In the following post, we’ll show exactly how RevPAR can be distorted, highlight the potential impact this can have on your business, and offer solutions to mitigate the risk.
Hotels often use RevPAR as a way to measure performance against their competition, which typically includes a handful of hotels in their geographic area with similar levels of service and facilities.
RevPar can be calculated in two ways. The first involves multiplying your property’s average daily room rate (ADR) with your occupancy rate. The second involves dividing your hotel’s total room revenue with the total number of available rooms in the period being measured.
But as we’ll discuss, the data that RevPAR reveals is just part of a more nuanced financial picture.
The trouble with using generic formulas to calculate RevPAR is that they don’t take into consideration the channel mix.
If every reservation that a hotel took was simply a walk-in, with no commissions paid out, then RevPAR would be totally accurate. But in our complex distribution world, things aren’t that simple.
The modern-day hotel has a broad mix of business lines that encompass direct bookings, GDS, and OTAs. And it’s the high commission rates and mix of OTA pricing models that can so often throw RevPAR off.
OTA pricing — comparing net vs gross
Using RevPAR and getting a distorted view of the figures is easy to do, and it most commonly happens because OTAs use either a net or a gross model of revenue. Over an extended period of time, hotels can end up using these distorted figures to make strategic decisions.
OTAs such as Hotels.com, Orbitz and Travelocity all use a net or merchant model, which involves the booking site collecting the payment, and then giving the hotel its share (minus commission). In contrast, OTAs such as Booking.com use a gross or retail model, whereby the hotel collects the initial payment, and then pays Booking.com its commission fee later.
Unfortunately, senior managers may be less aware of the impact of these pricing models on benchmarking and reporting of aggregate channel performance. For those who are aware, bonuses on total rooms revenue may motivate managers to prefer OTAs with a gross versus net rate plan.
Over the course of the year, tracking these different models of revenue isn’t problematic—the end of year P&L statement will ultimately reflect all of these commissions.
What is a problem is how things get skewed in the short term. On a day-to-day basis, tracking this RevPAR statistic can lead to errors in decision-making because the statistic has been misleadingly inflated.
Net and gross models each involve unique patterns in costs, rates and revenues. Without understanding these patterns, it’s easy for a hotelier to overestimate or underestimate performance.
It’s worth noting that the majority of third-party sites use a ‘‘net’’ model, which means there’s a greater chance that hotels will rely on distorted distribution figures that extend beyond the OTA distribution channel.
How distorted figures can mislead hoteliers: a case study
To illustrate how hotels can fall victim to misinterpreting metrics over time, we created a scenario involving a hotel that relied on revenues and costs between varying OTA commission models (i.e., net/merchant vs. gross/retail).
Taking hypothetical data from a European hotel group, we devised three scenarios around a property selling 100 rooms (100% occupancy in this channel) through the OTA channel at a commission rate of 15%, and with a daily rate of 190 euros.
These three scenarios each took place over one month using the following mix:
- 75% retail to 25% merchant
- 25% retail to 75% merchant
- 50% retail to 50% merchant
To make it easier to see how metrics can be distorted, our example keeps net revenue (less commissions) the same in all three scenarios, as shown in Table 1 below:
As the table illustrates, gross rooms revenue (€16,863), ADR (€168.63) and sales commissions (€713) all are understated when a large chunk of business is given to the merchant or net channels, as hotels do not receive from these merchants the total revenue collected from the customer—the commission is already taken out of the payment. This has the unintended effect of deflating the ADR making the commissions payments look low.
Likewise, hotels that work primarily with retail OTAs will see higher ADR but much higher commission payments.
We then expanded the scenario by looking at twelve months of activity (see Table 2 below). This includes an assumed variation in both month-over month occupancy and those resulting from a mix in OTA retail vs. merchant pricing models.
The data above could easily be misinterpreted to show that performance is rising or falling. In reality, the net income for the three models is the same each month, and the total is €4,667,404 for the year.
To illustrate this point further, consider that the hotel received 75% of its OTA channel business in April from providers using a merchant model. In this instance, the revenue would be €423,249.
Now in the next month, imagine the hotel received just 25% of its OTA channel business from providers using a merchant model. The revenue would then be €519,670. This seems to show that from April to May, there was an increase of 23% in revenue. But this assumption is incorrect.
In reality, if the hotel had 75% of its OTA channel business in May coming from providers with a merchant model, the increase would actually be just 13%.
That’s a pretty significant difference, and one that reveals how performance (and subsequent planning) can be misinterpreted and lead to costly mistakes.
Of course, it’s an easy mistake to make given that net revenue is the same in all three example models. But this just reaffirms why it’s crucial for decision makers to really get to grips with how a mix of gross and net OTA pricing models affects forecasting.
How to make a plan for success
Essentially, a hotel needs to differentiate between reporting on actual differences in performance and variations in commission models. To do this, start by taking data by rate model and use this to create an isolated set of metrics.
If you look at gross revenues from merchant OTA providers, you’ll gain more meaningful ADR figures and get a more accurate assessment of your costs. That means actively adjusting reporting from merchant providers to include gross room revenues as collected from guests and actual commission costs as kept by the merchant.
The risk is that many managers look only at the channel average, rather than at each metric in isolation. If the mix of commission models leads to extreme values, this could end up leading to ADR, RevPAR, and commission costs being overstated or understated.
The solution? We suggest hoteliers expand the way they look at the data. So as well as looking at the aggregate across channels, also look at how costs and revenues change over time based on different retail and merchant channels.
Finally, it’s imperative for hoteliers to choose the right comparison in order to draw accurate conclusions. We encourage you to gross up your merchant sales, and cost when you’re analyzing across channels. When you look at individual channel performance, be sure to carefully account for different OTA pricing models.
This article is based on research that originally appeared in the Journal of Revenue and Pricing Management on July 26, 2016 by Cathy A. Enz and Elizabeth C. James.
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