Establishing Room Rates Yvonne Yang - RDM LRJJ

Contents Tariff construction Positioning price Establish room rates Pricing rooms: Market Condition approach Rule-of-Thumb approach Hubbart Formula approach Yvonne Yang - RDM LRJJ

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 Revenue Mgr Director of Sales Front-Office Mgr Yvonne Yang - RDM LRJJ

Tariff construction How much to charge for its accommodation What is “Price”? An amount ($) as an exchange to acquire goods or services In order to understand: How much to charge for its accommodation 2 fundamental methods of approaching the problem How to be attractive and competitive with other hotels Yvonne Yang - RDM LRJJ

Positioning Your Price Approaches to Positioning Your Price 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. 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. Yvonne Yang - RDM LRJJ

Positioning Your Price 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. 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. 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. Yvonne Yang - RDM LRJJ

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. Yvonne Yang - RDM LRJJ

Establishing Room Rates 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? Yvonne Yang - RDM LRJJ

Pricing Rooms Market condition approach Rule of thumb approach Hubbart formula approach Yvonne Yang - RDM LRJJ

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 Yvonne Yang - RDM LRJJ

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 Yvonne Yang - RDM LRJJ

Market Condition Approach Disadvantages 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 Yvonne Yang - RDM LRJJ

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. Yvonne Yang - RDM LRJJ

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) Yvonne Yang - RDM LRJJ

Rule-of-thumb Approach Average 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 Yvonne Yang - RDM LRJJ

Rule-of-thumb Approach 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 Yvonne Yang - RDM LRJJ

Hubbart Formula Approach “Bottom-up” approach Method: Calculate desired profit  Calculate pre-tax profits Calculate fixed charges and management fees Calculate undistributed operating expenses Estimate non-room operated department profit/loss Calculate required rooms division income Determine rooms division revenue Calculate average room rate Yvonne Yang - RDM LRJJ

Hubbart Formula = ARR Example: Return Costs Look at desired Profit Add all costs Gives Average Price per Room Return Costs = ARR Yvonne Yang - RDM LRJJ

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. Yvonne Yang - RDM LRJJ

Case 1: Holiday Inn Answer 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 Income before fixed charges Plus: Undistributed operating expense 480,000 Required operated departments income 600,000 Less: Other departments' income Rooms department income 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 Yvonne Yang - RDM LRJJ

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 Yvonne Yang - RDM LRJJ

Case 2 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% Yvonne Yang - RDM LRJJ

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 Required operated departments income 1,042,000 Less: Other departments' income Rooms department income 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 Yvonne Yang - RDM LRJJ

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. Yvonne Yang - RDM LRJJ

Case 3 Information Yvonne Yang - RDM LRJJ Alternatives #1 #2 #3 #4 #5   #1 #2 #3 #4 #5 Desired ROI 14% 15% 16% 17% 18% Interest Rate 12% 13% Tax Rate 30% Estimated Annual Fixed Charges (excluding interest) $700,000 Undistributed Operating Expense $3,000,000 $3,500,000 Departmental Profits -Food -Telephone $300,000 $400,000 $450,000 $10,000 Varible Cost per room sold $15 $20 Occupancy rate 65% 70% 75% 80% Yvonne Yang - RDM LRJJ

Case 3 Answer Yvonne Yang - RDM LRJJ #1 #2 #3 #4 #5 Net Income   #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 $1,040,000 $1,120,000 Other Fixed Charges $700,000 Undistributed Operating Expense $3,000,000 $3,500,000 Food Income -300,000 -400,000 -450,000 Telephone Income -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 82,125 87,600 ADR $81.74 $77.34 $94.28 $85.09 $81.35 Yvonne Yang - RDM LRJJ