Ms. McGuire, PhD

Revenue Management

Private vs. Public Rates: How to Discount Without Starting a Price War

By Kelly McGuire, PhD, Director of Hospitality & Travel Global Practice, SAS, Institute

Broadcasting deeply discounted rates through widely visible channels is the best way to start a price war. Competitors have faster access to price information than ever before, and with improvements in technology allowing more rapid price changes throughout all channels, no sooner have you made a change, then you could find your market responding. As soon as that happens, you’ve lost your opportunity to steal market share and reap the volume benefits that were supposed to offset your discount.

Discounting to stimulate demand helps to ensure that you are generating sufficient revenue to meet short term financial obligations, but it has long term implications on your price position in the market. The only way to balance the opportunity with the challenge is to be surgical in the way that you offer discounts. Basic revenue management theory combined with some behavioral economics will help you stay out of a price war, while still driving enough volume to meet your financial obligations. First we’ll define public versus private channels, and then we’ll talk about the revenue management and behavioral economic theory underlying this pricing strategy.

Public channels are those that are available to any customer who “walks up”. These include the hotel website, OTAs, call centers or even the sign outside the hotel. The impact of public channels should not be taken lightly. They do more than just facilitate a booking. Rate shoppers like Rubicon scrape these channels and make the rates available to your competition practically immediately. The general public uses these channels to understand your price position, make value determinations and compare their willingness to pay to the rates you are offering.

Private channels have restricted access. You have to “be somebody” or “do something” to get access to the rates. These are channels like meeting planners, travel agencies, loyalty member email lists, social media fan pages, or Twitter followers. Any channel protected by a password or by an “opt in” list. While these channels may have different degrees of price sensitivity or reach, they are not where the general consumer or your competitors typically go to find out what you are charging.

Offering discounts through private channels will impact your ADR, but not the public perception of your price position. As with any pricing decision, however, you need to do some careful analysis to determine whether the pricing discount will generate significant enough volume to make up the loss in revenue. If you simply grant a discount to the same demand that would have materialized anyway, then you’re leaving money on the table.

At the core of utilizing public channels versus private channels is the concept of rate fences, one of the principles upon which revenue management was founded. Rate fences are any qualifications or conditions placed around a particular rate that limits access. For example, a senior citizen discount requires you to be of a certain age to take advantage. A pre-paid, non-refundable rate is not attractive to business travelers who might have a last minute change. The point of a rate fence is to allow you to sell a discounted rate to fill excess inventory without diluting revenue from guests who would have been willing to pay more. Rate fences can either be physical, such as room location, room type or included amenities, or non-physical, like advanced purchase conditions or association memberships (AAA)(i).

In an increasingly transparent world, private channels are a good example of a rate fence. You have to have special access to view pricing through the private channels; therefore, you are already “qualified” for whatever discount is appropriate to offer there. While Twitter, for example, might seem relatively public, you still need to have a Twitter account and follow the hotel (through whatever degree of separation) to know about any rates offered through that channel. Other channels are more exclusive, certainly, but the principle is the same.

Simply using private channel will not be enough to ensure successful discounting. How you implement the discounts, including appropriate fencing within the offer, is equally as important as the channel you offer it through. First and foremost, you should be very careful not to offer discounts to existing demand that would have paid a higher price. In some private channels, it may be more appropriate to market exclusive product or offer attractive packages rather than a discount off of a basic room. As Chris Anderson, Professor of Revenue Management at Cornell’s School of Hotel Administration said in a recent webcast, “One of the things I see is that firms are doing a good job of proactively going after bad business. They are aggressively using online channels such as Travelzoo and Groupon to push low-price deals out to as many customers as they can reach. Not a good strategy. You should be thinking how to up-sell, to target customers who are willing to pay more.” Don’t make the mistake of thinking of all private channels as an opportunity to throw out more cheap rates.

Once you identify an opportunity where discounting will benefit you, we can turn to behavioral economists to give us more advice about how to implement it. Behavioral economics is a branch of economics where researchers use social, cognitive and emotional factors to understand the economic decisions of individuals and institutions. Researchers in this area have conducted extensive research across multiple industries to determine how customers react to pricing policies. Here are three suggestions for how this body of work can help in hotel pricing strategies.

1. Research has established that consumers will punish firms they perceive as pricing unfairly by refusing to patronize them (and, in the era of social media – telling thousands of their closest friends and followers to stay away as well)(ii). Given this, establishing reasonable “fencing” rules around discounts is essential to maintain customer satisfaction and ensure repeat business. Rules should be logical and easy to explain. They should be very clear to the customer, both at the time of evaluation of the offer and at the time of purchase to avoid any actions that the consumer may perceive as unfair.

2. Consumers use a “reference price” or a “reference transaction” as part of the process of evaluating fairness. The reference price is how much consumers think something should cost, and a “reference transaction” is how they think a transaction should be conducted. Both of these are based on previous experience with the product or service. Discounting through public channels, without clear fencing, is particularly dangerous because that discounted rate could become the consumer’s reference price. Once that happens, any pricing above that amount is likely to be perceived as unfair. In my opinion, shifting the reference price is the most dangerous consequence of a price war. Once reference prices are established, it is extremely difficult to raise rates again. Your private channel can be a fence that helps maintain a reasonable reference price in the minds of the customer, while allowing for discounting. “My travel agent offered me a good deal this time. The normal price is over $50 a night more.” “I only got that deal because I stayed over on Saturday.”

Several studies have been conducted to establish the perceived fairness of variable pricing, which is the result of applying revenue management strategies, in the hotel industry. Research has shown that over time, consumers have begun to expect that hotels will charge different prices at different times (essentially shifting their reference transaction)(ii). However, that reference price will still be used, even if it has become a “range” rather than a single price. “I usually pay somewhere between $100 and $150 for a room there.”

1. Consumers find discounts more acceptable than surcharges, so any price differences should be framed as a discount where possible. Think, for example, how you would react to a “Young Person’s Surcharge” versus a “Senior Citizen Discount”. So, offer twenty percent off if you stay for three nights rather than twenty percent extra if you are only staying two nights.

As a final note, should you be forced into a price war – or at least into dropping your “public” rates to avoid losing too much market share – consider using up-sell or packaging to generate incremental revenue. As Professor Anderson recommends, don’t be tempted to proactively chase bad business. If you’ve had to lower your “basic” price, focus efforts on up-selling upgrades or create packages that include value-add items like internet and breakfast. Careful analysis of your customer base will uncover opportunities to add additional incremental revenue that could help you offset the discounting.

At the end of the day, whether you’re worried about getting sucked into a price war or not, the best advice is the same. Any pricing decision should be well thought out and analyzed before it is implemented. You need to analyze the implications of matching a competitor rate. You should understand the demographics and potential booking volume of each channel. You should be gathering information about customer needs and preferences that can be used to design profitable packages and pricing strategies. Go back to basics, and make purposeful, data driven decisions. All of these strategies will ensure that you are not going to just follow the lemmings off the cliff.

References

(i) See Sheryl E. Kimes “A retrospective commentary on “Discounting in the hotel industry: A new approach” in Cornell Hotel and Restaurant Administration Quarterly; Aug 2002, 43, 4, pg. 92 for a good discussion of rate fences.

(ii) The following articles provide good examples of the extensive research done on pricing fairness, reference pricing and framing, and were used as references for this section:
M.C. Campbell, “Why Did You Do That?: The Important Role of Inferred Motive in Perception of Price Fairness,” Journal of Product and Brand Management, Vol. 8 No.2(1999), pp 145-152;
M.C. Campbell, “Perceptions of Price Unfairness: Antecedents and Consequences,” Journal of Marketing Research, Vol. 36, No. 2 (June, 1999) pp. 187-199;
D. Kahneman, J.L. Knetsch and R. H. Thaler, “Fairness and the Assumption of Economics,” Journal of Business, Vol 59 (October 1986), pp. S285-S300: P.J. Kaufmann, G. Orrmeyer and N.C. Smith, “Fairness in Consumer Pricing”, Journal of Consumer Policy, Vol. 14 (1999), pp. 117-140.

(iii) S.E. Kimes, “Perceived Fairness of Yield Management,” Cornell Hotel and Restaurant Administration Quarterly, 35, 1 (February 1994), pp 22-29; and S.E. Kimes and B.M. Noone “Perceived Fairness of Yield Management – An Update,” Cornell Hotel and Restaurant Administration Quarterly, 43, 1 (Feb 2002), pp 21-30

Kelly McGuire leads the Hospitality and Travel Global Practice for SAS, Institute. In this role, she is responsible for driving the offering set and setting strategic direction for the practice. Before taking on this role, she was the industry marketing manager for Hospitality and Gaming at SAS. Ms. McGuire works with product management, sales and R&D to ensure that SAS solutions meet the needs of the market. She is responsible for the outbound messaging regarding SAS’s Hospitality and Travel capabilities, particularly in the areas of revenue management and price optimization. Ms. McGuire works closely with IDeaS Revenue Solutions, a SAS company, helping to integrate IDeaS revenue management solution with SAS’s marketing solutions. Ms. McGuire, PhD can be contacted at 607-216-5800 or Kelly.McGuire@sas.com Extended Bio...

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