Fundamentals of Pricing: Price Management Before and Beyond Revenue Management

It has become so central, that most tend to see it as a one-size-fits-all solution for competing, sometimes overlooking the bigger picture.

This is not just a shortcoming of revenue managers alone, but of business-level and corporate-level management and, even worse, of destination management organizations and leaders, who play a critical role in the positioning and meaning of the destination in which the assets under revenue optimization actually exist.

It’s in fact somewhat daunting and value destructive to watch the global discussion on RM, mostly led by IT companies and hotel and airline sales departments, just focused around price points, ALoS(1), occupancy levels and booking windows.

The C-Suite(2) has some ideas about its fundamentals, but as most corporate executives still come from the pre-digital era, they are mostly followers to what revenue managers are doing, instead of providing them with economic and strategic context and instead of creating optimal business contexts so that revenue managers unleash the full potential of their businesses.

 

Our argument is that price (or revenue, if you will) must begin to be managed far before RM teams and techniques come in, as should the entire business context revolving around a given asset, which intrinsically affects price levels beyond revenue management delivery capabilities.

RM basically deals with price tactics, while calling it price strategy. And if no one is actually handling the strategic side of pricing, by thinking someone is, value may never be optimal.

There’s a lot built into a given price, as price is a numeric translation of the economic value of a business or asset.

All forces that ripple through our businesses need thus to be primarily addressed and managed, so that afterwards, and only afterwards, RM teams may be able to translate the intrinsic and ascending economic value of the business into optimal price output.

The key forces involved in the formation of a price are macroeconomics, microeconomics, corporate finance, strategic marketing, business operations and, in the tourism sector, destination management.

Macroeconomics

Economies grow and shrink, sectors benefit from growth or are harmed by recession in different ways. Countries are worth more or less, given their GDP and GDP per capita levels, and so are the assets on them. When economies grow, price levels go up, as the whole value of the economy is increasing. Economies are also have cycles, so price levels are affected upwards and downwards by those. And by purchase power parity too. Economies are inflationary, deflationary (sometimes, stagflationery), and this also impacts consumption. This is the real side of an economy. As to its monetary side, exchange rates and interest rates are also a key factor in pricing… Why are we discounting a rate when occupancy is low, if a given feeder market currency is appreciating against ours? How will an interest rate increase of y basis-points impact my demand and price levels?

Microeconomics

The price-consumption curve has a negative slope, meaning the higher the consumption, the lower the price (diminished marginal utility of goods and services). In Hospitality we operate in reverse mode, as we market a fixed and highly perishable inventory (more room nights sold are equivalent to higher future prices, as availability is scarcer). So price levels are also a function of capacity (supply quantity and type). Elasticities also play a role, by showing the variation patterns mutually induced by price and demand.

Corporate Finance

The rate of a room night may be interpreted as a stock price, in a given moment. The stock price reflects the future value of a company, today. It reflects what it does and is, in terms of product/service, strategy, financials, investment levels, team, innovation, etc. So does a hotel price, as it has a strong correlation with the type and scale of the underlying investment or asset. A bigger and better located investment must aspire to higher prices than otherwise (Top-Down approach). The reverse is also true, as hotels with higher cash flows are also worth more, so they can translate that into higher market prices (Bottom-Up approach). On top of this, price levels relate also to the liquidity of a company… if struggling with cash shortages, downward price forces will be stronger, as such companies need to anticipate cash to sustain the business, sacrificing rates while at it.

Destination Management

Even when our asset is the destination, one needs to manage or impact the local business environment and community, in terms of general attractiveness (Physical Factors, Entertainment, Culture…), awareness and visibility (PR, Branding), Accessibility (Flights, roads…), as it is a critical part of the value chain. Our price already does factor all those in. So if we want to build it further and gain relevance or even dominate the value chain we need to master the environment. If the value chain is not managed as whole, for same-level occupancy, price won’t peak.

Strategic Marketing

Remember Philip Kotler’s oldies goldies 4 Ps? Price is merely one of them. Promotion, Placement and Product, the remaining. And that’s for Product Marketing, alone. In Service Marketing, they go up to 7 Ps, by adding Participants (customers and staff), Physical Evidence (the environment where service happens) and Procedures (how is service delivered). Price levels must include the contributions of each of these, and each must be managed as a source for optimized pricing. Revenue managers, by dealing only with one of the Ps, tend to disregard the others and how may they impact their own P, so the underlying risk is that all Ps tend to produce sub-optimal returns.

Business Operations

Price is the best measure for positioning. It’s the “positionometer”, if you will. We assess it by comparing ourselves to others. For same occupancy levels, higher prices mean higher positioning. They are impacted by brand, name, service level, product quality, distribution mix, innovation, sales force efficiency, competitors and suppliers rivalry, perceived destination value. For example, by allowing a hotel to become obsolete and thus increasing a generational gap with your target markets, won’t assist much in maintaining or increasing rates, so overall competitiveness goes under.

So, price is mainly a consequence of all above and not of skills and installed-knowledge of RM, as a discipline. There has always been price management, millennia before RM. RM operates under the above. It serves and optimizes the above. And the above must also dynamically serve RM, so it may produce even better results (so that price better translates the full intrinsic value of a business)

RM business-thinking and automation (present Total Revenue Management and future Big Data Analytics) need thus to start factoring in metrics deriving from all these aspects. The entire organization needs to immerse RM teams in all of that too. We need to work with all the tools in the toolbox (business environment), so that the RM tool may function at its peak potential.

The next level must then be for RM teams to integrate knowledge from corporate level strategy, from hotel development and investment banking, from destination management and competitiveness in their day-to-day decision making. This will allow them to have a 360º view of the business and the asset, and to keep gaining and sustaining relative pricing momentum.

RM needs to be able to answer questions like: Why is same-chain ADR several times higher in NY or Paris, when compared to Lisbon or Madrid, given brand, RM teams and business strategy are one and the same? How can I narrow the gap, by increasing the lowest of the two? Why is the growth rate in RevPAR lower in this destination when compared to its competitor’s? Is it converging to or diverging from the competing destination? In a given brand, can we build price that may lead the asset to become operated by the brand immediately superior to this one? What is the GDP volatility correlation to my asset’s pricing? How will I design or update my rates, after a given service or product innovation has been launched? How do I reposition my business through pricing, given newly enhanced service levels? Given my asset profile and operational dynamics, may an RGI(3) of 90 be considered good or an RGI of 110 poor? Which compset position may be my “natural” one? Then, it needs to factor all this rationale in its tactics and procedures.

C-Suite will need to manage not only the business, but the business environment too, using RM as an economy, destination and operations competitiveness barometer, not just as a price management tool.

This is not easy or fast, but at this point in time, it’s somewhat worrying that it’s not even being fully considered or openly discussed.

It won’t be mathematicians, statisticians, computer programmers or revenue managers who will do it for us, as they already have abundant tactical and specific tasks to deal with. And so, our value is not really being optimized, under the on-going perception that it is.

RM is and will continue core to the sustainability of businesses. But if we are not managing price before and beyond revenue management techniques, the optimal consequences of price management may never be dwelling in our books.

References:

(1) Average Length of Stay
(2) Corporate-Level executives such as CEO, CFO, COO, CMSO
(3) Revenue Generator Index (our RevPAR divided by our CompSet’s. It is a relative measure of positioning & performance)