Establishing Room
Rates
Yvonne Yang - RDM LRJJ
1
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Contents
Tariff construction
Positioning price
Establish room rates
Pricing rooms:
Market Condition approach
Rule-of-Thumb approach
Hubbart Formula approach
Yvonne Yang - RDM LRJJ
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Tariff construction
• How do hotels set their rates?
• A determination of:
– Economic calculation
• To price & to understand how consumers
react to the pricing strategy
Revenue
– Marketing decision
Mgr
• Positioning
FrontOffice
Mgr
Yvonne Yang - RDM LRJJ
Director
of
Sales
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Tariff construction
• What is “Price”?
– An amount ($) as an exchange to acquire
goods or services
– In order to understand:
• How much to charge for its
accommodation
• How to be attractive and
competitive with other hotels
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Positioning Your Price
• Approaches to Positioning Your Price
1. Skim - to skim, set your prices higher than the
competition does so you can "skim off" the higher-paying
customers. If the competition is charging $79, you might
set your rates at $89 and $99, in hopes of getting the
people who are willing to pay a bit more.
2. Match - to match, set one rate to match the competition
and another rate slightly higher. For instance, if the
competition is charging $79, you might also charge $79
for one type of room and have an $89 rate available for a
better room or option.
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Positioning Your Price
3. Surround - to surround, offer one price that's lower
than the competition's price and one price that's
higher. If the competition is charging $79, offer a $69
rate to attract the bargain-seekers, and offer an $89
rate for a slightly better room or option.
4. Undercut - to undercut, offer a price that is the same
as your competition and a lower one as well. If the
competition is charging $79, offer a $79 rate and a
$69 in hopes of attracting more customers.
5. Penetrate - to penetrate, set your rates lower than
those of the competition. If the competition is
charging $79, offer rates such as $69 and $59 in
hopes of getting consumers to try your products.
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Positioning Your Price
The table above illustrates the five approaches to
positioning your price against the competition's. In
this example, the competition is charging $79.
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Establishing Room Rates
• Criteria's influencing room
rates:
•
•
•
•
•
Size (square meters)
Type of room and bed
Location / View
Grade (Stars *)
Furnishing / Amenities
(features)
• Level of Service
• Type of business
• Etc…
• What about?
Yvonne Yang - RDM LRJJ
• Season ?
• Weekday or
Weekend?
• Time of arrival?
• Inclusive or non
inclusive?
• Per person or per
room?
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Pricing Rooms
1. Market condition approach
2. Rule of thumb approach
3. Hubbart formula approach
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Market Condition Approach

The simplest and the most commonly used
approach

Management looks at comparable hotels in the
geographical market and sees what they are charging
of the same product (normally 6 to 10 hotels)


These properties are called as “competitive set”
The competition can be based on location,
property ratings, property type, brand identification, or
other factors
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Market Condition Approach

This could be done by “blind calls” to competing
hotels, the following questions will be considered:
- Are our rates lower or higher than the competing hotels?
- How are our rates affecting our revenue?
- What is our occupancy percentage? What are the ones
of the competing hotels?
- If we increase or decrease our rates, will our total
revenue improve?
- Have any trends emerged during the past 3 to 6 months?

This also could be done by “industry report”: IBHS
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Market Condition Approach
Disadvantages
 If the property is new, construction costs will most
likely be higher than those of the competition
 This approach does not take the value of the
property into consideration (newer facilities and
amenities)
Reality
 Rates might also be obtained through price order
company such as certified accounting firm
 Revenue managers among hotels might have
direct discussion with competitors
 Rates may also be available from public sources:
Internet, GDS, CRS or published rate brochure
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Rule-of-Thumb approach
 Set the rate of a room at $1 for each $1000 of
construction and furnishings cost per room,
assuming a 70% occupancy.
 Example: a hotel with the average construction
and furnishings cost per room is $125,000, the
minimum average room rate would be $125.
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Rule-of-Thumb approach
 A well-maintained hotel worth $100,000 per room
today may have been constructed at $20,000 per
room 40 years ago
 The average selling price will be $20 per room
 A much higher rate would appear to be appropriate
since inflation, increased costs of labor, furnishings
and supplies have not been taken into account
(CPI)
 This approach DOES NOT take inflation into
account.
• This approach DOES NOT consider other facilities
and services (e.g.: F&B, recreation, laundry)
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Rule-of-thumb Approach
Average per-room cost for hotel development:
Segment
Per-room cost

Budget/Economy
$52,800

Mid-range w/o F&B
$85,600

Mid-range with F&B
$103,100

Full Service
$165,900

Luxury/Resorts
$516,300
From Hotel & Motel; Jan. 12, 2012
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Rule-of-thumb Approach
• A hotel costs investors a total of
$15,465,000/-, and has 300 rooms. Calculate
an ARR with this information
• A second hotel costs $9,895,000/- and has 60
rooms. Calculate an ARR
• A boutique hotel costs 2,500, 00/- and has 12
rooms. Calculate an ARR
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Hubbart Formula Approach
“Bottom-up” approach
Method:
1. Calculate desired profit

2. Calculate pre-tax profits
3. Calculate fixed charges and management fees
4. Calculate undistributed operating expenses
5. Estimate non-room operated department profit/loss
6. Calculate required rooms division income
7. Determine rooms division revenue

8. Calculate average room rate
Yvonne Yang - RDM LRJJ
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Hubbart Formula
• Example:
Return
– Look at desired Profit
– Add all costs
Costs
=
– Gives Average Price per Room
Yvonne Yang - RDM LRJJ
ARR
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Case 1
Holiday Inn Hotel, a proposed 30-room with a fully equipped
restaurant, will cost $750,000 to construct. An estimated
additional $50,000 will be invested in the business as working
capital. Of the total $800,000 investment, $400,000 is to be
secured from the Bank of China at the rate of 10% interest
and cash $400,000 provided by the owners. The projected
occupancy rate is 80% for the year. The owners desire a
15% annual return on their investment after the hotel pays
income taxes of 25%. The estimated undistributed expenses,
not including income taxes and interest expense total
$480,000. The estimated direct operating expense of the
room department are $7 for each room sold. Consider a year
to have 365 days.
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Case 1: Holiday Inn Answer
Item
Calculation
Owner's investment
Amount
400,000
Desire net Income for the owner（ROI: 15%）
400,000*0.15=60,000
60,000
Income tax rate:25%
Pretax income=60,000/1-0.25
80,000
Plus: Interest expense :10% annual interest
400,000*0.1=40,000
40,000
Income needed before interest expense and taxes
120,000
Plus: Estimated depreciation, property taxes, and insurance
0
Income before fixed charges
120,000
Plus: Undistributed operating expense
480,000
Required operated departments income
600,000
Less: Other departments' income
0
Rooms department income
Plus: Rooms direct expense
600,000
30*0.8*365*7=61,320
Rooms Revenue
Number of rooms sold
61,320
661,320
30*0.8*365=
Required average room rate
8,760
75.49315
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Case 2
– The proposed Harris Place (a 50 room, room only
lodging facility) is to be built in mid-Michigan.
Jeremy Harris, the owner is concerned about the
ADR, construction costs, borrowing costs, and
their impact on future profits. He provides you
with the following information.
Proposed Costs of the Lodging Facility:
•
•
•
Land Building Equipment -
$400,000
$2,000,000
$1,000.000
Yvonne Yang - RDM LRJJ
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Case 2
Financing
•Equity (desired return on investment (ROI = 15%) $1,000,000
•Debt (8% annual interest rate)
$2,400,000
•Income Tax Rate: 40%
•Property Taxes: $120,000 per year
•Fire Insurance: $30,000 (annual)
•Depreciation of Building: 40 year life straight line method, ($50,000
per year)
•Depreciation of Equipment: 10 year life, straight line method,
($100,000 per year)
•Undistributed Operating Expense: $300,000 annually
•Rooms Department Direct Operating Expenses: equal $30,000
annually
•Expected Paid Occupancy: 70%
•Determine the required ADR to achieve Jeremy Harris’ goal of earning an
ROI of 15%
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Hubbart Formula Case 2 Answer
Item
Calculation
Owner's investment
Amount
1,000,000
Desire net Income for the owner（ROI: 15%）
1,000,000*0.15
150,000
Income tax rate:40%
Pretax income=150,000/1-0.4
250,000
Plus: Interest expense :8% annual interest
2,400,000*0.08
192,000
Income needed before interest expense and taxes
442,000
Plus: Estimated depreciation, property taxes, and insurance
120,000+30,000+50,000+100,000
300,000
Income before fixed charges
742,000
Plus: Undistributed operating expense
300,000
Required operated departments income
1,042,000
Less: Other departments' income
0
Rooms department income
1,042,000
Plus: Rooms direct expense
30,000
Rooms Revenue
Number of rooms sold
1,072,000
50*0.7*365=12,775
Required average room rate
12,775
83.91
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Case 3
• Barbara Rope, a wealthy investor, is
considering investing $2,000,000 in a 300
room hotel. Debt financing would total
$8,000,000. She desires to know the
average room rate her hotel will have to
charge, given the following alternatives.
Yvonne Yang - RDM LRJJ
www.lrjj.cn
Case 3 Information
#1
#2
Desired ROI
Interest Rate
Tax Rate
14%
12%
30%
Estimated
Annual Fixed
Charges
(excluding
interest)
$700,000
Undistributed
Operating
Expense
Alternatives
#3
15%
12%
30%
#4
#5
16%
13%
30%
17%
14%
30%
18%
14%
30%
$700,000
$700,000
$700,000
$700,000
$3,000,000
$3,000,000
$3,500,000
$3,500,000
$3,500,000
$300,000
$300,000
$400,000
$450,000
$450,000
$10,000
$10,000
$10,000
$10,000
$10,000
Varible Cost per
room sold
$15
$15
$20
$20
$20
Occupancy rate
65%
70%
65%
75%
80%
Departmental
Profits
-Food
-Telephone
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Case 3 Answer
#1
Net Income
#2
#3
#4
#5
$280,000
$300,000
$320,000
$340,000
$360,000
$400,000
$428,571
$457,143
$485,714
$514,286
$960,000
$960,000
$1,040,000
$1,120,000
$1,120,000
$700,000
$700,000
$700,000
$700,000
$700,000
Undistributed
Operating
Expense
$3,000,000
$3,000,000
$3,500,000
$3,500,000
$3,500,000
Food Income
-300,000
-300,000
-400,000
-450,000
-450,000
-10,000
-10,000
-10,000
-10,000
-10,000
Room
Department
Expense
$1,067,625
$1,149,750
$1,423,500
$1,642,500
$1,752,000
Room Revenue
$5,817,625
$5,928,321
$6,710,643
$6,988,214
$7,126,286
71,175
76,650
71,175
82,125
87,600
$81.74
$77.34
$94.28
$85.09
$81.35
Pretax Income
Interest Expense
Other Fixed
Charges
Telephone
Income
Est. Room Sold
ADR
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