Sunday, October 17, 2010

Is discounting the solution?

There has been a lively discussion on our Facebook page about the reasons why the motel sector is steadily losing market share. 

The following article that appeared in the latest Resort Brokers "Tourism Informer" was mentioned by a Facebook friend that covers one aspect of the decline. This was written by Gordon McGregor a director at Resort Brokers and gives a simple, easy to understand overview on the perils of dropping tariff. After reading, most moteliers will enthusiastically nod in agreement. 

While it is difficult to argue with the sentiments we wouldn't recommend that motels consider taking in long term tenants as a solution to boost flagging occupancies:

"Seldom will any motel operator think about discounting when the market is strong and the business is going well. However, when business declines or looks set to decline many operators consider the option of discounting – a rudimentary fix for declining trade – but what are the effects?

It surprises us that many operators of motels have little idea of just how their business is performing on a monthly basis and it is often not until their accountants present them with their annual accounts that they have a semblance of the past year’s trade. So to consider discounting without any real analysis of the financial effects can be disastrous. Dropping room rates is the easiest thing to do and may seem like the only logical approach to adopt in a declining market – we hope to give you another perspective on this issue.

The New Zealand accommodation sector has been reasonably insulated from the international effects of several Gulf Wars, SARS, Asian crises, terrorist attacks, Bird Flu and political unrest. Statistics have shown us that our accommodation markets bounced back faster than most other countries. However, dark clouds hit the horizon for many of our operators as long ago as two years with higher petrol prices, higher food costs and increased interest rates affecting domestic travellers. Just as these events settled we were lumbered with the credit crisis which has been a world wide event and has been of a lasting nature.

The effects to this crisis and the ripples to follow look set to be with us for some time to come as the focus goes onto sovereign debt issues. Governments can only get more money by raising taxes and the mere act of higher taxes means lower disposable incomes. Many travellers make decisions on trips and holidays based on a combination of cash at hand, cost of travel, and future prospects. So as total room nights sold are under threat many motelliers dust off the sandwich boards demonstrating an acceptance of tougher times ahead and a quick fix attitude.

Reducing room rates seldom ends up in getting more business in anything other than the short term as the market has proven that others will match or better your pricing structures and so the downward spiral begins.

In tougher times it is often better to concentrate on increasing your revenue from other income steams – up-selling your inventory, promoting the use of the pay laundry facilities, pushing tourism operators and  restaurants and receiving commissions, complimentary early check in and late check out, or utilising excess capacity into another use. If you are running your motel at 50% occupancy it would be an easy process to check your records and see how often your motel operates above 70% - if your motel has 20 rooms it might pay to look at having 5 or 6 of the rooms let to permanent occupants on monthly or 6 monthly tenancies.

You will also recall from previous articles by the writer that the industry has a major problem in that not enough revenue is put aside for repairs, maintenance and refurbishment. Harder and quieter times might give you an opportunity to pick up the paintbrush, sew some new curtains, recover some furniture or the like. Look to reposition yourself upwards instead of cheapening your product by reducing price.

Let’s have a look at some numbers (See Figure 1). In this situation I have assumed a 20 room motel that has been running profitably based on an average room rate of $115.96 and an occupancy of 64.4%. The costs detailed are based on averages over 12 sample motels so this is not an actual property.

Many operators understand the concept of increasing room rates adds revenue almost unfettered to the bottom line – what they seldom consider is that by reducing the room rate it has the opposite effect.

The motel above has been operating pretty well with the operator benefiting from a bottom line profit of just short of $170,000. Now let’s assume that the neighbours put out their sandwich boards and market their comparable rooms at $95.00 in an attempt to “steal” your trade. “Not on” you say, so you try to dissuade the neighbours from discounting but you hit a brick wall because their occupancy has increased and they are feeling smug about their marvellous initiative. Now you feel that you have no choice and other operators follow suit – you match the rate and beat it a bit in an attempt to have customers come to your door. You might even comfort yourself that it is a temporary move and that you will only sell a few rooms at this rate.

Sorry, the rot has set in. Customers who have paid more on the internet or through other means arrive and see your discount signs and no amount of explanation can relieve them of their frustration – you’ll probably never see them again – customer loyalty straight out the window. So now you and others have entered a price war – who will be the winner – the customers only. All operators stand to lose.

Only so many bed nights can be sold in any particular market so acceptance of the situation and maintaining the status quo is the most sensible approach. However, you have now chosen to make the bad times worse. You feel pretty comfortable that you have maintained your occupancy at 64.4% but let’s check to see what this has done to revenue and bottom line (see Figure 2).

Now you can see that your revenue has reduced $122,000 with a bottom line profit being only $48,100 (a reduction of $121,195). Reducing your room rate has a very minor effect on costs of operation.You now have a very susceptible motel and any further price reductions will see you out of business.

We have seen a number of motelliers walk from their businesses over the last 12 months and if the situation persists others will soon follow. Now if everyone was sensible and accepted that there were less room nights available and all shared the burden then the situation would be quite different. If everyone maintained their room rates and accepted lower occupancy then there would have needed to be an almost 20% drop in total room nights to equate with the losses suffered by the industry in the example above.

The figures below show that if you maintained the rate then occupancy would need to drop from 64.4% to 46.04% before you netted the same bottom line as the discounted model (see Figure 3).

NB. The costs in italics have been adjusted rudimentary on a pro rata basis on changed revenue. So we can see that price wars are expensive and only the guests gain from the experience. It accelerates and exaggerates a problem. The only way discounting works is if only a small part of the market participates in the practice – if the majority hold firm then the market can sustain and those that discount can actually achieve extra-ordinary profits.

Other influences can also come into play to erode your profit and you need to focus on costs as well. Who do you think is going to pay for leaky homes – Council’s main source of revenue is from rates and they are in the gun for 25% of the remedial costs – so rate payers will face increases as this impacts. Rates went from 3.22% of revenue to a massive 4.15% in the discounted model. Landlords are often seeking a rent review even in hard times and the rent went from 32.46% of revenue to 41.82% in the discounted model. Now if a rent increase is achieved the effect is compounded.

The emissions trading scheme will also ensure that electricity costs will increase with some suppliers already announcing higher charges. GST is also going up which will impact on costs even though some is recoverable. You can see in every day life, even in a recession costs can increase and each and every time this happens it has a negative effect on your bottom line. The conclusion is easy – don’t discount, encourage others not to discount and survive to fight another day.

Inexperienced and inappropriate behaviour will not just help destroy your business but others as well. Sit tight, control costs, offer incentives to customers which don’t cost you money and accept any market decline. It always comes right as it is in human nature that we all want things to get better and they will. It’s easy to reduce rate but it takes years to get it back up again – a price war has lasting effects."

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