The Cost of a Filled Room

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October 01, 2008
Gaming | Technology
Bill Geoghegan - Bill@LGTConsulting.com

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© 2008 Hospitality Upgrade. No reproduction without written permission.

Anyone who has taken a recent airline flight has seen that on most flights, all the seats are full.  Airlines have been the masters of revenue management for many years.  Their accountants have carefully calculated the amortization cost of the plane, the number of hours it can fly in its lifetime, maintenance cost per hour flown, etc., and determined a fixed cost-per-seat mile.  The cost of the crew is the same no matter whether the plane is half empty or fully loaded.  Whether the crew has to work harder on a flight does not factor into the costs, and the cost of the peanuts (if any) is peanuts. 

Of course, there are many factors that go into the cost-per-seat mile calculation, including a complex but straight-forward cost associated with the amortized cost of an airplane, the number of hours it can be flown, maintenance, crew costs, etc.  Today, in the age where passengers are paying for drinks and meals, the variable costs are few —primarily the additional fuel required to fly an incremental passenger.  If a seat goes empty, it still has a cost associated with flying that seat to a destination.  As a result, any revenue defrays that cost, even if that revenue is less than the fixed cost of the empty seat.  There can be other services contributing to the revenue for that airplane, including the amount of freight or mail that is flown, but for an airline to be profitable, it must fill all the seats on the plane.  On occasion, a factor known as density altitude (a combination of the altitude of the runway and the ambient temperature) may limit the amount of weight under which a plane can take off, therefore limiting the number of passengers that can fly on that flight, but for the most part, an empty seat is a non-recovered cost. 

Some hotels take an opposite position on the fixed cost for a room.  For the purpose of revenue management, many hotels consider the cost of an empty room to be $0, assuming that leaving a room empty has no cost. While flying an airplane empty takes a small bite out of the useful life of the plane, leaving a room empty means that there is less wear and tear on the furniture and carpet, and, if properly controlled, little or no energy cost.

 Putting one or two people in that room for one night has a very specific cost, that being the assigned cost of cleaning the room (guestroom attendant wages, linens, towels, etc.) plus the amenities (shampoo, mouthwash, water).  Additionally, the wear and tear factor must be considered, but that is a cost in terms of the number of nights occupied, not a daily cost or per mile flown cost as you might have with an airplane. 

In surveying a number of hotels, depending on the location’s labor costs and quality level of the hotel, these costs could range from less than $15 up to $50 or more per room night.  If the room goes empty for the night, these costs are not incurred.  If the room is occupied, the hotel must receive net revenue not less than those costs.  This means that a very simple calculation of the minimum price that can be charged for a room is that cost plus the cost of any distribution channel commissions and royalties that must be paid.  A hotel with a $35 per room night cost with its highest distribution channel receiving a 20 percent commission and a chain or brand royalty of 6 percent must set its minimum rate at about $46.50 per night.  Any reservation coming in through the highest cost channel will still cover the incremental costs of the room night, and a reservation through any other channel would be positive revenue.

Of course, simply covering the incremental cost of occupancy would not cover the fixed costs of the hotel.  In addition to any debt service, mortgage, real estate taxes and utility costs, there is also the cost of staffing the hotel for the targeted occupancy.  Most staff must be paid whether the hotel is fully occupied or not.  Many Las Vegas hotels run at a staff level that can handle 100 percent occupancy, so gaining an incremental room does not have any additional staffing costs, but many more rural casino hotels are lucky to run at 50 percent to 60 percent occupancy, and getting additional trained staff to cover higher occupancy is problematic.  While a hotel can occasionally handle more guests than the number for which it is staffed, eventually the customer service will suffer and with it the reputation of the hotel. 

For a transient (non-resort) hotel, there are few other sources of revenue beyond the room night charges, especially where there is no restaurant or bar on premise.  For the casino or resort hotel, there is often enough incidental revenue gained to offset a lower price for the room.  As a result, the minimum price that can be charged for a room at a transient hotel must also include a per room night amortization of all the fixed and staffing costs.  Basing the incremental room cost at $0 for a hotel that cannot gain revenue beyond room night charges would result in costs that exceed revenues (i.e. a loss).

Not so many years ago, a major Las Vegas casino hotel was staffed for 80 percent occupancy.  Instead of attempting to fill the hotel, they managed their occupancy by pricing the rooms high enough when they expected to exceed 80 percent to discourage the guest from booking.  If the guest booked at the higher price, they would accept the reservation, but continue to raise the rate to discourage additional guests.  Their ADR was excellent, and they made a good profit, but the restaurants and shops suffered, as did the casino business.  The resort was taken over by a larger entity, which immediately targeted 100 percent occupancy.  The ADR suffered, but the bottom line was much greater, the restaurants and outlets boomed, and the casino flourished. 

In the gaming environment, it has been the casino that has driven the greatest revenue to the resort, filling a percentage of the rooms and paying the hotel for those rooms.  While it is typically just a paper transaction, it allows the hotel to realize a base occupancy at a known rate.  Lesser players not sponsored by the casino are charged a rate lower than the published rate, the difference sometimes supplemented by the casino.  This second segment adds another level to the base occupancy and rate that the hotel can predict. 

A third level of guests is groups, and it is both these and the independent guests that cause a rethinking of the $0-based room cost.  When a resort attempts to raise occupancy by reducing the published rate, it will frequently do so at the cost of losing already booked business from groups or independent travelers.  Many companies and travel agencies monitor changes in booked rates, and will cancel previously booked reservations in favor of the newer, less expensive one.  As a result, lowering the price can actually cannibalize existing reservations made at a higher price.

In a non-casino resort, it is relatively easy to determine the non-room revenue contribution of a guest, because most (although not all) guests will charge any incidental purchase to their room folio.  At worst, the guest might pay directly with a credit card, but with some work, a large percentage of in-house guests charges can be identified by the name on the credit card, and most of revenue generated by in-house restaurants and shops can be attributed to registered guests. 

In the casino, this is not the case.  Notwithstanding the non-guests that visit the casino or shops, it is difficult to identify the in-house guests’ contribution to revenue.  In addition to playing anonymously (not signing up or using a player card) many guests pay cash for meals and other purchases, and many times use their winnings from the casino to make impulse purchases that they would never had made if they had not received a windfall.

The next step in predicting the value of a filled room will not occur until we can find a technique or technology that can identify a guest’s spending habits passively.  Disney created a way by providing a resort identification card that gets a guest into a room, and also allows charges at all outlets within the parks.  In addition to making it convenient for the guest, it also allows them to accumulate the real value of the filled room, no matter what the cost.

Bill Geoghegan is a consultant in Las Vegas. He can be reached for comment at Bill@LGTConsulting.com.

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