Plotting future profits with yield management
In response to increased competition, increasingly volatile market conditions characterised by excess capacity, slow recovery from recession and falling average room rates, many independent and group hotels have adopted the management techniques known as Yield Management (YM). Developed by the airline industry following airline deregulation in the 1970s, YM proved an effective tool for maximising both passenger numbers and airline revenue. In hotels, YM can be defined as a revenue maximisation technique which aims to increase net yield or profit by allocating a predicted number of rooms to distinct market segments at the maximum achievable price which each segment can withstand.
Current accommodation management techniques are not that far removed from an organised YM system. Indeed, most hotel managers practise some form of YM, such as adjusting room rates to temper demand fluctuations between peak and off-peak seasons, mid-week and weekend business. However, a formal approach to YM can improve the financial performance and service provision of hotels by basing decisions on the acceptability of the product and the propensity of the guest to spend. If hotel managers choose to sell a large number of rooms for one night at low rates, average room rate, and therefore profit, will be low. By holding out for room sales at published rack rates, demand will be low and guests may go elsewhere. Neither of these situations is desirable. YM is a management tool which, when combined with the skills of the management team, can determine how many rooms to allocate for daily sale at various rates, such as 15% of capacity at rack rate, 25% of capacity at 85% of rack rate, 35% at 50% of rack rate and 25% at 40% of rack rate. This formal approach to YM is more complex than many of the existing practices in that room inventory is allocated on a daily basis for months -- even years -- ahead and rates are carefully calculated to ensure they are competitive. Where demand is low, a greater number of rooms are available at a lower rate but if demand should increase, or if demand is high, the low rates are closed and higher rates immediately opened.
Misconceptions
Before looking at the key stages in a formal system, it may help to clarify some general misconceptions about YM. Yield management is neither a scientific technique nor a computer system. It is an approach to increasing profit by responding to facts we have about the past; what we know about the present; and what is likely to happen in the future. Computer-based tools are often necessary to forecast demand, note cancellations and 'no-shows', determine restrictions on discounting procedures, etc. However, many yield techniques do not require computerisation but do require the experience of hospitality managers -- something which cannot be replaced by technology and remains fundamental to the success of any YM programme.
YM is applicable for both group and independent hotels, small and large hotels. It is effective in any establishment where:
capacity is relatively fixed
demand can be separated into distinct market segments
inventory is perishable
the product is sold in advance of consumption
demand fluctuates substantially and
incremental sales costs are low and capacity costs are high
Perhaps the most popular misconception is that YM only works where demand exceeds supply. Demand forecasting is one of the first steps in a formal YM system. This forecasting technique identifies high and low demand levels not just monthly or weekly, but daily, so that in periods of high demand the maximum room rate is achieved and on low demand days, marketing and sales staff co-ordinate their activities to stimulate demand in distinct price sensitive market segments.
Measuring Yield
The key factors in determining room revenue are average room rate and occupancy. YM aims to simultaneously optimise both these variables and uses a yield efficiency measure calculated as follows:
Revenue realised
Revenue potential
Therefore a 200-bedroom hotel with a £70 rack rate which sells 173 rooms at an average rate of £59 yields:
Rooms sold x average rate
Room rate x available rooms
173 x 59
= > 72.9% yield
70 x 200
The traditional practice for hoteliers would be to calculate the occupancy and percentage of room rate achieved, which for the sample hotel outlined would be 86.5% and 84.2% respectively. By determining the percentage yield, hoteliers can more accurately determine the extent to which they are achieving the absolute maximum revenue possible from room sales.
KEY STEPS IN YM
Data Collection and Forecasting
To put a YM system into operation, extensive detailed data is required in quite specific formats. Markets must be segmented into many more distinct components than the broad dichotomy of business and leisure to establish a market fit product provision. The characteristics of each market such as demand, price sensitivity, propensity to spend, booking patterns, booking lead times, duration of stay, check-in and departure patterns, all need to be identified. In essence, it must be possible to quantify the projected demand from each market segment per day, up to 12 months in advance. To enable forecasting variable such as weather, holiday patterns, national and local events and developments in transport links need to be assessed. Managers should clarify their hotel's strengths and weaknesses from the viewpoint of each market and appropriate room rates should be set for the segment. The management forecasting strategy is one of the most important YM functions and should involve all senior management. It requires a great deal of internal and external business knowledge, as well as constant awareness of the external conditions governing economic climate.
Optimising guest mix and capacity levels
The fixed capacity and high marginal cost nature of the industry requires managers to adopt the yield techniques of optimising guests mix and capacity levels. YM seeks to reinforce the aim of revenue generation within accommodation management by (i) the provision of a product/service which more accurately meets market needs and by (ii) redefining the outcome (increased revenue) whereby the aim of management moves from revenue maximisation to profit maximisation. This requires a detailed segmentation analysis using the available expertise of sales and marketing divisions, rooms inventory management and/or front of house manager, financial control and the general manager. This segmentation approach provides each hotel department with detailed information, enabling more profitable decisions on the mix of guests and level of business to be targeted for each market segment daily. A detailed segmentation of the market which includes the spending profiles and costs of supporting each segment enables a comparison of yield per market segment. By knowing the net contribution to profit per segment, managers can optimise guest mix and capacity levels.
Overbooking is an essential YM technique in helping maximise capacity levels. Cancellations, no-show arrivals and early guest departures form the basis of a complex calculation to determine the overbooking level each day in advance. Formal YM systems have the capacity to calculate overbooking levels and continually modify the percentage of rooms being overbooked. This practice is capable of even further expansion by determining the overbooking level per market segment.
Technological input
YM systems require the extensive provision, sorting and manipulation of data. There has been much development in the use of technology as an aid to enhancing yield techniques. Artificial Intelligence has enormous potential for handling the complexities of YM because of its abilities in complex problem solving, reasoning, perception and analyses of data. Linked with Expert Systems -- a 'knowledge base' software package -- the complexities of yield calculations, forecasting and overbooking parameters can easily be handled.
While YM is not a computer system, the full potential of YM cannot be realised without some computerised assistance. Many YM practices can be implemented manually, but technology can simplify and prove cost-effective, particularly in forecasting demand, cancellations and expected no-show arrivals, flagging dates when discounts should be restricted or introduced and calculating the displacement costs of accepting advance group reservations.
Pricing
Most hotel managers use different price bands and employ the tactics of adjusting rates in response to demand. Formal yield strategies have the magnitude to increase the scope and frequency of pricing decisions which more effectively align room prices with market forces. Supported with a market segmentation strategy, hoteliers have the scope to formulate price with a full awareness of the costs, spending capacity and net yield per market segment.
YM changes the traditional practice of having a limited range of room rates relating to room type. Instead, room rate is determined by demand and the room rate may change several times over a few days -- even daily. If the hotel's YM system is effective, the fluctuating room rate is used to be price selective rather than uncompetitive. This means the only time a potential guest can reserve a similar cheaper room with a competitor is when your hotel is aiming for (and can realistically expect to book) guests who generate a higher net yield. The challenge for hoteliers is to take advantage of the individual characteristics of each market segment in their provision, packaging and pricing of the hotel product by matching different rates against different purchase behaviour within each market segment. Therefore, managers must be aware of the price elasticity of demand and implement rational restrictions which prevent price inelastic trade-downs, such as a non-booked walk-in guest paying 40% of rack rate rather than full rack rate. Only when hoteliers are aware of the price elasticity of demand for accommodation per market segment, combined with the elasticity of yield (the impact of price change on net yield) can a more realistic and competitive price be formulated.
Training
The implementation of a 'yield' driven system radically changes the traditional client/staff dialogue. Guests are accustomed to booking a particular room type at an established price which may often be discounted. The emphasis within YM changes this approach in that staff sell the hotel room at a price which is determined by just about everything other than room type. From the outset, the transaction becomes difficult to handle as guests will expect a specific rate per room type. This conflicts with yield strategies and highlights the need for specialised training in this area. An enquiry for a single room at single business rate on a Tuesday evening requires sensitive handling to inform the guest that:
(a) the rate requested may not be available on the Tuesday required;
(b) the rate requested may be available on a Tuesday night if booked and confirmed fourteen days in advance;
(c) rooms are available on the Tuesday night requested at a higher rate;
(d) rooms are available on a Thursday night at the rate requested for Tuesday.
Incentive Schemes
YM systems can be expected to present difficulties for sales departments. Traditionally, such staff are rewarded by the amount of sales they make -- often on the basis of occupancy or average room rate. The implicit assumption in this approach is that all room nights are equally beneficial to the hotel regardless of rate. However, a more effective incentive scheme within the context of YM incorporates incentive points which are directly related to the sales generated on high, medium and low demand days. Sales staff who sell high rates on low demand days should accrue greater incentives than the sale of heavily discounted rates on low demand days.
Travellers and hotel guests have become accustomed to choosing the best product, price and service from a highly competitive market. In today's changing and highly competitive hotel environment, the application of YM provides an opportunity for hospitality executives to gain a competitive edge on the hotel room product and price while focusing on the net return.
Kevin Donaghy is
