Pricing Strategies and their impact on Revenue - Research Paper Example

? Pricing Strategies and their Impact on Revenue Pricing Strategies and their impact on Revenue Introduction Revenue management has been a practice in the hotel industry for approximately 20 years (Anderson et al., 1994). Good revenue management results from a correlation of pricing and hotel occupancy. In essence hotels ought to set their rates according to demand factors. Pricing remains an elemental factor that influences revenue streams in the hotel industry. Studies carried out in the recent past was concerned with competitive pricing as concerned with changes in prices between hotels and their direct competition. The study came to the conclusion that the hotels which maximized their revenue tended to have relatively higher prices and did not engage in price undercutting (Enz & Canina, 2008). Another study found that Asian market consumers did not seem to be influenced by discounts (Lomano, 2008). It may be argued that since these studies were conducted in varying Geographical regions and in different economic circumstances, they may offer practical insights that may be used to determine pricing in the hotel and hospitality industry (Varki & Colgate, 2001). There is however a shortage of research as regards the impact of pricing on individual hotel revenues. Markets have had relatively stable occupancy and a steady growth in revenue since the beginning of the century (O’Neil et al., 2006). The changing dynamics of the market through the provision of advertising through the internet and an increase in supply is certain to lead to increased competition. It is thus important that the hotel industry reevaluate their pricing models to reflect their changing dynamics if they are to maximize their revenue (O’Neil et al, 2006). This paper will study the impact of these changing dynamics on the hotel industry with specific focus on individual hotel case studies and other strategies and economic models. Purpose The defining purpose of this literature review is an analysis of available literature concerning pricing in a market context and how it affects hotel revenue and its management. The review studied the correlation between hotels charging relatively lower prices and client demand for rooms. The review further goes on to analyze literature with regard to the behavior of demand when a particular hotel decides to set higher prices than the competition. The review evaluates the influence of contextual pricing approaches on financial performance of the hotel; whether it is advantageous to charge higher or lower prices than rivals. The review additionally analyzed the response of clients concerning price strategies through the study of relative ADR. The literature review recommendations are made basing on the views of data studied from various journals and from the opinions of experts in the hospitality industry. The significance of customer satisfaction, loyalty, resulting from quality provision of service is linked to pricing and subsequently revenue management. Discussion The concept of revenue management has its roots in the mid 1980s airline industry (Belobaba, 2002). Due to its success in the airline industry it was subsequently adopted by the hospitality industry. Pricing remains an elemental part of revenue management as can be shown by a variety of literature on the subject. Since the concept was adopted from other service industries, its definition may tend to be different in each of the perspectives used (Stanford, 2003). Price Elasticity of Demand The price elasticity of demand is defined as the quantity of a good or service demanded relative to its price. When Price Elasticity of demand is greater than 1 it means that demand is influenced by prices and vice versa. Strobl et al. (2012) found that the hotel industry’s prices are influenced by demand. During periods of low demand, rooms are discounted and available to all. During periods of high demand, administration would apply revenue management and avail rooms only to customers who would maximize revenue. Revenue management is advantageous in that it makes it difficult for the high end customers to benefit from discounted rates (Canina & Cathy, 2006). Good example is during the London Wimbledon when five star hotels average $300 a room. During the low season the rooms would cost about $200. According to Cross et al. (2009), the increase in demand that is brought about by discounted rates usually does not manage to cover losses in revenue as a result of the lower pricing. These results would imply an inelastic demand curve for the hotel ion question. If that is the case, the best perspective would be the raising of prices or the maintenance of prices. This can be explained by the nature of the hospitality industry which has perishable inventories that are also fixed everyday. In order to maximize profits it is essential to use revenue management, and attempt to differentiate services and products offered so as to increase demand (Viglia et al., 2012). Segmentation in Relation to Pricing Strategies Segmentation is the process that entails the planning and execution of acts which are geared towards the satisfaction of private, psychological and social needs while at the same instance fulfilling corporate goals (Siguaw & Skogland, 2004). Clients are usually segmented according to their different needs and as such the corporation needs to take into account these needs when performing an evaluation of customer attributes. After the determination of the attributes, the firm will be able to differentiate the different market segments according to these characteristics (Canina & Enz, 2005). For instance London hotels have special weekend packages for families from the given locality. Kimes and Writz (2003) asserted that as customers were different it is important to segment them, and then focus on the critical group. Clients who tended to buy art regular prices also tend to be more loyal and as such these are the clients to focus on. A hotel with proper information regarding the various segments is thus able to make estimations on the demand of each segment and put in place differential pricing. Hotels may determine the pricing of its services based upon willingness to pay since it is the perception of value which makes people pay rather than the value of the service. A study conducted by Canina and Carvell (2003) found that there was a marginal difference in room occupancy when there was marginal differencing in pricing from the competition. Only huge differences led to a shift in demand reinforcing the notion of perceived value. Service quality and customer loyalty in relation to pricing strategies Clients usually make an evaluation of services according to a combination of its attributes for instance intangible, inseparable, heterogeneous and perishable (Sunmee & Mattila, 2005). For example a hotel customer makes hotel valuation based upon the whole experience not just the room. The quality of service is thus of particular importance if customer satisfaction and loyalty are to be achieved. A study conducted by Lomano (2008) found that hotels with good service could charge as much as 12% more than the industry average. An enhancement of the quality of service could thus serve as an important tool for better pricing. Chen et al., (2012) assert that customer satisfaction and loyalty is the primary objective in the service industry. Customer satisfaction leads to the same customers telling their friends about the hotel and as such there are a reduction in costs of recruiting new customers. Loyal and satisfied customers also tend to be more willing to pay higher prices which increases revenue (Varki & Colgate, 2001). A Number of research done shows that perceptions of quality greatly influenced the setting of prices, the probability of losing clients, and the probability of the hotel getting recommendations. Studies show a positive correlation between customer satisfaction and loyalty on financial performance (Enz & Canina, 2008). In essence, when a hotel made customer satisfaction its goal, loyalty would result from it eventually resulting to an increase in profits and revenue. A hotel that delivers services that are of a better quality than the competitors would make customers to be more satisfied and increase the perception of value among customers. This eventually makes it win new clients and maintain existing ones which leads to an increase in revenue and market share. Pricing Strategies Cost leadership and differentiation are the most important approaches used for competing in the service industry. Cost leadership entails the selling of services at prices less than the industry average as a strategy of attaining market share. Differentiation on the other hand is the making of the service different form that of the competition through value addition according to customer preferences (O’Neil et al., 2006). An important factor to be taken into consideration is the cost. The cost should always be below the revenue generated by the differentiation. Luxury hotels usually offer this differentiation through the provision of personalized services. Stanford (2003) found that hotels often opted to offer rooms at discounted rates since hotel rooms are considered perishable. While discounting is more common than premium pricing in the hotel industry, Belobaba (2002) found that hotels which had a low variable cost and a high fixed cost experienced difficulties in balancing the demand for occupancy in day to day operation. Perishable inventory combined with low variable costs made it wiser to sell at low prices rather than make a total loss. Even as discounting may be more common than premium pricing, hotels make more money than the rivals if they charged higher prices even if they did not attain full occupancy. The increased revenue resulting from the higher prices charged is usually more than enough to cover the reduction in occupancy (Strobl et al. 2012). In essence premium pricing would is more effective in maximizing revenue as opposed to offering services at a discount. Revenue Performance Measures The administration of the hotel typically uses a number of measures to evaluate revenues. The hotel occupancy rate remains the elemental indicator of these evaluations. Cross et al., (2009) asserts that services which are similar in characteristic usually sell for similar prices in competition based markets. The Average Daily Rate is an important measure in evaluating hotel revenue performance. The ADR as a measure is however incomplete since it focuses only on one dimension; occupancy and does not take into account the amount of revenue from the occupancy. A good example is an ADR of 95% yielding 700$ while another of 87% yields 950$, the ADR would assume that the 85% is better while this is impractical. Another measure which is better is the Revenue per allocated room which takes into account, both the ADR and occupation of rooms (Viglia et al, 2012). Kimes and Writz (2003) were of the opinion that ADR, REVPAR and occupancy should be used together in order to get a more holistic perspective. Another theory postulates that businesses lack the freedom to when they are in competitive markets and as such, have to react to the changing dynamics of the market (Siguaw & Skogland, 2004). Hotel administrators are usually under pressure in instances of price reduction by rival competition. Canina and Carvell (2003) goes on further to propose that it is only the relative measures of ADR, occupancy and REVPAR which are practical in a competitive hotel industry since administrators are influenced by competition. Bargaining Theory of Pricing The bargaining theory of pricing is based upon the notion that there is a variety of prices in a market due to the factor of bargaining. Differences in the prices of products and services typically arise from competition, but in instances from the charging of different prices by different sellers. Sunmee & Matilla (2005) postulate that such situations go contrary to the model of perfect competition which asserts that it is impossible to varied prices in the market place. Such circumstances arise from the rational perspectives of the buyers. Rational buyers will not pay a price for a good if they may get a lower price elsewhere (Chen et al. 2012). Bargaining is a common occurrence in the buying and selling of products and services in daily living. In the hotel industry, walk in guests usually pay different rates from guests who have their rooms reserved fro them. The corporate guests may have more bargaining power since they may be affiliated with companies and hence they present possibilities of bringing in more business. Walk in guests on the other hand come in as individuals and hence they have less possibilities of bringing in more business hence the less bargaining power and the higher rates charged. Many of the intentional price discrimination strategies are similar to this model. The administration of the hotel usually attempts to carve out differentiations in the market which are typically not transferrable. As such what may be perceived as differential market pricing is in actual fact a segmentation of the market. Enz & Canina (2008) give a further explanation by asserting that products and services with same attributes in a market, their price is usually influenced by other considerations such as lack of information on higher or lower price, and benefits of better location. An organization’s inability to control prices usually leads to bargaining setting the prices. A good example of this is the Sri Lankan hotel industry whereby travel agents set prices that they deem fit. Belobaba (2002) goes further to assert that perfect competition does not allow for a firm to have such a large market share as to influence pricing openly. Whereas the hotel may be a monopoly making it avoid bargaining, the monopolist does not want to lose market share and thus keeps prices low. Conclusions and Recommendations This literature review provides relevant studies looking into the relation ship between pricing strategies and revenue. It provides insight into how ADR, occupancy and REVPAR offer a platform on which revenue and pricing are determined in the hotel and hospitality industry. Literature has shown that there is a correlation between prices in the market and the relative measure of ADR, REVPAR and occupancy rates. The study has analyzed the optimization of revenue for a hotel in a competitive environment whereby the hotel has direct competitors. While the review of literature does give an optimal strategy that is to be adopted in maximizing revenue, it shows the influence of competitive pricing on the overall demand, and REVPAR. An evaluation of the optimal prices and the effect of changes in pricing, it is necessary to have profitability costs and of demand and supply. This literature review has shown the futility of discounting so as maintain occupancy of hotel rooms. Discounting has been proved to be worthless, in maximizing revenue since the maintenance of rates or the shifting of the same upwards result to better incomes since clients have a sense of value in service and products that are priced relatively higher than the industry average. A look at the current situation in the market also reveals the futility of lowering prices as form of beating the competition. In competitive markets, a lowering of price is certain to be noticed instantaneously by rivals who would subsequently lower theirs making the industry as a whole lose revenue. While the conditions of revenue and pricing are similar, each executive needs to adopt a strategy that is best suited according to the relative conditions in which they operate. Hotel administrator have to decide on whether to follow a system of discounting in order to retain market share or decide to improve their customer satisfaction and loyalty in order to increase their revenue. It is advisable for hotel executives to assert that customer satisfaction and loyalty are the core of the service industry and thus strive to attain high standards of quality in order to foster this and increase their revenue. References Belobaba, P.P. (2002). Back to the future? Directions for revenue management. Journal of Revenue & Pricing Management, 1 (1), 87-89. Canina, L., & Carvell, S. (2003). Lodging Demand for Urban Hotels in Major Metropolitan Markets. The Center for Hospitality Research. 3(3), 5-24. Retrieved from http://www.hotelschool.cornell.edu/chr/pdf/showpdf/chr/research/urbanhotels.pdf Canina, L., & Enz, A. C. (2005). An examination of revenue management in relation to hotels pricing strategies. Cornell Hospitality report, 5(6), 22 – 47. Retrieved from http://www.hotelschool.cornell.edu/app/attach/get.html?id=14455&target=web_attach&file=file.pdf Canina, L., & Enz. A. C., (2008). Pricing for revenue enhancement in Asian and Pacific Region hotels: A study of relative pricing strategies. Cornell Hospitality report, 8(3), 28 – 42. Retrieved from http://www.hotelschool.cornell.edu/research/chr/pubs/reports/2008.html Chen, S., Chen, K., & Wang, C. (2012). Total quality management, market orientation and hotel performance: The moderating effects of external environmental factors. International Journal of Hospitality Management. 31(1), 119-129. Retrieved from http://www.sciencedirect.com/science/article/pii/S0278431911000466 Cross, G. R., Higbie, A. J., & Cross Q. D. (2009). Revenue management’s renaissance. Cornell Hospitality Quarterly. 3(2), 103 – 124.Retrieved from http://cqx.sagepub.com http://www.hotelschool.cornell.edu/research/chr/pubs/reports/2005.html Kimes, S.E., & Writz, J. (2003). Has revenue management becomes acceptable? Journal of Service Research, 6 (2), 125-135. Lomanno, M. (2008). Discounting rates leads to decreased product value. Hotel and Motel Management, 223 (21), 22. O’Neill, W. J., Mattila, S. A., & Xiao, Q. (2006). Hotel guest satisfaction and brand performance: The effect of franchising strategy. Journal of Quality Assurance in Hospitality & Tourism, 7(3), 12 - 26. Siguaw, J., & Skogland, I. (2004). Understanding Switchers and Stayers in the Lodging Industry. The Center for Hospitality Research. 4(1), 5-29. Retrieved from http://www.hotelschool.cornell.edu/chr/pdf/showpdf/chr/research/siguaw120403.pdf?my_path_info=chr/research/siguaw120403.pdf Stanford, P. (2003). Are Discount Tickets Good for Business? Stanford Graduate School of Business. 21, n. pag. Retrieved from http://www.gsb.stanford.edu/news/research/mktg_discount_tickets.shtml Strobl, A., Peters, M., & Sperdin, A. (2012). It is all about the emotional state: Managing tourists’ experiences. International Journal of Hospitality Management. 31(1), 23-30. Retrieved from http://www.sciencedirect.com/science/article/pii/S0278431911000375 Sunmee, C., & Mattila, A.S. (2005). Impact of Information on Customer Fairness Perceptions of Hotel Revenue Management. The Cornell HRAQ, 46 (4), 444-451. Varki, S., & Colgate, M. (2001). The role of price perceptions in an integrated model of behavioral intentions. Journal of Service Research, 3(2), 232–240. Viglia, G., Fraquelli, G., & Abrate, G. (2012). Dynamic pricing strategies: Evidence from European hotels. International Journal of Hospitality Management. 31(1), 160-168. Retrieved from http://www.sciencedirect.com/science/article/pii/S0278431911000958 Read More