Distribution: The Cost of Distribution Hitting the Inflection Point

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June 15, 2011
Distribution
Cindy Estis Green - cme25@cornell.edu

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It was a simpler time in the hospitality industry when the cost of distribution was based on call center expenses; the only incremental costs were the 10 percent travel agent commission. With the advent of electronic distribution, hotels started to balk at the cost of GDS fees and complained to the airlines (the original third-party vendors that built the global distribution systems which first sold hotel rooms) that they wanted to display more rate categories, and that the ranking on the screen needed to be random, rather than alphabetical.  Some might call these the good old days.

Consumers have gone online in droves and the distribution landscape resembles a bowl of spaghetti. Connecting all the parts that allow a consumer to shop, check rates and availability, explore hotel and destination amenities and book has become an industry unto itself. There are now many more areas of distribution cost: call center, GDS, a hotel’s own website (brand.com), online travel agencies and the costs associated with the dispersion of rates, inventory and hotel information to the hundreds of websites used for travel shopping along with the conduits to return the ultimate booking into the hotel’s property management system. There are many types of intermediaries facilitating the connection between all these moving parts: channel managers, switches and booking engines, all of which incur costs in addition to travel agency commissions that can now range from 10 percent to 35 percent.  Total costs of distribution, including direct expenses plus implicit costs (such as deep discounting in exchange for first-page placement or prominent featured positions) can cost upwards of an astonishing 50 percent of room revenue, and this steep cost may apply to a third or more of a hotel’s business. The hotels with the clout of a large brand may be half as much. Either way, for many hotels, the cost of distribution has more than doubled or tripled in the last 15 years. Unfortunately, the rates have not.

The transparency of pricing in the online sphere means that a deep discount used as a lead rate to gain visibility and volume is out there for all to see. This yields erosion in other channels when consumers or travel professionals expect access to the promotional rate instead of the corporate or meeting rate that was previously negotiated. Some hotels have gone from an anchor offering, usually called the best available rate, that serves as the basis for negotiated rates, to having rates hinged on the lowest available rate, which essentially becomes the default rate due to its prominence in the marketplace. In other cases, the incidence of deeply discounted rates, intended to be offered as part of a package, may turn up as room-only offers on related sites of the partner agencies. These circumstances may accumulate to the point where the net operating income (NOI) of some hotels is seriously threatened in highly competitive markets. 

Conditions of sale may further exacerbate the situation. For instance, in the name of rate parity, distribution partners often dictate guidelines limiting the rates and offers a hotel can make through its direct channels; it's become a one-rate-fits-all market, even when a sub-segment of customers qualify by length of stay, frequency of visits, stay pattern or other condition for a different rate or preferential treatment. The profit analysis has to be made to decide if the limited rate set and corresponding volume offered by the third party compensates for the inability of the hotel to pursue higher rates or provide preferential treatment for particular customers. The hotel’s capacity to target each segment of its customers with finely tuned offers is effectively disabled when third party conditions constrain them from customizing rates and services to be more relevant to guest’s needs. The result of these constraints are at odds with the ultimate goal of the hotel marketer which is to convey their understanding of the guest’s needs at every point of contact, including the booking process, especially when it is through a hotel-controlled direct channel.

The current situation is not sustainable. When times were flush, it was easier to accept high costs of distribution; there was a sufficient volume of high profit business to compensate. However, with the low tide of the 2009 recession, the pits and scars of the underlying distribution relationships became hard to ignore.  Concurrently, more hotels became increasingly dependent on the highest cost distributors. It was a perfect storm that contributed to one of the lowest points in profitability for hotel owners for the last 20 years.

Now that the demand for hotel rooms is rising, the industry has to examine the complex circulatory system that delivers consumer bookings. Like any evaluation of operating costs, expenses need to be reduced; if a specific cost cannot be lowered, then a hotel can shift its demand to more cost-effective channels. Although a hotel cannot force any given consumer behavior, it can certainly create a bias that makes one channel more attractive than another; there are opportunities to influence online behavior. But most hotel revenue management and sales and marketing personnel are not skilled in the techniques to do this and the tools to do so are limited. That was a primary reason why hotels were driven to the costly third-party channels in the first place; they were a quick and easy source of volume that the hotels could not produce themselves. As the demand grows, the industry has reached an inflection point: is it possible to develop the methodology for building volume through direct channels at a lower cost? Or is it better to make a conscious decision to discharge this responsibility to third parties and accept the new costs of distribution as a given, creating a new economic model for hotels? Practically speaking, in this scenario, the hotels retain operational control, full profit responsibility, but a substantially limited role in demand management.

For hotels that prefer to shift consumer traffic through lower cost direct channels, substantially different techniques have to be deployed.  It isn’t like operating expenses that can be reduced simply by cutting labor or buying less costly materials. There have to be more direct connections built that carry robust sources of high traffic volume, a more aggressive outreach through traditional and emerging search engines to attract consumers, richer content to merchandise the hotel, and a better shopping/buying experience. There also has to be intelligence applied in each channel to determine the product/service and price offered that will most appeal to a hotel’s client base. When done effectively, consumers will feel their needs are met; happier consumers come back more often and spend more money, a natural recipe for success–more revenue and lower costs.

The metrics used to assess a hotel’s performance have not been adequate to alert a hotel about declining margins, even during periods of sufficient demand. Enhanced performance metrics are needed to track a hotel’s progress in building its business mix; a hotel has to determine the channel and segment mix that will result in optimal profit for the dynamics of their local marketplace.

Close inspection is required of channel demand: the variables that influence it, and affect forecasting, and the costs associated with each conduit. As has always been the case in the hotel business, few hotels can fill up on one business segment or one distribution channel. A diverse portfolio of distribution partners delivering different business segments at varying costs is a healthy objective. However, given the minimum costs to run the operation and to attract and retain customers, moving from a distribution cost high of 10 percent of revenue in the old days, to the new high of 35 percent to 50 percent may leave precious little for the essential reinvestment, new development and employment growth during the good times. At this inflection point, the owners, brands and members of the extended and complex hospitality distribution network can consider the opportunity to collaborate on a sustainable model moving forward.

Cindy Estis Green is a marketing consultant who has worked in hospitality for over 30 years. She specializes in online marketing, distribution and data mining. She can be reached at cme25@cornell.edu.

©2011 Hospitality Upgrade
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