1. Chapter 9 Room Rates

2. Learning Objectives
A recognition of the undercurrents and market factors which cause room rates to rise and fall.
A recitation of reasons why achieving full rack rate during economic downturns is a virtual impossibility.
A sense of the impact on the hotel’s average daily rate from generally accepted industry practices like discounting, dynamic pricing, and wholesaling.
An ability to calculate and understand three common rate formulas including; the Building Cost Rate, the Hubbart Room Rate Formula, and the Ideal Average Room Rate Formula.
An appreciation for the potential increase in average daily rate from a front office staff well trained in the art of upselling.

3. Room Rates and The Economy (1 of 4)
Supply and Demand
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. 3

4. Room Rates and The Economy (2 of 4)

5. Room Rates and The Economy (3 of 4)
Competition
You need to charge enough to make money, but not more than your competitors, or you will “kill” the market.
Elasticity
Rate Cutting 5

6. Room Rates and The Economy (4 of 4)

7. Additional Factors in Rate (1 of 4)
Surcharges
Room Taxes
Room Taxes impact demand
Room Taxes and online travel companies
Resort Fees and Other Hidden Charges

8. Additional Factors in Rate (2 of 4)

9. Additional Factors in Rate (3 of 4)

10. Additional Factors in Rate (4 of 4)

11. Discounts from the Rack (1 of 4)
Rack Rate: The standard posted rate
Discounts off Rack Rate
Most customers do not pay rack rate, so why bother?
The impact of rate cutting
Government per diems
Special Cases: Seniors, Military, and Others
Employee Courtesy Rates
Auctioning 11

12. Discounts from the Rack (2 of 4)

13. Discounts from the Rack (3 of 4)
Double Occupancy
Charging per person, rather than per room
Trend in USA is to charge for the room, rather than per-person
Commercial and Corporate Rates
Negotiated Rates and Dynamic Pricing
Comps and FAM Trips
Seasonal and Weather-Related Rates
Other Discounts Off the Rack 13

14. Discounts from the Rack (4 of 4)

15. Time as a Factor in Rates (1 of 2)
Arrival Time
Departure time
The 24 hour stay
Day Rates
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

16. Time as a Factor in Rates (2 of 2)
Incentive rates
American Plan Day
Guests on American plan (AP) or modified American plan (MAP) must be given their full quota of meals

17. Determining the Proper Room Rate (1 of 7)
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!
The Renovation Cost Rate 17

18. Determining the Proper Room Rate (2 of 7)
The Hubbart Room Rate Formula
Operating Expenses 1,102,800
Taxes and Insurance ,000
Depreciation ,750
Reasonable ROA ,000
Total ,084,550
Less Income from other sources ,200
Amount needed from room sales $ 1,945,350
Revenue from room sales needed $ 1,945,350 18

19. 2016/2017 Hotel Development Cost-Per-Room Amounts
Source:

20. Determining the Proper Room Rate (3 of 7)
Number of rooms available (Per Day)
Rooms available per year (item 2x 365) ,120
Less allowance for vacancies 30%) ,636
Number of rooms to be sold ,484
ADR per room to get ROA (item1/item5) $ 86.52

21. Determining the Proper Room Rate (4 of 7)
The Hubbart Room Rate Formula
Shortcomings 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? 21

22. Determining the Proper Room Rate (5 of 7)
Square Foot Calculation
Use numbers from Hubbart Formula, but use square footage of room, not number of rooms
Hotel has 27,250 square feet in 88 rooms
@ 70% occupancy only 19,075 sq.ft. will be 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) 22

23. Determining the Proper Room Rate (6 of 7)
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
Rate Categories

24. Determining the Proper Room Rate (7 of 7)
Upselling
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

25. The Hubbart Formula Exercise

26. 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.

27. 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
8,760
Required average room rate

28. 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,

29. 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%

30. Case 2: Answer Item Calculation Amount Owner's investment 1,000,000
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
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

31. 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.

32. Case 3 Information Alternatives #1 #2 #3 #4 #5 Desired ROI 14% 15% 16%#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%

33. Case 3 Answer #1 #2 #3 #4 #5 Net Income $280,000 $300,000 $320,000#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