Where would a hotel manager start in determining the fair price for a guest
room? What is a fair value? This question has daunted innkeepers from the
beginning. Charge rates too high, and no one will stay with you. Setting rates
too low, and the owner makes less money. For many years in the beginning
of the modern hotel era, hotel managers simply guessed. As unscientific as this
approach sounds, it did work to an extent. After a hotel has been in business
for a while, managers would know by instinct and past experiences what rates
to set. In some ways, this instinctual approach had merit. It allowed for flexibility
and swift market response.
That approach stopped being effective when new lodging management
associations emerged. As owner-operated and owner-managed hotels looked
to expand and evolve into chains and franchise operations, they needed to
borrow capital. It is the banking industry that forced a change in the way
hotels set their rates. The guessing approach didn’t translate well into the language
of income statements. In order for financing to become available, a
standardized rate formula was developed.
In the 1940s the American Hotel Association (the precursor to today’s
American Hotel and Lodging Association) asked a gentleman by the name of
Roy Hubbart to develop a way to compute room rates.1 Mr. Hubbart came up
with a method to calculate a hotel room rate based on the costs incurred in
operating the hotel and a reasonable return on investment for the investors.
Going beyond simple room cost, the Hubbart formula allowed the hotel to scientifically
illustrate to a banker what the return on investment would be.
This quantifiable approach was well received. Financing for any business
enterprise has always been contingent on return on investment and forecasts.
Though this rate formula has its detractors today, it was a valuable milestone
in the evolution of the industry. Here is how the Hubbart formula works.
The Hubbart formula incorporates three different sections, or schedules,
into its calculations: Schedule I looks at specific financial calculations; Schedule
II looks at the rates per occupied room; Schedule III incorporates square
footage into the analysis.
Schedule I attempts to determine the costs incurred with the hotel operation
and incorporate a reasonable return on investment (or ROI). Operating
expenses, taxes/insurance, and depreciation are understood to include all the
same criteria used to determine room cost (Figure 7-1). What the Hubbart formula
does differently from strict room cost analysis is to incorporate a fair
market ROI for the investor. This ROI level can vary widely, but it is understood
to be a fair market value based on equity and interest expense on debt.
The numbers used in the Hubbart formula examples presented here (Figure
7-1, Figure 7-2, and Figure 7-3) are for illustrative purposes only.
Schedule II of the Hubbart formula (Figure 7-2) uses the figure reached
at the end of Schedule I to determine the average daily rate the hotel would
need to charge to meet its obligations—those obligations being operating costs
and owner ROI. Schedule II is similar to the opportunity cost calculation in
that it considers the total number of room nights available for sale in a year
(365 days times the number of rooms available per night). It goes further in
that it takes into consideration an estimated occupancy percentage. Determining
this occupancy percentage is where the Hubbart formula gains detractors.
What would be a fair occupancy percentage? Some hotel markets consistently
run very high occupancy levels. Other areas are susceptible to market fluctuations.
Hotel room supply in an area can vary, as does the demand. Occupancy
expectations must be based on detailed analysis of competition, market supply,