Hotel Distribution Cost: The Only Cost Driver That Can Save Your Property’s Bottom Line in 2017
By Max Starkov, Adjunct Professor NYU Tisch Center for Hospitality, Founder & Director at NextGuest Digital
Bleak Picture Ahead for Hospitality
STR's 2017 projections for the United States expect occupancy to decrease by -0.3%, while ADR increases by 2.8% and RevPAR by 2.8% respectively. Interestingly, the average supply and demand will level off at 1.6%, with some markets experiencing significant increases in supply: New York +14%, Denver +10%, Seattle +8%, Houston and Dallas +7%, Miami +6%, etc.
In short, 24 out of 26 major markets will experience higher supply vs demand growth, which inevitably will lead to occupancy declines due to over-supply and the negative impact of Airbnb.
What can hoteliers do to improve the bottom line?
To begin with, in this not very optimistic scenario painted by STR and CBRE, hoteliers cannot easily increase ADRs, improve occupancy and RevPAR and will be running out of options to improve top line revenue and the bottom line in the remaining months of this year and in 2017.
Why? Except for distribution costs, hoteliers have very little leverage over the 6 main cost drivers in hotel operations:
- Labor Costs: creeping up due to unionized labor contract and mandated minimum wage/living wage increases in many municipalities
- Debt Service: at best interest rates on commercial loans are staying flat
- Franchise Fees (Rewards, Marketing, Royalty, Reservation, etc.) are creeping up, as usual
- Utilities: normally 5% of gross - Water, Sewage, Gas & Electric are all creeping up; Water & Sewage are growing pretty fast lately
- Real Estate Taxes: always creeping up at the whim of local municipalities
- Distribution Costs: reflected in the property P&L under both COGS (OTA distribution costs go under Travel Agent Commissions) and Sales & Marketing Expenses (direct online booking expenses such as website maintenance, SEO, SEM, direct response online media, email marketing, etc. are typically bundled here together with payroll for the sales team)
The importance of these cost drivers varies property by property and largely depends on the size of the hotel, condition of the physical plant, whether property branded or independent, amount of debt and geographic location.
The 6th main cost driver, Distribution Costs, has been rising steadily over the last 5 years due to OTAs increasing market share by over 40% vs hotel direct bookings. The recently released study by Kalibri Labs "Demystifying the Digital Marketplace" provides concrete evidence of this dramatic shift:
- Back in 2011 there was one OTA booking for every 4.3 direct bookings; in 2015 there was one OTA booking for every 2.7 direct bookings, i.e. OTAs gained 40% market share.
- As a result of this shift from direct to OTA distribution, and in spite of the fact that the U.S. hospitality industry generated 7.4% more guest paid revenue in 2015 vs 2014 ($145.5 billion vs. $135.5 billion), the net revenue captured by hoteliers decreased, which resulted in nearly $600 million not being added to NOI (Net Operating Revenue).
What can hoteliers do in the remaining months of 2016 and in 2017?
Hoteliers can realistically influence ONLY one of the six cost drivers - distribution costs - by focusing on and investing smartly in their direct booking strategy, and shifting share from the OTAs to the direct channel.
1. Adopt a "Direct is Always Better" Top-Down Strategy
Adopt a corporate-wide "Direct is Always Better" Strategy with the primary goal of generating more direct online bookings and shifting share from the OTAs to the direct channel. Without such a strategy, the property ends up with under-staffed and under-budgeted direct online marketing efforts, bandwidth and focus.
Who at the property "owns" the website and its results and performance? Whose salaries and bonuses are determined by the website's revenue and ROI? Who is incentivized when the market share needle is moved from OTAs to direct online bookings? Most properties and hotel companies do not have clear responsibilities and incentives assigned to direct online channel production, resulting in a very muddled – but convenient for some – picture of channel contribution, ADRs and distribution costs.
When the property embraces a "Direct is Always Better" top-down strategy and the on-property team sets a primary goal of generating as many bookings as possible via the direct online channel – by far the most profitable channel today – the team can work together to seize market share from the OTAs as a united front. A comprehensive "Direct is Better" strategy should include direct booking share benchmarks and objectives, employee responsibilities, performance compensation tie-ins and bonuses, guest "book direct" value adds, and more.
Educating the property staff that direct guests = best guests and empowering them to be responsible corporate citizens with the property interests at heart is part of the overall "Direct is Better" strategy. "Customer Lifetime Value (CLV) of direct guests is far greater than CLV of guests acquired via OTA" – confirms Michael Harris, VP of Ledgestone Hospitality, LLC. "Direct guests' average length of stay is greater, net profit is better, therefore CLV is also bound to be greater."
Determine who at the property "owns" the website and its results and performance; develop a bonus/reward system for DOSM and Revenue Managers to incentivize them to push more direct bookings and truly focus on more profitable bookings.
2. Start Treating Direct Online Distribution Costs as… Distribution Costs:
Currently direct online bookings and their distribution costs (ongoing website technology upgrades and content optimization, dynamic content personalization, reservation abandonment programs, hosting, SEO, paid search, online media and retargeting, first-party and real-time data marketing, email marketing, social media engagements, consulting, etc.) come from the Sales & Marketing Budget, which is a line item in the property budget.
Just imagine the following Scenario A:
An online travel consumer comes to the hotel website, likes the property location, product and services, but finds a better rate on Expedia and books there. The distribution cost is either not reflected in the P&L at all if this is a merchant booking, or goes under COGS/Travel Agency Commissions in the case of an agency booking. As we all know the COGS line item is rarely scrutinized at all, and practically has no budgetary limitation. On the contrary, any increase in the COGS line item puts a dent into the G&A Expenses, which limits direct distribution even further. This "unlimited commission potential" allows OTA bookings to grow exponentially without being restrained by the property budget, which isn't the case with direct online bookings.
In Scenario B, an online travel consumer comes to the hotel website, likes the property location, product and services, likes the rate which also includes some unique value-add, and books there. The distribution cost (the prorated website and digital marketing expense required to engage, bring in and convert this travel consumer) comes out of the Sales & Marketing line item, part of the G&A Expenses of the P&L, which is severely restricted and often subject to budget cuts.
Same travel consumer, same booking dates, entirely different treatment of the distribution costs. It is extremely ironic that the most cost-effective bookings – from the direct online channel, are severely restricted by the property's sales and marketing budget, while the most expensive bookings – from the OTAs with cost of distribution of 15%-25% – are not restricted and can grow exponentially.
The Sales & Marketing line item in the property budget for many properties also includes payroll for the sales and marketing staff. Why is that? In my view, "pure" online Advertising/Marketing expenses needed to generate direct online bookings via the hotel website should be separate from the payroll for sales and marketing personnel, same as the Revenue Management team payroll is NOT included in COGS/Travel Agent Commissions, but rather in the overall Payroll Expenses. Unless the property has a Digital Marketing Manager, fully dedicated to generating revenues via the hotel website and digital marketing, payroll for the sales and marketing staff should be treated as labor costs and made part of the general labor Cost line item of the property budget.
If we separate the actual advertising/marketing expenses, the majority of which now go to digital, it is very easy to determine the cost per direct booking (digital advertising/marketing expenses/website bookings) and easily compare this to the OTA distribution cost. Recognizing direct distribution costs as COGS will unleash the property's ability to adequately fund the direct online channel efforts, boost bookings via the property website and drastically decrease OTA dependency. Lowering overall distribution costs will allow the property to fund payroll and staff empowerment, renovations and product/services improvements, invest in human resources, and add a hefty chunk to the bottom line.
In other words, the cost of direct distribution via the property website should be treated in the property P&L in exactly the same way as OTA commissions, i.e. as COGS and deducted from the gross room revenue, thus unleashing the property's ability to adequately fund the direct online channel efforts, boost bookings via the property website and drastically decrease OTA dependency.
3. Invest in Direct Booking-Generating Technology and Marketing
Endemic under-investing in direct online booking-generating technology and digital marketing is one of the main reasons why hospitality has allowed the OTAs to gain market share by 40% over the past 5 years.
Have you visited your own property website lately and liked the experience? Have you tried to access your website via mobile and felt frustrated from poor usability and download speeds? When was the last time you ran a multichannel digital marketing campaign for your hotel? Are you engaging your past and future guests via smart data marketing, programmatic advertising and dynamic rate marketing?
To achieve a level of real success and lessen dependence on the OTAs, hoteliers must invest adequately in the correct website and digital technology and marketing techniques to engage past, present and future guests and drive direct bookings throughout the entire path to purchase.
We have a very comprehensive whitepaper on the subject: The Smart Hotelier's Guide to 2017 Digital Marketing Budget Planning, which provides hoteliers with a concrete roadmap to jumpstart the property's direct bookings and guide its digital marketing and distribution strategy throughout the year. With so many moving pieces in a hotel's digital budget: from enhancing the property website, to revenue-generating technology, to smart data marketing, it's important to create a strong plan of action that is realistic and aligned with your business goals.
4. Adopt an Effective Merchandising Strategy to "Sell on Value" vs "Sell on Rate"
The commoditization of the hotel product, in which hotels are forced to compete with the OTAs strictly based on rate, leaves the hotel little opportunity to communicate the value of the hotel product to potential guests. The OTAs have mastered the "sell on rate" game, and hoteliers have little chance in winning this battle. To combat this, hoteliers need to re-learn how to "sell on value" as opposed to "sell on rate," and need to adopt an effective website merchandising strategy.
The direct online channel offers limitless opportunities for the hotelier to present the hotel product and value proposition directly to the online travel consumer. A merchandising strategy is centered on communicating the unique features of the property (hotel services, meeting and event space, the latest promotions and special offers, local attractions, and more) and focuses less on the rate alone. A strong website merchandising strategy allows the hotel to showcase merchandising content on the prime real estate of the website – front and center of the visitor's attention – and personalize relevant content based on the user.
Implementing a strong website merchandising strategy will maximize room bookings and revenue on the property website, generate group leads and RFPs, sell and promote the hotel services (dining, spa, etc.), engage and convert potential customers, and more.
With bleak industry forecasts for flattening and even decreasing occupancy, and supply outweighing demand in many major markets, the only cost driver hoteliers have any control over is distribution costs. All the other major cost drivers: labor costs, debt service, franchisee fees (for branded properties), utilities and real estate taxes are beyond the hotelier's control and are creeping up one way or another.
Lowering distribution costs by increasing direct bookings and shifting share from the OTAs should become priority #1 for the hospitality industry in Q4 2016 and in 2017. How can hoteliers achieve that?
- By adopting a corporate-wide "Direct is Always Better" Strategy with the primary goal of generating more direct online bookings and shifting share from the OTAs.
- By recognizing direct distribution costs as COGS in the property P&L - in exactly the same way as OTA commissions, thus unleashing the property's ability to adequately fund the direct online channel efforts, boost bookings via the property website and drastically decrease OTA dependency.
- By adequately investing in website and digital technology and marketing techniques to engage past, present and future guests and drive direct bookings.
- By adopting an effective merchandising strategy to "sell on value" vs "sell on rate," a strategy centered on communicating the unique features of the property (hotel services, meeting and event space, the latest promotions and special offers, local attractions, and more)
Founder & Director at NextGuest Digital. Recognized as a thought leader in digital marketing strategies in hospitality, Max is a frequent guest speaker at industry events and conferences. His expertise is sought after by a diverse client portfolio of top tier hotel brands, luxury and boutique hotel chains, hotel management companies, resort and casino companies, franchisees and independents, as well as major Wall Street investment banks and financial institutions.More from Max Starkov
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