Profit Maximization in the Hotel Industry

Most hoteliers are familiar with and know about the concept of Occupancy. In fact, for most of them, it is the single most important metric that they have to track. The reason why the metric holds such a venerable position is that it is considered an important indicator of profit-making potential, and thus an integral part of the profit maximization strategy (Stutts, Wortman, & Stutts, 2006). Is it really that important, though? A review of occupancy, especially as it relates to profit forecasting and maximization reveals that it is not a good metric for projecting potential profits. 

 When dealing with revenue management in the hospitality industry, Occupancy is one of the three main indexes used to assess the profitability of hotels. Along with Average Daily Rate (ADR) and Revenue Per Available Room (RevPAR), Occupancy Rate is one of the main ways to determine the viability of a hotel business (Stutts, Wortman, & Stutts, 2006). It is calculated by finding the number of rooms sold over a specific period as a percentage of the available rooms. While it is a valuable metric and gives great insights into profit potential, there are some misconceptions about occupancy that limit its usefulness to a hotelier. First, most hoteliers tend to assume that it should be used as the target for profit maximization. As a result of this assumption, most hoteliers go on to treat Occupancy as the index that indicates the need for price adjustments. The inflated importance of Occupancy as a performance indicator is evident in its wide use as a forecast tool in hotel budgets and forecasts.

Using the Occupancy Rate as a Key Performance Indicator is flawed. The reason for this is simple. While there is a correlation between, ADR, RevPAR, and the Occupancy Rate, some of the indexes are not as reliable in projecting profit-making potential. A high Average Daily Rate would not mean much to the hotel’s potential profits, especially if the establishment were empty (O’Neill & Mattila, 2006). Conversely, having a high Occupancy and a low Average Daily Rate rarely maximizes the hotel’s profit potential. Hoteliers need to understand that selling rooms at low rates to increase occupancy does not mean profitability for the hotel.

The decision by the New Hampshire Resort’s management to charge higher nightly rates in the winter, when the average Occupancy Rate is 75 percent, as compared to the summer when the occupancy rate is 85 percent, is inconsistent with profit-maximization. Conventional wisdom would demand that the resort charges more when the rooms are in greater demand. However, such an action plan would err by failing to account for other indicators. RevPAR is arguably a better ratio because it incorporates both room rates (ADR) and Occupancy (O’Neill & Mattila, 2006). It is thus a convenient way to assess not just how well the resort is doing in filling the rooms, but also how much they would be able to charge. The question that every hotelier, including those who helm the New Hampshire Resort, should concern themselves with, is how to get more bookings and increase the revenue they make on each room, on average. 

So While Occupancy Rate and Average Daily Rate both tell a story about a hotel’s performance, they are only part of the story. Discerning hoteliers thus need to rely on RevPAR as the Key Performance Indicator to watch out for and manipulate, if profit is to be maximized. 

References

O’Neill, J. W., & Mattila, A. S. (2006). Strategic hotel development and positioning: The effects of revenue drivers on profitability. Cornell Hotel and Restaurant Administration Quarterly, 47(2), 146-154.Stutts, A. T., Wortman, J., & Stutts, A. T. (2006). Hotel and lodging management: An introduction. John Wiley & Sons.