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Interview – The role of pricing in managing supply and demand

In this interview, Breffni discusses with Mariana the role of pricing in managing supply and demand.
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Well, Breffni, thank you so much for coming. My pleasure. And before we start going into more details in the course, why don’t we start by what you think is the role of revenue management. So very simply put, revenue management is about maximizing revenue across all revenue-generating streams within your hotel, so everything from guest rooms, to food and beverage facilities, to conference and banqueting facilities, right through to your spa facility. There are so many facets to revenue management. What aspect are you going to focus on this course? So in this course, we’re going to focus on pricing for revenue management. And we’re specifically going to do that in the context of rooms.
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However, it’s important to understand that the basic concepts that we’re going to cover in relation to guest rooms can be applied to all revenue-generating streams within your hotel. So as one moves through this course, the idea is to start thinking about the concepts that they learn in relation to guest rooms, and think about how they can be transferred to other revenue-generating streams within the hotel. And where does pricing fit in revenue management? So with that question, pricing is one of the most critical components of revenue management. In fact, it’s often referred to as a strategic lever of revenue management. So the idea is that we use price to balance supply and demand.
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So at a very basic level, when we forecast that demand is going to be very low, we use price to stimulate demand, so, for example, in the form of discounts. And then, when we forecast that demand is going to be very high, well, we know that filling rooms isn’t going to be an issue. So what we focus on is driving as high a price as possible in order to maximize revenue. And what is it about hotels that allows you to use pricing to manage supply and demand? So we’ve got an interesting cost structure in hotels. So when you think about the two types of costs for hotels, we’ve got, on one hand, fixed costs, and then we’ve got variable costs.
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So when you think about fixed costs, they’re the costs that don’t change in the short term, so, for example, the monthly mortgage, or base payroll. Every month, they have to be paid, regardless of what level of business that we’re doing. So if I sell an extra room in my hotel, it doesn’t change the nature or volume of my fixed costs. On the other hand, when I do sell a room of my hotel, I incur what we call variable costs.
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So the variable cost of selling an extra room are things like the cost of having an employee clean the room, or the cost to replacing amenities or linen in the room, they’re only incurred if we sell a room on a given night. So when you think about it, hotels tend to have very high fixed costs. So we’ve got this high fixed-cost base. It doesn’t go away regardless of what volume of business we do. And then we’ve got the variable cost of selling an extra room. And this tends to be very small. So for example, for a hotel, it could be as low as $10 or $20.
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So the idea is that if I go even $0.01 above my variable cost– so let’s say, for example, my variable cost is $20. I could theoretically sell my room for as low as $20.01 and have $0.01 to make a contribution to my fixed costs. Now, I’m not suggesting for one moment that we go as low as $0.01 above my variable cost. It would take me a long time to drive profitability in that instance. However, the point is that that kind of illustrates how much pricing flexibility we have, that if we go any amount above our variable cost, we make a contribution to our fixed costs.
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So circling back to where we started with price, when I look at those two extremes, low demand and high demand, this pricing flexibility gives me the opportunity to play with price, for example, introducing discounts during low-demand periods to stimulate demand, and then focusing on driving price during high-demand periods. Wonderful. Looking forward to the rest of the course.

In this video, Mariana our Associate Professor discusses with Breffni the role of pricing in managing supply and demand. Breffni will answer the following questions:

  • What’s the goal of revenue management?
  • What aspect of revenue management will you cover in this course?
  • Where does price fit in revenue management?
  • and what is the characteristic of the cost structure for hotels, that allows you to balance supply and demand?

And from your point of view, what is the role of pricing in managing supply and demand?

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Hotel Revenue Management: the Strategy and Tactics of Hotel Room Pricing

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