Revenue Management Definition
Before explaining what is revenue management more in details, it’s important to go over the definition of the revenue management in the hotel and hospitality industry. This is also the opportunity to review the core foundation of revenue management, the strategic pillars as well as its importance.
Revenue Management or Yield Management in a nutshell, is selling the right product, to the right customer, for the right price, to the right channel, at the right time. If you saw an advertisement today, bought a coffee or booked a room online, chances are that you have been “revenue managed”. These tactics and strategies allow different businesses to get the most out of their potential, a way to maximize their revenue.
Why Revenue Management is so important for hotels?
Depending on the circumstances and market conditions, we have experienced in our portfolio a revenue increase of anywhere between 5-20% YoY. The prior time invested, technology used and market performance always have a strong impact on the revenue increase as well, but overall the uplift in revenue and profitability of using revenue management are considerable. Also considering that there isn’t any increase in marketing spend.
Now if revenue management is so important and profitable for hotels, why don’t all industries use it? Well the truth is, in order to be able to optimize revenue and use the practices, there are a number of conditions that need to be met:
- You need segmented markets, there has to be differentiation in the customer types.
- You need a fixed capacity, which means that you have a limited number of inventory to sell. Take the example of a hotel. No matter how much demand it has, you can only sell each day the number of rooms you have, never more.
- It needs to have perishable inventory. Continuing with the previous example, let’s say a hotel has 200 rooms. If 50 of those are not sold today, that hotel will never be able to sell those 50 rooms again. That potential revenue is lost. And this happens every single day of the year.
- Following that we have low marginal servicing costs. Which basically means that businesses that benefit from revenue management tend to have a high fixed cost and low variable cost. Essentially because it implies that we can strategize around demand without too much concern for high variations of cost.
- The booking requests are made in advance of the day of arrival. Guests are booking their stay several months, weeks, days or hours ahead of the time that they arrive.
- Uncertain demand forecast. Guest demand varies by season, day of week or even time of day, which allows you to strategize differently for each one of these
KPIs in hotel revenue management
Before we go any further, let’s explain some key revenue management jargon which are keys to understand what is revenue management. A couple terms that you need to know. These represent the key metrics of revenue management.
Average Daily Rate
The first one is referred to in the industry as ADR, which is Average Daily Rate. It can also be known as ARR – Average Room Rate. This metric represents the average revenue you are making per room that you sell. It’s calculated by dividing revenue by room sold.
ADR = Rooms revenue / Number of rooms sold
Then we have occupancy, which is calculated by dividing rooms sold by rooms available. This gives you a percentage of how much of your inventory was sold on any given day.
Occupancy %= (Rooms sold / Room available) x 100
Revenue Per Available Room
Lastly, we have the RevPAR, also known as Revenue Per Available Room. Calculated by dividing revenue by your rooms available. RevPAR is actually the most important of the three, because it’s what allows us to make industry level comparisons. If you think about it, ADR and Occupancy are heavily dependent on the type of property. A smaller hotel will be able to reach higher ADR levels or occupancy because it does not need to worry about filling too many rooms. Hence, it wouldn’t make to use either of those metrics to compare different properties. To solve this problem, RevPAR was created, because it allows you to proportionally benchmark your performance versus other properties.
RevPAR = Rooms revenue / Rooms available
RevPAR = Average daily rate * Occupancy rate
The fundamentals of revenue management
At the core of revenue management’s existence is the law of demand and supply. To begin with, let’s look at each component separately and how they interact with each other.
The law of Demand
Demand is going to decrease as the prices increases. It represents how guests react to price changes. Think about it from a brand perspective. Louis Vuitton has relatively few customers because of how expensive it is, however Zara on the other hand, being a much more budget conscious option for the average person, attracts a lot more customers.
Louis Vuitton makes its profit from high margins, whereas Zara from volume/a high number of units sold.
The law of Supply
The higher the price, the more sellers are willing to participate in the exchange. As price increases, so does the supply. When the price is low, sellers are not motivated to sell at that price point, due to low margins. When you have an increase in profit for each given sale with less effort to generate volume, this is a lot more appealing for business.
Hotel Demand, Supply and Maximum Revenue Zone.
Now let’s put this into hotel terms. You have rooms you want to sell, and you want customers to fill those rooms. You have to find the price point that keeps demand strong, but not to the extent that the demand suffers. It’s fundamental to maintain this balance between supply and demand. Let’s call this area around the optimal balance/equilibrium point, the maximum revenue zone, which is essentially where you want to be playing at.
Why is this important?
Let’s have a look at what happens when prices are too low. You’ll have too much demand, your rooms will fill too quickly, and then there will be an excess of demand that you are unable to capture because of the lack of inventory. The rooms that you did sell could have been sold at a higher price and margin is lower.
Now what happens when prices are too expensive? Well, you’re not going to be able to sell all of your rooms, and you are going to have an excess of inventory that is being wasted. You’re not making any revenue on those rooms. Even if you are getting a good amount of revenue per room, it’s potentially not going to outweigh the amount of rooms that were not sold.
Now, I am sure you can see what revenue management is all about. Basically, you are going to do your best to stay in that maximum revenue zone which is continuously moving, every day of the year. It’s an ongoing effort to find the best price point and strategy at any given time. Your revenue management strategy needs to take into account industry trends, time of the year, competition, local demand, weather, price sensitivity, among other factors. All of this is going to have an impact on the point of equilibrium between supply and demand.
What are the Strategic Pillars of Revenue Management?
Looking at the core principles of hotel revenue management we could look at the following elements for an effective optimization:
- Pricing & Inventory Management
- Channel & Market Mix Optimization
- Demand Forecast
- Sales & Marketing
- Technology & Distribution
Start Revenue Management in your hotel today
If you would like help with any aspects of your hotel revenue management, please don’t hesitate to contact us. Visit the Contact page to get in touch now.
We also offer a free revenue management audit on any topic of your choosing. We can review your current sales strategies and book a short call with you to discuss actionable improvements.