Rate Optimization: Enhancing Your Hotel’s Pricing Strategy For many hotels, developing effective pricing strategies remains a complex issue for revenue managers. Their goal, ultimately, is to maximize companywide revenue and profits while building strong hotel partner relationships within their marketplace. The emergence of rate optimization has made strides to demystify pricing practices and help revenue managers understand the demand characteristics of their products, understand the price sensitivity of demand and design a rate spectrum that is tuned to all these. This allows hoteliers to take full advantage of their business opportunities, ensuring that they are capturing the maximum revenue at all times through an optimized rate spectrum. Beyond the scope of regular revenue management practices such as selecting the correct overbooking, rate restrictions and best available rate, lies the challenge of selecting the correct rates to choose from in the first place. Rate Optimization is the practice of selecting the rates offered in a rate spectrum based on the historical price sensitivity of demand. The goal of rate optimization is to understand the demand characteristics of products and the price sensitivity of demand and define a rate spectrum that will capture the maximum revenue over time.
Dr. Ravi Mehrotra
President, IDeaS Revenue Optimization
Price Sensitivity, or Elasticity of Demand
The Price Sensitivity of Demand is a measure of the change in demand to a change in price. If a small change in price is accompanied by a large change in demand, the product is said to be elastic, (or responsive to price changes). However, a product is inelastic if a large change in price is accompanied by a small amount of change in demand.
IDeaS - A SAS COMPANY
Rate Optimization: Enhancing Your Hotel’s Pricing Strategy
Price sensitivity can have a dramatic impact on revenue. For example, if the rate offered for a product is too low, the demand for the product may be significant; however the revenues from the sale of the product may be low. In turn, if a rate offered is too high, there is a risk that not enough demand will materialize, and the lack of demand for the product at the high rate may result in a reduction of potential revenue. Between these two extremes is a rate offering that will capture the demand to maximize the overall revenue. It is crucial to determine, in advance, the correct rates to be used when there is excess capacity or excess demand. An incorrect determination of the rate spectrum is likely to affect the overall revenue for a set of products. The reduced price offered to the price sensitive segment of the market may also be associated with the grade or class of service or reduced cost of delivering the service, but this is not necessary when employing market segment pricing.
Price Elasticity of Demand will always have a negative value in this context. A large change in quantity demanded due to a change in price suggests that the demand is more elastic. Price Elasticity of Demand is important because it predicts what is likely to happen to revenue due to the change in quantity demanded as the price is changed.
For example, if Price Elasticity of Demand is -0.4, the Price Elasticity of Revenue will be +0.6. If the price increases by 10 percent, quantity demanded will decrease by 4 percent and revenue will increase by 6 percent. On the other hand, if Price Elasticity of Demand is -1.5, the Price Elasticity of Revenue will be -0.5. If price increases by 10 percent, quantity demanded will decrease by 15 percent and revenue will decrease by 5 percent. For a given price change, the revenue increase or decrease depends on the Price Elasticity of Demand. If the price increases the revenue will increase as long as the Elasticity of Demand is between 0 and -1. The revenue will be maximized at the price point where the Price Elasticity of Demand equals -1 and Price Elasticity...