Cathy A. Enz, Ph.D., the Lewis G. Schaeneman, Jr.,

Professo of Innovation and Dynamic Management and executive director of Cornell’s Center for

Hospitality Research

Hotel Pricing in a Networked World From the

Executive Director

THE RISE OF THE INTERNET has shown us that net- works are a powerful force. Because networks are quickly mobilized, they may be even more pow- erful than monolithic bureaucracies. Hotel com- panies have attempted to use the internet for dis- tribution with mixed results. If hoteliers do not understand consumer behavior or the principles of network organization, they run the risk of los- ing revenues and pricing control to third-party internet distributors. In this brief essay, I want to begin the discussion of how the hotel indus- try must adapt the power of the network con- cept to pricing-especially since the industry is already subject to network-style forces that are driving down prices to the potential ruin of all.

A detailed discussion of the nature of con- temporary networks can be found in a book by John Arquilla and David Ronfeldt, who have been examining the nature of networks since at least 1993 (see: www.rand.org/publications/MR/ MR1382).’ The key point in Arquilla and Ronfeldt’s argument is that effective networks can move information rapidly-more rapidly than occurs in a bureaucracy. Many hoteliers are us- ing internet distribution channels without a clear understanding of how networking affects their own organization and influences the pricing of their products and services.

I propose that hoteliers rethink their current beliefs about price discounting, because pricing is especially susceptible to network-style mani- pulation. An example of how this can occur appeared in a January 2003 Wall Street Journal article. By checking prices or making bids at four different web sites, a Journal reporter was able to book a $269 hotel room at the Westin Maui for $150.’

’ Networks and Net-wars: The fiture of Terror, Crime, andihfihan~ ed. John Arquilla and David Ronfeldt (Santa Monica, CA: RAND, 2001), www.rand.org/ publicationslMRlMR1382. 2 Ron Lieber, “How to Get Four-Star Hotel Rooms at a Two-Star Price,” wall Street Journal, January 30, 2003, p. Dl.

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Westin’s web site shows that the company is aware of this potential problem-pricing has become transparent and many consumers have learned to book a room at one price, shop for a better price, and then cancel and rebook. Westin’s web site proclaims that it offers the lowest rate. Indeed, a quick check of rates for a future date at this writing determined that none of the third- party sites offered a lower rate than did Westin’s.

So, what has happened here? To begin with, I am in no way singling out Westin, but that chain happened to be the Journal’s target. What has happened is that consumers have learned from the industry that they can get a better price by not going directly to the hotel. They have learned to use the power of networks to move informa- tion-in this case, from the hotel’s CRS to the customers themselves.

To make matters worse, customers often do not need help from a network, because a hotel’s own promotions and packages erode its revenue without adequately increasing demand. The preliminary results of a study at the Center for Hospitality Research shows the damage that discounting can do to hotel revenues. I am conducting this study with my co-researchers, Cornell professor Linda Canina and Mark Lomanno, of Smith Travel Research. Using STR data, we have analyzed industry-wide data and found that, as many have long suspected, dis- counting does not increase demand as much as it reduces revenues.

It should come as no surprise that discount- ing has a chilling effect on revenues. The dis- counting concept is based on the core micro- economic principle that reducing your price means that additional consumers will enter the market and you will sell more rooms. The hotel industry has never been able to apply this prin- ciple successfully, and the CHR study demon- strates why this is so. New consumers do not enter the market in response to hotel discount- ing. Instead, current consumers simply get more for less and revenues fall. As the accompanying graph indicates, hotel demand is price inelastic. As a general principle, this inelasticity means that the loss of revenue is strongly related to the price of the room and that discounting is not offset by

FEBRUARY 2003

Mean monthly percentage changes, 2001 and 2002: ADR, RevPAR, and Occupancy

30%

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, Percent change in ADR, 2001* -Percent change in ADR, 2002”

c-Percent change in RevPAR, 2002

“Percent change in RevPAR, 2001

1 Percent char-me in --T---L 1 I ,Occupancy, 2002

‘Percent change in Occupancy, 2001

increased room sales, even when extreme price reductions are introduced. The study results show that this pattern is true for all price segments of the industry and for hotels with both low and high occupancies.

That is why regaining control of distribution (and pric- ing) is critical for the hotel industry. Just as the airlines have tried to regain control of their distribution through Orbitz.com, so are a group of hotel chains attempting to gain control of distribution and pricing by offering their own web site, Travelweb.com. This is a promising start, but hotels at all levels must take additional steps. Property-level pricing decisions must be based on a stronger understanding of how to price fairly and avoid the temptation for a quick occu- pancy boost. Our data are clear, the demand boost will not be large, but the loss of revenue will be painful.

If controlling information is a key to using networks suc- cessfully, then hotels must set their own policies about what room rates and availabilities they will share with third-party distributors. This requires a careful touch, since the third-

party sites (e.g., Travelocity, priceline.com) can perform a use- ful function of clearing the market of excess supply. The im- portant point is that those rooms should, in fact, be excess. Rooms that are likely to be sold anyway should not be avail- able through discount-oriented sites. That means that a hotel operator must have a good idea of expected rooms demand. Along that line, a team of Cornell researchers has examined the price inelasticty of hotel demand, and the Center for Hospitality Research will soon issue a report based on that teams findings.

Most important, a new model of pricing would not imme- diately resort to discounting in an effort to boost business. It would instead marshal resources to manage our brands and sell what we promote-a value proposition that includes a great experience, a pleasant interlude, a moment free from worries and concerns-and not just heads in beds. We at the Center for Hospitality Research will continue to examine the industry’s pricing policies with a goal of helping to create a new, network-based pricing model. n

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