Hotel segments and the laws of economics

The opportunity to examine hundreds of hotel markets and thousands of competitive sets because of joining STR Analytics, we have observed that the hotel industry operates some counter to other sectors of the economy.

During a severe economic recession, most of industries find products which cater to the budget-conscious lose less or even increase demand relative to those that appeal to the luxury segment. But STR data indicates the opposite occurs in the hotel industry.

In other industries, customers continue or even increase demand for products offered by the likes of McDonalds, Wal-Mart and Hyundai, while Ruth’s Chris, Neiman Marcus and Cadillac suffer lower demand than ever. But in the hotel world, the economy and luxury segments both lost 8.8% in occupancy from 2008 to 2009 based on the 2009 year-end results. Something inverted is going on here.

Worse yet, it was the economy and midrate properties that held prices to the greatest degree (both on a dollar and%age basis) as evidenced by average daily rates declining a mere 5.5% to 6.8%, while upscale, upper-upscale and luxury hotels dropped prices between 10% and 16% during the same time frame.

I recognize the ADR declines in the larger hotels result from segmentation shifts (group to transient) as well as from decreased rates, but Hotel 101 suggests the transient guest should be asked to pay more than the group rates, so a shift out of groups should be a net positive in rate and negative in occupancy, not the other way around.

As a result, upscale hotels actually saw demand increase in 2009 as a result of these price contractions as guests shifted somewhat out of luxury (perhaps due to the AIG effect) and shifted hugely out of midrate and economy properties because when presented with their cake (upscale accommodations) and the chance to eat it, too (at low prices) guests not surprisingly indulged themselves.

So how did this inverted market economy/anomaly engulf the hotel industry?

Following the past two years of performance trends, the statistics speak for themselves. Luxury hotels react first in a downturn by offering the deepest (percentage) discounts initially (16.6% from 2008 to 2009). For a USD 300 ADR property, that equates to now charging USD 250. Following suit and in an attempt to maintain a price differential for the consumer, the upper-upscale hotels in the market will drop their USD 200 rate to USD 175; the upscale hotels go from USD 150 to USD 135; focused-service and first-class extended-stay from USD 130 to USD 120; midrate from USD 95 to USD 85; economy from USD 65 to USD 60 and budget from USD 60 to USD 55. Meanwhile occupancies decline most at the budget and economy properties and, in general, the lower-price tier because guests prefer the nicer products and the price gap between the tiers has contracted.

This is a problem, particularly for the less expensive products that lose business because their biggest competitive advantage, namely relative pricing, has been significantly diminished. But it also severely hurts the upper end of the market because it reinforces, often for years to come, their typically more affluent guests’ perception that price has greater weight in their decision than it should.

Perhaps next time we have a downturn, or even next week as we try to emerge quickly from this capsized economy, we can turn the hotel industry right-side-up with regard to the laws of economics. Hold prices as best we can and let the market decide what accommodations consumers demand. If more travelers shift out of luxury and upper-upscale hotels and into midrate and economy hotels, so be it. Those who have the money and value what luxury and upscale have to offer will still pay the premium, and half of that market at full rate is better than all of that market at half rate.

And if discounting does need to occur, let’s do it in the direction it is supposed to flow for everyone’s benefit. The budget hotels initiate lower pricing to the price-conscious traveler since low-cost alternatives are the primary competitive factor they offer to guests. This means that they should go from USD 60 to USD 50 (-16.6%), the economy properties follow suit and lower rates from USD 65 to USD 55; midrate from USD 95 to USD 80; focused-service and extended-stay from USD 130 to USD 115; upscale from USD 150 to USD 135; upper-upscale from USD 200 to USD 180 and eventually luxury going from USD 300 to USD 275. This bottom-up approach to discounting puts the price emphasis in the segment where it belongs, the economy tiers where price is the main differentiator. It also allows the upscale and luxury brands that offer amenities well beyond price to entice guests to pay more if they still value higher levels of service and accommodations, which all our surveys suggest they do.  This enables demand to either slide downward or ideally, decline equally across all chain scales. In either case, each segment loses less revenue during the downturn and more importantly, recovery can occur much more quickly.