With costs of acquisition growing twice as fast as revenue per available room (as Cindy Estis Green of Kalibri Labs has documented), the rising RevPARs give a false sense that all is well and getting better. 

However, once the demand acquisition costs for each source are factored in, the picture often looks less healthy, and hotel owners are increasingly demanding that the bottom line be as healthy as the top line appears. The costs of the acquisition of bookings (whether through PPC or via channels) are rising so quickly, that at present rates, they look certain to squeeze overall hotel profitability despite healthy growth in top lines.

• Smart owners understand the disguised costs that appear as lower ADRs from merchant model OTAs. Expense line items for retail commission costs (think of a commission payment sent to Booking.com) are easier to find on a financial statement than the lower ADR number received from a merchant model OTA after its net rate discount (think of Expedia paying a hotel after it received the guest’s money). But that is a distinction without a difference.
• Owners furthermore realize that there’s no real difference between OTA costs (merchant or retail) and a discount given to a wholesaler/bed bank. There often is a difference in degree in that the wholesale discounts are deeper, and perhaps a cosmetic difference in that those deep discounts are supposed to be hidden from travelers, but that’s not a fundamental difference in kind.
• On another front, marketing costs such as pay-per-click payments (PPC) to Google or meta-search engines, have risen so fast that the effective PPC costs for filling a room are on a trajectory to be no less, and in some cases higher than an OTA retail commission.
• Another cost that used to be considered separately but is in fact akin to paying for a demand source is the cost of affiliation with a chain/brand or representation company/soft brand. Unsurprisingly, free markets tend toward equilibrium and the costs of affiliation are remarkable similar to distribution costs. And why shouldn’t they be? In the final analysis ---- and despite suggestions to the contrary by competing hotel departments ---- corporate rates, loyalty-fueled stays and brand recognition-driven bookings are a demand source just like OTAs and PPC campaigns.

No surprise then that ownership groups are very keen to establish incentives for hotel management (whether it be a brand or an independent group) that are driven not only by gross room revenue but also by profitability targets to make sure managers pay as much attention to the bottom line as the top line.

At the same time, guest behavior changes, plus competition from OTAs, meta search engines (think KAYAK), hybrids (think TripAdvisor) and alternative lodging providers (think Airbnb and HomeAway), plus Google’s evolution have changed the landscape.

The worrisome picture is true overall for acquisition costs but increasingly so for PPC and mobile advertising costs. The old hotelier mindset of thinking of OTAs as enemies and Google as a friend is being replaced by a healthy recognition that we’re all “frenemies.” Unsurprisingly, as hotel PPC bid costs rise, the PPC ROIs that at first looked very enticing may need a serious second look.

Essentially, looking at all-in costs demand generation via Google PPC is not too different from retail commissions or net rate discounts, and managing these high and fast increasing costs often makes the entire difference between rising or declining profits. In some cases, for example a single night stay, effective Google PPC all-in costs may actually be quite a bit higher than a typical retail commission.

The increasing importance of re-targeting, programmatic digital advertising and programmatic cable targeting might suggest an out (if you don’t like the above trends, go programmatic) but in fact, markets are markets and arbitrage opportunities will be eventually snuffed out.

One key industry executive recently observed that cost-free bookings have never been free. That is, what appears to be “free” as a booking via a hotel’s website and central reservations system in fact comes attached to a variety of costs, including:

• Technical, transaction and servicing costs
• Brand/repco fees including the costs attached to loyalty-driven bookings
• Negotiated rate discounts

Consider for example the estimated costs imposed by an affiliation with a major brand.  Affiliation contract terms range widely depending on whether one is talking about a franchising model with royalty fees, a brand-managed property or a repco/soft brand. 

Any one of these can be a major demand generator, but owners and management companies often evaluate the opportunity costs around independence and affiliation, essentially comparing the greater third-party demand generation costs associated with independence versus the added affiliation costs associated with a brand or repco.

As indicated by the author in a Tnooz.com post on July 9, 2015: In this new world, every day and in every way, smart hoteliers are making choices:

• Affiliation vs. independence
• Google vs. channels vs. metas
• Negotiated rates vs. consortia discounts vs. loyalty program costs

These choices all center around the theme raised above: What’s the cost and revenue for that head in that particular bed? And which approaches can most cost-effectively deliver that demand?

What independents cannot cost-effectively do is engage in brand advertising above Google, which means TV, cable and mass market digital advertisements. This approach can work for large chains and for omnipresent distributors such as KAYAK and the OTAs, but is not cost effective for an individual property or a small hotel group.

While the answer is not the same for every hotel, group or chain, there are three broad possibilities. Hotels can:

• Innovate/differentiate in remarkable ways to find “Blue Ocean”. Blue ocean strategy is the simultaneous pursuit of differentiation and low cost to open up a new market space and create new demand.)
• Become part of a brand big enough to engage in demand generation
• Turn demand generation over to pros like Booking.com and Expedia
• Double down on PPC (whether Google or meta-search or both)

On the innovation front, authenticity and novel experiences open the door to all sorts.  One of our clients in China, faced with giant incumbents, sought innovation in one of its brands via an aggressive eco-friendly posture. URBN, a brand of the Cachet Hotel Group, is China’s first carbon-neutral hotel and derives much of its demand from climate-conscious guests who specifically search for carbon-neutral properties.

As for joining a brand, it is a well-trodden path and requires no explanation (other than understanding that corporate sales, loyalty and brand distribution aren’t free any more than Web bookings are free). Loyalty redemptions, brand/repco program fees and the benefit of corporate sales are best treated as opportunity costs like any others.

Turning demand generation over to Booking.com or Expedia may deserve a bit of an explanation and it’s not as odd as it may sound. For example, citizenM knew as it started that the costs to introduce its brand, get enough awareness in several continents, and on top of that generate tactical demand, were prohibitive. So it treats Booking.com as a strategic partner to generate demand and focuses instead on making the in-house experience “wonderful.” 

One interesting trend that goes some of the way to explain citizenM’s choice and Booking.com’s extraordinary growth is the public’s ever-increasing ease with digital self service.

Historically, merchant model OTAs such as Expedia have long justified their insistence on net rate discounts that are nominally larger than comparable retail commissions, on the grounds that they incur added costs such as:

• Credit card processing fees
• Customer servicing costs (phone calls with questions, cancelations, etc.)

However, what seems to be increasingly happening is that as retail commission OTAs such as Booking.com improve the user experience on their sites, consumers are increasingly able and willing to self service on retail agency websites. This means that hotels don’t have to worry as much about post-booking call center costs for servicing retail commission bookings. 

In this light, the delta between Booking.com’s retail commission costs and Expedia’s net rate discounts should perhaps be smaller than it was some years back… and this is perhaps one of the reasons for the relative popularity of the retail commission model among hoteliers.

Regardless of the chosen strategy though (innovate, join a brand, rely on distributors), what we see everywhere is a focus on holistic demand generation and a fuller understanding of the opportunity costs around all demand sources as the key to achieve superior competitive performance in hospitality.

This is very healthy for hoteliers and we see evidence of how increased competition among hotel distribution alternatives is leading to a better deal for hotels. As reported in the Financial Times on August 31, 2015, (Starwood targets UK and Europe for growth with Tribute chain), Starwood is proposing that “independent hotel owners pay between 4 percent to 6 percent of their room revenues to Starwood in return for access to the group’s booking system, marketing and its Starwood Preferred Guest loyalty scheme.”

This news report is very surprising as normal fees (see Affiliations Costs chart) are two to three times higher. It may be that the Financial Times got it wrong, but if true, Starwood is offering Tribute hotels the benefits of affiliation for half of typical charges that say Marriott would charge an Autograph hotel.

Along another positive front, Google has recently recognized that (as shown above) its old CPC model was increasingly problematic for independent hotels and even for brands. Accordingly, it has shut down Hotel Finder and announced a global program based on the retail commission model. The Google Hotel Ads Commission Program is available globally and, together with Google’s Instant Booking (for now U.S. based), it allows hotels to pay a modest commission on actually delivered bookings without having to gamble on PPC costs that were getting out of hand.

Taken together, these developments suggest that although other distribution costs are rising too fast, there is downward pressure on both brand affiliation costs and Google-based distribution costs, which owners and operators will surely welcome.

Max Rayner is a partner at Hudson Crossing and his practice areas include strategy, transactions, agile transformation, product innovation, technology and user experience.