Case 2– The proposed Harris Place (a 50 room, room only

lodging facility) is to be built in mid-Michigan. Jeremy Harris, the owner is concerned about the ADR, construction costs, borrowing costs, and their impact on future profits. He provides you with the following information.

Proposed Costs of the Lodging Facility:

• Land - $400,000

• Building - $2,000,000

• Equipment - $1,000.000


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Financing

•Equity (desired return on investment (ROI = 15%) $1,000,000

•Debt (8% annual interest rate) $2,400,000

•Income Tax Rate: 40%

•Property Taxes: $120,000 per year

•Fire Insurance: $30,000 (annual)

•Depreciation of Building: 40 year life straight line method, ($50,000 per year)

•Depreciation of Equipment: 10 year life, straight line method, ($100,000 per year)

•Undistributed Operating Expense: $300,000 annually

•Rooms Department Direct Operating Expenses: equal $30,000 annually

•Expected Paid Occupancy: 70%

•Determine the required ADR to achieve Jeremy Harris’ goal of earning an ROI of 15%


Case 2

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Hubbart Formula Case 2 Answer

Item Calculation Amount

Owner's investment 1,000,000

Desire net Income for the owner （ ROI: 15% ） 1,000,000*0.15 150,000

Income tax rate:40% Pretax income=150,000/1-0.4 250,000

Plus: Interest expense :8% annual interest 2,400,000*0.08 192,000

Income needed before interest expense and taxes 442,000

Plus: Estimated depreciation, property taxes, and insurance 120,000+30,000+50,000+100,000 300,000

Income before fixed charges 742,000

Plus: Undistributed operating expense 300,000

Required operated departments income 1,042,000

Less: Other departments' income 0

Rooms department income 1,042,000

Plus: Rooms direct expense 30,000

Rooms Revenue 1,072,000

Number of rooms sold 50*0.7*365=12,775 12,775

Required average room rate 83.91


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Case 3

• Barbara Rope, a wealthy investor, is considering investing $2,000,000 in a 300 room hotel. Debt financing would total $8,000,000. She desires to know the average room rate her hotel will have to charge, given the following alternatives.


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Case 3 InformationAlternatives

#1 #2 #3 #4 #5

Desired ROI 14% 15% 16% 17% 18%

Interest Rate 12% 12% 13% 14% 14%

Tax Rate 30% 30% 30% 30% 30%

Estimated Annual Fixed Charges (excluding interest)

$700,000 $700,000 $700,000 $700,000 $700,000

Undistributed Operating Expense

$3,000,000 $3,000,000 $3,500,000 $3,500,000 $3,500,000

Departmental Profits

-Food

-Telephone $300,000 $300,000 $400,000 $450,000 $450,000

$10,000 $10,000 $10,000 $10,000 $10,000

Varible Cost per room sold

$15 $15 $20 $20 $20

Occupancy rate 65% 70% 65% 75% 80%


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#1 #2 #3 #4 #5

Net Income $280,000 $300,000 $320,000 $340,000 $360,000

Pretax Income

$400,000 $428,571 $457,143 $485,714 $514,286

Interest Expense

$960,000 $960,000 $1,040,000 $1,120,000 $1,120,000

Other Fixed Charges

$700,000 $700,000 $700,000 $700,000 $700,000

Undistributed Operating Expense

$3,000,000 $3,000,000 $3,500,000 $3,500,000 $3,500,000

Food Income -300,000 -300,000 -400,000 -450,000 -450,000

Telephone Income

-10,000 -10,000 -10,000 -10,000 -10,000

Room Department Expense

$1,067,625 $1,149,750 $1,423,500 $1,642,500 $1,752,000

Room Revenue $5,817,625 $5,928,321 $6,710,643 $6,988,214 $7,126,286

Est. Room Sold

71,175 76,650 71,175 82,125 87,600

ADR $81.74 $77.34 $94.28 $85.09 $81.35

Case 3 Answer


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