Real Estate Forum - November/December 2009

creativity to take advantage of a horrible recession, and it was a little fun.”

Such a survivor-themed package is apropos for the current state of the lodging industry. As RevPAR plummets to unprecedented levels, hotel owners have been forced to slash rates and offer special—some would say desperate—promotions to lure guests to their front desks just to get through this economic maelstrom.

Not many operators and owners would admit they have resorted to such tactics, saying only that they try to meet their individual market in terms of pricing. Nevertheless, the statistics bear out the reality of average daily rates that are sinking, well, almost daily.

PricewaterhouseCoopers projects

ADRs are on path to decrease by 8.8% this year. Next year looks a bit better: room rates are expected to drop by only 1.8%. RevPAR is projected to slump by 16.4% in 2009, followed by a

0.7% dive in 2010.

“Everyone is saying they are not cutting rates…until they have to,” says Leslie Ng, chief investment officer for Interstate Hotels in Arlington, VA. “Everyone is finding that, in virtually all markets, they have to cut rates if they want to” remain competitive.

Within Interstate’s portfolio of 229 hotels, RevPAR declined 20.6% year over year, ending the third quarter of 2009 at $78.28. ADRs fell 12.8% to $119.84 over the same period.

Much of the pressure to scale back rates is coming from corporate customers who now have the upper hand in negotiations. “They are renegotiating their corporate rates and want to lock in not only for one year but perhaps two or three years,” Ng says.

But is reducing rates the way to go? According to a study released this year by the Center for Hospitality Research at the Cornell University School of Hotel Administration in Ithaca, NY, slashing ADRs is an ineffective strategy, whether the economy is robust or stagnant.

The report, titled “Competitive Hotel Pricing in Uncertain Times,” was authored by Cathy

A. Enz, a Cornell full professor in strategy and the Lewis G. Schaeneman Jr. professor of innovation and dynamic management; Linda Canina, Cornell’s associate professor of finance and editor of Cornell Hospitality Quarterly; and Mark Lomanno, president of STR Global, a research firm that tracks hotel data worldwide.

The trio decided to undertake the study to get a better understanding of average daily rate patterns in the hotel business. “Not much is known about pricing in the lodging industry,” Canina states. “One of the common trends is that when things are bad, hotels tend to discount. But there was nothing written about whether that is a good strategy or a bad one. Because if hotels discount and their profits don’t increase, what’s the point?” Previous studies tended to look at pricing at the macro level by aggregating data for supply and demand on an industry-wide basis. By doing so, the implication was that lowering ADRs would increase demand and, therefore, revenues.

However, pricing decisions are typically done in reaction to what is happening at the local level. In other words, Hotel A slashes its rates and its competitor, Hotel B, follows suit. “Hotels either charge more or less than their competitors,” Canina says. “That gave us the idea of looking at the pricing of a hotel relative to its competitors at a local level.” Accordingly, the researchers delved into the pricing behavior of more than 67,000 hotels between 2001 and 2007. During that timeframe, there was a distinct downturn (2001-2003) and a robust period (2004-2007), thereby giving a window into what price cuts had been in both good and bad economic conditions.

The researchers categorized hotels from 30% below to 30% above their competitors’ pricing, Canina details. Then they looked at their percentage differences in occupancy and in revenue per available room.

The researchers found discounting ADRs did increase occupancy, but those extra heads in beds failed to boost RevPAR.

Conversely, those hotels that resisted the urge to cut room rates saw higher revenues per available room, even though their occupancies suffered a bit.

There were some variations based on how much lower or higher a particular hotel’s prices were compared to its competitors, but the pattern pretty much held true for all lodging segments and in all economic climates.

“So if a hotel is looking at comparative pricing relative to its competitors, it’s better off having higher prices, lower occupancy and higher RevPAR,” Canina says. “During good and bad economic times, the same result holds. So it is not dependent upon the state of the economy.”

Admittedly, when hotels are getting battered as they are today, it’s hard for an operator to overcome the temptation to discount. That is because hotels evaluate their performance based on occupancy, not RevPAR. “So, yes, they will have higher occupancy, but they won’t have higher profitability,” Canina says.

If hotels discount
and their profits
don’t increase, what’s the
point of discounting?”

Linda Canina Cornell University School of Hotel Administration

The only way to keep ADRs high and increase revenue and occupancy is to stimulate demand—a difficult proposition when people and businesses don’t have the money to travel. “That’s not happening now because a lot of people are unemployed,” Canina explains.

Moreover, wealthy individuals are also feeling the pinch. “Before, luxury properties were not as sensitive to a downturn in the economy as mid-scale and economy hotels,” she adds. “But luxury hotels are being hit quite hard by this recession.”

Most in the industry agree that luxury properties and resorts have been hit the hardest, and urban markets are increasingly competitive. Geographically, formerly high-flying cities such as Las Vegas and New York have experienced the biggest downfall. “The ones that had the extraordinary gains during the past several years are having the largest declines during this downturn, partly because the rates were so high,” Ng says.