Cost optimization and profitability: Cost-optimization has always been a central notion in revenue management. That being said, the pandemic brought renewed attention to the topic. Today, more than ever, proper cost control is crucial to navigate these difficult waters and prepare for the "new normal." Whether we like it or not, every single decision revenue managers take on a daily basis, has an impact on the bottom line, meaning that revenue management is not only about optimizing the revenue streams, but also about increasing profitability. Favoring the distribution channels with the highest profit has become imperative in our industry. But how can hotels calculate the cost-per-acquisition of each channel? What should be taken into consideration? And how can this analysis influence one's distribution decisions?
With roles changing from Revenue Management to Revenue Strategy, profitability has been at the forefront of most revenue decisions and has recently become more critical. The cost can assume various elements such as intermediary costs, commission costs, reservations, sales and marketing and personnel costs. What is important is for businesses to develop individual channel/vendor based strategies that aim to optimize customer segments. Profitability led channel strategy can view acquisition costs individually for each customer segment group, which leads to profitable negotiations.
A data-led and curated distribution approach will help to optimize demand per channel and also help to manage costs
Profitability is the name of the game ... it has been since a lot of years ago, but it wasn´t in our Revenue Manager DNA, Cost were out of our picture.
We have been looking after the top of the P&L Funnel , we have taken care only about the incomes trying to get as much RevPar as we could, but in reality a revenue manager must be aware also about the bottom of that P&L Funnel and try to understand how the cost works and how that could affect our profitability , let give you and example ... if you are working in a seasonal hotel you must integrate in your pricing strategy all the Break even numbers and details in order to understand the best day possible to open your property.
The covid situation has forced Revenue Managers to give a step forward and stat looking all related to cost in order to better calculate all the Break Events scenarios ... this has been one of the biggest change that the COVID situation has brought us.
- Access to bottom of the P&L Funnel (al the cost structure) figures
- Star to have a look to this very cool2 KPIS : GOPPAR
- Always think in profitability instead of price or income
- You need to understand and control all your distribution costs , which are that you could manage directly.
Could we start to talk about becoming a Profit Manager instead of a Revenue Manager??? ... Let's discuss that in The Revenue Manager The Series on the 10th June.
My recommendation is that you start with a thumbnail approach to understanding net incremental profit from your major distribution channels. A story is sure to emerge from that exercise and you may want to dig deeper at that point. Here is an approach we have used with success in the past:
- Start by listing ADR by channel (net ADR to the property in the case of an OTA) over a reasonable period of time (1-month minimum).
- Subtract your transaction costs per your CRS agreement.
- Subtract revenue-dependent brand costs such as franchise fees tied to revenues in order to get an effective ADR.
- From there, subtract your Rooms Department Cost Per Occupied Room (CPOR). Remember to include labor costs for on-property reservations.
- Factor in Energy / R&M Incremental CPOR if you want to truly understand net incremental profit. Also, for branded properties, consider property-level brand CPOR associated with premium loyalty membership awards, in-room amenities, club lounges, and other services.
You will notice that we have ignored costs associated with property website development, maintenance, and advertising in the thumbnail approach, but these could easily be considered if you like with some basic assumptions regarding the shelf-life of the site, etc.
Once you have completed this part of the exercise, consider volume potential by channel to direct your marketing initiatives and take a moment to review/validate your pricing strategies.
Sometimes ADR and net operating income (NOI) growth can more easily come from shifts in market mix, but making assumptions about the value of one channel over another without doing the analysis can lead to flawed results.
While cost optimization (or rather, profit measurement in general) is crucial for hotel operators, just like for any other business, our current reality is that hoteliers are offered a very minimal amount of technical functionality that would make profit maximization a user-friendly task.
We need better tools that would allow the industry as a whole to track or forecast total revenue, or manage and optimize expenses, or easily benchmark performance against each other in a standardized manner, for different regions, sizes or types of hotel properties.
Traditional limitation of current systems (as well as integrations and data flows between those systems) to only concentrate on the top line room revenue also contributes to the problem of different departments working in silos as they don't use the same metrics to assess their performance and often contradict each other in their initiatives. We are lacking tools that would help different stakeholders understand what actions need to be taken in each department that will ultimately result in profit maximization.
The industry needs to generate investment interest in this area.
We can learn from the existing tools that have been introduced to help target profit maximization but there's still a lot of room for improvement in our tech stack in order to allow hotel operators to build optimal strategy that maximizes overall profit and not just top-line room revenue.
More integrations and partnerships need to happen to ensure reliable and consistent flow of data between key operating and reporting systems in the hospitality ecosystem.
Finding a calculation that fits every hotel is impossible – different taxation, rules of cost allocation, franchise vs managed vs owned % fees, P&L fee structures, etc.
We also need to be realistic. RM has never had the notion of cost optimization – it's just been talked about for the last 1000 years, as much as we talk about TRevPAR.
The industry must decide what it wants 'Revenue Management' to be, because at the moment, we want it to be everything, yet we don't even have the capabilities to cover Rooms Revenue Management properly, so how are we growing those capabilities overnight? This doesn't mean we can't get there, but we also need to be realistic about getting one thing right and more importantly adopted industry wide before "chasing the next squirrel".
There is also a big difference between profitability and driving profit!
Revenue Manager One focuses purely on profitability %. Only takes highly profitable customers, turns away all the low-cost business – it's not profitable enough, right???
Yet forgets that the hotel never fills!
Revenue Manager 2 focuses on profit – gets offered a piece of business but has to pay 50% commission – realises profitability is bad, but considering there is no displacement – hotel made additional profit on this and was able to upsell.
If you want to get started though: Keep it simple:
- Focus on acquisition first, then on how to get the client through another channel that works better for you: better marketing channels, better PR, higher profit, loyalty – not everything is $$$ value.
- Don't get hung up on profitability %. In High demand times Cost of Acquisition matters, however, in Medium and especially LOW demand periods there is no displacement, and profit-generating business should be taken to drive profit.
- BEFORE you start on your journey into profitability – talk with your finance director to figure out WHICH cost is actually making or breaking profitability.
The revenue management is evolving. Although its core business is optimizing revenue, every single decision of a revenue manager has, indeed, an impact on the bottom line = profit. For this reason, revenue professionals should take a step ahead and include a channel cost analysis in their strategy.
How to calculate the Customer Acquisition Cost is a controversial topic, since there are different levels of analysis. Apart from commissions there are many other costs to consider. In fact, the CAC can range from 15% (in a few cases) to 30% (more likely) of guest paid revenue.
Here is a list of the main costs:
- commissions (included the "mark-up commissions", which are taken off the full rate. This is the case of wholesaler net rates, opaque and net merchant model OTA)
- Discounts (genius, country rates, members only ect.)
- transactions and channel fees (GDS, booking engine, outsourced reservation center etc.)
- GDS, OTA and google ads campaign, metasearch, social media
- loyalty investment
- consortia affiliations
- S&M expenses (benefits, such as free minibar or an F&B credit have to be counted as well as a marketing expense). And what about the website and the booking or sales staff? These are also costs
Why is a channel cost analysis so important? Because it helps to determine the most profitable channels and take the right decision in terms of inventory management with a focus on the profit. As an example, it is clear (from above) that direct reservations don't have a low cost either! So, is it always necessary to disintermediate at any cost? Your channel analysis will reveal it. And you will be able to apply a cost control driven distribution and push the high margin channels at the detriment of the low margin ones.
Start Treating Direct Online Distribution Costs as… Distribution Costs!
Currently direct online bookings and their distribution costs: ongoing website hosting and technology upgrades, website content optimization, SEO, website visitors referrals fees (metasearch and paid search CPCs, online media and retargeting referrals, etc.), hosting, analytics, data marketing, email marketing, social media marketing, digital marketing agency fees, etc. - all come from the Sales & Marketing Budget, which is a line item in the property budget.
For 20 years we at NextGuest (now merged with Cendyn) have been tracking the cost of direct bookings across our portfolio of hotel clients. The average all-inclusive direct cost has varied through ups and downs in the marketplace but has always been in the range of 4.25%-4.5%.
How are OTA commissions treated? OTA commissions are either not reflected in the property budget and P&L report in the case of merchant bookings, or fall under COGS/Travel Agency Commissions in the case of an agency booking.
Just imagine the following Scenario A: an online travel consumer comes to the hotel website, likes the property location, product and services, likes the rate which is in parity but 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.
In Scenario B, an online travel consumer comes to the hotel website, likes the property location, product and services, but ultimately books the property on Expedia (better rate, better user experience, etc.). 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.
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.
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 immediately squeezes the budget allocation for Sales & Marketing Expenses i.e. limits budget for direct distribution even further. This "unlimited commission potential" allows OTA bookings to grow exponentially without being restrained by the property budget at the expense of the direct online bookings.
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.
It's absolutely vital to take a look at the big picture and consider cost-per-acquisition when setting distribution strategies. Being professionally focused on Meetings & Events I want to stress the vital times we're in when it comes to the Meetings & Events distribution landscape. Things are moving. Most often, meetings are “requested”, not booked by sending an RFP to a hotel Meetings & Events representative. Quite often we see this one-channel approach as many hoteliers feel anxious about putting inventory online and some Meetings & Events require a tailor-made approach.
On the other hand, we see more distribution options becoming available. Future proof hotels are adding a direct booking engine for function space to their website and others are taking it one step further by working with OTA-like parties specialized in Meetings & Events.
When deciding what to do there are 2 things to consider: 1. Booking experience. Put yourself in the shoes of someone that tries to book a meeting. In these fast-passed times, people expect instant confirmation, especially when booking last minute. 2. Cost of acquisition. The main options for Meetings & Events are:
- RFP to hotel
- Direct via website
- OTA-like third party
All three options involve cost: Option 1 is most heavy on labor cost and requires hotel own marketing initiatives. Option 2 will involve software (license) costs, SEO and also marketing efforts. Option 3 will take care of marketing and SEO but will involve a commission model.
Just like with hotel rooms the name of the game is balance between channels taking into account experience and cost.
When creating a distribution strategy for the hotel, it's vital to consider channel-specific acquisition and distribution costs. But should it be the primary factor when choosing a hotel's distribution mix? I think that before calculating channel costs, hoteliers need to answer the following questions:
- Which segments book through a specific distribution channel?
- Will the hotel get access to these guest segments through other channels?
- Does the distribution channel generate unique demand?
- Does the distribution channel generate demand in high or low demand periods?
- How much ancillary revenue hotel generates from guests booked via a specific channel?
Once these questions are answered, it's time to calculate distribution costs per channel. Naturally, hotels want to sell rooms via channels that have the lowest distribution costs. But can hotels afford to ignore less profitable channels?
In my opinion, hoteliers should consider channel-specific demand, ancillary spending, seasonality, and costs to answer this question. For example, if the distribution channel is expensive, but it brings demand that will not be booked through other channels or guests that book via this channel tend to spend more in hotel outlets than channel should be part of the distribution mix.
What if the channel is expensive and demand is not unique? In this case, hotels should develop a strategy to move customers from expensive channels to less costly channels (shift share).
What if two channels have unique demand and it's a high demand period for the hotel? The hotel should give preference to the distribution channels that have lower distribution costs and higher ancillary spending.
To conclude, hotels should not base distribution decisions only on channel costs. Instead, a variety of other important factors should be considered. Only when hoteliers see that whole picture can they make strategic decisions that will maximize profitability.