The Facts About Induced Demand

Never-the-less, after nearly a decade of little to no convention-oriented hotel development in the United States, such claims published by noted institutes gave me pause to consider the notion as a possibility. Rather than engage in theoretical debate, I believe the only way to examine the reality is to wait until these hotels were open and examine their performance and the performance of the markets in which they operate. Finally by mid 2005, we have several hotels opened long enough to at least establish some facts regarding the early market impacts of their development.

The zero-sum theory, as I will refer to it, that demand is finite and new hotel rooms only siphon demand from existing properties is a generalization that is undoubtedly true in general and thus on a national level and sometimes on a regional level as well. In fact on a national level, there has been no correlation between increases in supply and the affect on demand. Indeed the lowest national supply growth year over the past seven, 2004, also produced the highest growth in demand. In 2001, nationally, a 2.3% increase in supply was countered by the 3.4% decrease in demand.

And while this generalization may be true on a national level (ie. a meeting induced to one market is lured from another) it is certainly not true on a market to market basis. Strong markets that perpetuated the development of new full service hotels, most of which were developed with some form of municipal assistance, did in fact experience high levels of demand growth commonly defined as induced demand. Again, it is likely that the zero-sum equation left other markets in the regional or somewhere in the nation with decreased or lesser growth in demand but typically those were markets that did not offer comparable newer lodging products or suffered from other factors that made their demand vulnerable.

This is not to say that every market in which a new hotel is proposed would generate induced demand as overbuilt markets such as Detroit, New Orleans (even before Katrina), Downtown Dallas and the Denver Tech Center would not likely not benefit from new hotel development. Of the nearly 100 full service hotel feasibility or market studies conducted by my office in Boulder, Colorado since 2000, less than 20% had the forecasted economics that could justify development with or without public assistance. Of those, only four that were financed with a form of public subsidy or ownership have been open now for the greater part of a year or more. These four include the Indianapolis Marriott, the Sheraton Overland Park, the Austin Hilton and the Omaha Hilton. All four studies were conducted between 1998 and 2000. The Indianapolis Marriott outperformed our projections during all three years of its existence and the Sheraton Overland Park has underperformed our projections for its two years of operation. The Austin Hilton and Sheraton Omaha have also not achieved the level of income we forecast for their first year of operation. In these cases, although market occupancy was close to or better than our forecasts, average daily rates did not achieve the positive growth we anticipated in 2000 and 2001 thus reflecting the rate declines or minimal growth in ADR experienced nationally. In fact only four times in six years did these four markets (4 out of 24 = 15%) fail to exceed rate growth nationally. On the other hand, occupied rooms experienced their highest level of growth in all four markets in the same year that the new hotel opened. This Hilton in Vancouver, WA just opened last week and while it remains to be seen how well it will perform, the Hilton Budget is slightly above our forecast performed in 2002.

Source: Smith Travel Research

I can just hear the critics leaping out of their seats to say all this proves is that the market is stealing demand from the lower rated limited service hotels in these markets and that is why the room rates are below forecasts. But the competitive sets that we used in our studies and in this analysis include the properties that not only compete on a primary basis but on a secondary basis as well. Therefore, the hotels “theoretically” hurt in this food chain would have to be $30 to $50 below the competitive market and unlikely to lose their customer base to an upscale hotel. In addition, the limited service hotels in these markets have not experienced significant declines in occupancy or average rate following the opening of the full service hotels.

So that leaves only one conclusion. New meeting and convention-oriented hotels do induce demand to a market. Not always and not always to the same degree. But the suggestion not to mention the outright insistence, that no evidence exists to support the notion that new hotel development can induce demand to a given market is in and of itself FALSE.

Gregory Hartmann is Managing Director of HVS International, based in Boulder, Colorado. Greg and his 20 person staff in Boulder worked on over 1,300 hotel assignments in 2005 from single properties up to 650-property portfolios. Greg is a founding owner of HVS Technology Strategies, HVS Convention, Sports & Leisure, HVS Capital Corporation, HVS Boulder, HVS Dallas, and HVS Golf Services. He is Executive Director for the Center for Sustainable Tourism at the University of Colorado at Boulder and teaches the 3-credit hour sixteen week senior level course in Tourism Management each semester at the University of Colorado Business School. Mr. Hartmann owns an historic landmark office building, an inline hockey rink, the Outlook Hotel and Suites and the Republic of Boulder Restaurant and Microbrewery all in Boulder, Colorado. More...

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