Economics project on hotel industry

Microeconomics Project

Study of Pricing Strategy in Hospitality Industry

September1 2015 Submitted by: Section B | Group 10 Somyata Rastogi Deval Nigam Lipika Agarwal Pallav Singhal Pushkar Singh Shrey Bhat Vikas Gupta

15P070 15P080 15P090 15P097 15P100 15P110 15P120

Faculty: Dr Rupamanjari Sinha Ray

Page | 1

EXECUTIVE SUMMARY In this report, we have examined the pricing of hotel industry from three perspectives: cost, supply-demand and competition strategies. First effect on pricing due to external factors such as Economic scenario, CPI index, seasonality of demand and other factors. Internal factors such as occupancy rate and location advantages were also discussed. Indian hotel industry was studied by considering supply demand characteristics considering foreign tourist arrivals, capacity addition and supply demand imbalance. Shift of focus of hospitality sector towards food and beverage segment was underlined. Different pricing strategies related to competitors such as skimming, matching, and undercutting and penetrating was also touched upon.

Page | 2

Table of Contents Executive summary.................................................................................................................. 2 Defining the economic contribution of Travel & Tourism...................................................................4 Travel and Tourism Industry in India............................................................................................ 4 Factors affecting pricing in Hospitality Industry..............................................................................7 External factors.............................................................................................................. 7 Internal factors............................................................................................................... 8 Market structure - segmentation.......................................................................................9 Supply demand imbalance in Premium hotels category..................................................11 Economic explanation of demand supply mismatch........................................................13 By decrease in demand of hotels due to poor economic conditions:............................13 Increase is number of rooms offered or increase in supply..........................................14 Pricing Strategies................................................................................................................. 15 Target of Pricing................................................................................................................... 16 Bibliography........................................................................................................................ 19

Page | 3

Defining the economic contribution of Travel & Tourism Travel & Tourism is one of the most important economic activity in all countries around the world. This industry is not having direct economic impact but at the same time this sector has significant indirect and induced impacts on economy. The UN Statistics Division-approved Tourism Satellite Accounting methodology quantifies only the direct contribution of Travel & Tourism and recognises that Travel & Tourism's total contribution is much greater however, and aims to capture its indirect and induced impacts through its annual research.

Travel and Tourism Industry in India In 2014, the tourism industry contributed INR 7.64 trillion and 36.7 million jobs to the Indian economy. By the end of 2015, the travel and tourism sector forecasted to contribute INR 8.22 trillion or 7% of India’s gross domestic product (GDP) and 37.4 million jobs – almost 9% of total employment. Not only India is the second largest tourism market in Asia after China, the country was also ranked in the top 20 fastest-growing tourism destinations worldwide by the World Travel and Tourism Council. Placed eleventh in the list, the direct contribution of travel and tourism to GDP in India is expected to grow an average of 6.4 percent Page | 4

annually between 2014 and 2024.India’s travel and tourism economy is poised to grow 7.5% in 2015 over last year, exceeding the 6.9% growth that the global forum has predicted for the South Asian region. But the overall contribution of India’s travel and tourism sector to the overall economy is still relatively low (6.7% of GDP, against a global average of 9.8%). Investment in the sector is likely to rise by 9.3% in 2015 over 2014 when travel and tourism investments in the country accounted for INR 2.11 trillion, or 6.2% of total investments. It is expected to grow by annual rate of 6.5% over the next 10 years to INR4.33 trillion by 2025 that is 6.9% of the total GDP. Adding that, the tourism sector has the potential to contribute 46 million jobs to the India economy by 2025. Worldwide, the contribution to GDP from travel and tourism will have grown by 3.7% by the end of this year and the sector will contribute 284 million jobs, directly and indirectly, or one in 11 of all jobs on the planet. In 2014, foreign tourist arrivals (FTA) has increased to 7.46 million as compare to 6.96 million during the same period in 2013. FTA growth rate for 2014 is 7.1% compare to 5.9% growth last year. The largest source market for visitors to India was the United States, followed by the United Kingdom. In 2014, Foreign exchange earnings from tourist was 1,10,083 crores with a growth rate of 11.5% as compare to FEE of INR 1,07,671 crore with a growth rate of 14% during last year. Outbound travel from India is also on the rise; approximately 860 thousand Indian nationals traveled to the U.S. in 2013. This figure was forecasted to rise to 1.32 million in 2018. Europe is even more popular, with 1.77 million Indian tourists traveling there in 2014. Hotel prices in India are relatively low compare to other developed countries. It is only rising above 100 U.S. dollars once in the first half of 2014 when average daily rates reached 104.11 dollars in February. In 2013, Mumbai was the second cheapest city in the world for U.S. travelers staying in five-star hotels. With an average daily rate of 177 U.S. dollars, the city came second only to Warsaw in Poland, where the average price for a night in a five-star hotel was just 124 U.S. dollars.

Page | 5

Hotels are complex organizations, creating value for consumers and investors by combining bricks and mortar with people and technology. Their performance is not only affected by macroeconomic cycles and consumer trends, but is also linked to that of parallel sectors such as airlines and travel companies; seasonality of demand, and product innovation affect performance. Cost

Pric e Compe tition

Dema nd

Page | 6

Factors affecting pricing in Hospitality Industry External factors 1. Economic Scenario: the economic scenario of the world has direct impact on hospitality industry. When economic is growing consumers’ earning is growing and this lead to increase in spending power of customers. This lead to positive demand in hospitality industry. This demand can be correlated to the demand of rooms of five-star hostel across country. This increase in demand push the prices up in a positive economic environment and to cater customer demand in future major player in the market plans for expansion. This way hospitality industry contributes not only direct GDP contribution but also indirectly contribute by increasing the demand of infrastructures. The positive economic scenario led to increase in demand of rooms and in short run led to increase in room tariff. 2. CPI index: Inflation effect the growth of hospitality industry in two ways. First this lead to decrease in spending power of consumers and on the other way this lead to increase in expenditure incurred by the hotels on utilities such as electricity, fuel and food items.This lead to increase in cost of running a hotel and adversely affect the future growth plan. 3. Seasonal demand: Hospitality sector's business has cyclical trend with major earning occurring in seasons. Holiday destinations such as Goa, Puducherry, Andaman have a specific season where tourists prefer to arrive. This sees a spike in demand and hence the prices of the room. Also in Indian scenario all tourist destination see increase in demand of summer time due to kids’ vacation. 4. Growth of IT/ITES professional services: Each year thousands of students find employment in IT sector which is growing at a fast pace. As IT companies continue to grow so does their need for hotel rooms for various business engagements. Corporate clients are the most important clients for hospitality sector as they offer long term contracts and thus

Page | 7

provide stability of earnings to the hotel company. Growth is hotel industries of Bengaluru and Pune is largely due to growth of IT sector in these cities. 5. Travel and Tourism: As per the Travel and Tourism Competitiveness Report 2015 by the World Economic Forum, India is ranked 52nd in the world for its attractive tourist destinations. It is ranked the 17th best tourist destination for its natural resources and 10th for its cultural resources, with many World Heritage sites, both natural and cultural and rich fauna. India also bagged 35th rank for its air transport network. India is also ranked 8th overall for its price competitiveness. With such strong fundamentals, it is not surprising to suggest large demand for hotel industry in the future. 6. Technical Innovation: Penetration of new technology is increasing in business world. People are looking for cost effective way to conduct their business. So increase in use of video conferencing may lead to low growth of hospitality industry in future. Internal factors 1. Occupancy rate: Demand for rooms is highly seasonal in nature with occupancy varying substantially over the year. In order to maximise its revenue, hotel companies need to have knowledge of price elasticity of the room tariff. During the time of peak season price elasticity of demand is very low and hotels charges more tariff from customers but in the case of lean season to maximize their revenue and profit hotels adopt low pricing model as price elasticity of consumers is high during that time. Average occupancy rate of five-star Indian hotels stood around 60.4 per cent in 2013-14 as per HVS Indian Hotel Sector Outlook. 2. Expansion plans: With tourism and economy showing a positive outlook, many players in the industry are investing in capacity expansion. Over medium to long term this will help reduce Average Total Cost of the hotels and increase the earnings for the sector in general. However, increase in supply of rooms must be in tandem with the demand outlook. As per Page | 8

HVS Indian Hotel sector outlook, inventory of branded rooms was pegged at 1,08,059 in 2013-14 and expected to grow at 17 percent per annum. Oversupply of rooms due to new hotels can put additional burden on existing properties. 3. High Competition: Competition forces the players to go for reduction in prices to attract customers. For Example, Lemon Trees offered huge discounts in December 2014 to clear unsold inventory (unoccupied rooms). As hotel industry is not perfect substitute with each other offering so there is monopolistic competition exists in the market. 4. Geography factors: Leisure destinations such as Shimla, Goa, Dehradun and others command a premium over other locations as demand is high from tourists during season. 5. Cost elements: Costs are different in different cities. For Example, metro cities such as Mumbai and Delhi are more expensive as compared to tier 1 cities like Jaipur, Agra and other tier 2 and smaller cities due to variation in inflationary pressures. As a result, power, fuel and food & beverages costs vary. Thus prices of rooms vary across cities.

Market structure - segmentation

The market of hotel industry can be divided into these segments: Premium 5 star hotels Located in business district of metro cities Cater to business travelers and foreign tourists Considered to be the most expensive Mid player 4 and 3 star: Cater to: Average foreign and domestic leisure travelers. - Also caters to middle level business travelers

Page | 9

- Offers most of the essential services of luxury hotels without the high costs since the tax component of this segment is lower compared with the premium segment Budget hotels Do not offer as many facilities as the other segments but provide inexpensive accommodation to the highly price-conscious segment of the domestic and foreign leisure travelers But these days OYO rooms kind of startup are changing the scenario in this segment. Where they are providing above avg. service while charging only in range of 1000 – 2000 rupees Heritage Certain architecturally distinctive properties such as palaces and Forts, built prior to 1950, have been converted into hotels. The Ministry of Tourism has classified these hotels as heritage hotels Unclassified Cheap motels spread out across the country Very cheap and price is the only selling point The Budget Concept

 A new concept emerged as number of tourists willing to pay a high price for luxurious hotels has decreased while number of inbound tourist who travel has dramatically increased. Comfortable accommodation is not luxury anymore  The Americans innovated the “Motel” concept in the 60 th which was adopted by European in the 70’s with the creation of brands such as Ibis and Formula1, and Asia has come up with the “budget” concept.  The new concept offers what the customer is willing to pay for a good night sleep so that everyone is allowed to travel

Page | 10

Page | 11

Supply demand imbalance in Premium hotels category

According to the ICRA Ltd., there has been demand supply mismatch in premier hotel

segment. According to the statista.com, during last year occupancy rate was around 55-60%. Also growth addition in supply of premium rooms is more than 10% except this year it is only 4%. On the opposite side occupancy growth was sub 5%. This will lead to further demand supply mismatch and hotels have to wait for rather long time before they can able to generate profits.

Page | 12

YEARS 2008/09 2009/10 2010/11 2011/12 2008/09 TO 2013/14: Inventory 48,475 61,795 71,531 84,313 % Growth 3.0 27.5 15.8 17.9 Occupancy 59.5 59.5 60.6 59.3 % % Change -13.0 -0.1 1.8 -2.2 RPD 28,862 36,768 43,348 49,964 % Change -11.0 27.4 17.9 15.3 ARR 7,722 6,489 6,513 6,032 % Change -3.0 -16.0 0.4 -7.4 RevPAR 4,598 3,861 3,947 3,575 % Change -16.0 -16.0 2.2 -9.4 RPD-demand for room nights; ARR-Average RevPAR=- Revenue per Available Room

2012/13

2013/14

CAGR

93,479 10.9 58.4

108,059 15.6 57.1

17.4% -0.8%

-1.5 54,583 9.2 5,803 -3.8 3,388 -5.2 Revenue

-2.2 61,678 12.0 5,687 -2.0 3,246 -4.2 per

16.4% -5.9% -6.7% room

Occasional spurts in room occupancy rates and room tariffs offer a glimmer of hope on improving profits. But a recovery has been eluding the sector for many years. Shares of luxury hotel chains therefore have fallen significantly compared to broader benchmark indices. The situation is unlikely to improve soon, going by the supply addition forecast and current macroeconomic scenario. Analysts say that the slight uptick in room tariffs in some luxury destinations during the latter part of fiscal year 2015 was due to some improvement in inbound tourism and domestic tourist movement. Also, the capacity addition during the year was down to 4%.

Page | 13

Moreover, the gap between supply of rooms and demand growth is likely to widen in the coming quarters. According to ICRA, in the months ahead till March 2016, supply of premium hotel rooms is likely to go up by 12% and then 14% the year after. On the demand front, better business confidence is yet to translate into more travel. Weak corporate results and subdued wage and salary hikes are a threat to discretionary spending. Foreign tourist arrivals (FTAs) grew in the first six months of the calendar year, though the growth rate was less impressive than the year-ago period. Some analysts say the Internet and the technology revolution has also impacted adversely the need for business travel. In times of weak profitability, industry chose to cut down discretionary expenses like travel. Hence, occupancy rates may improve only marginally. But the higher room capacity may keep the revenue per average room at current levels. Certainly, with rising costs and capital expenditure, low revenue will hurt profits. The only silver lining is that in the last two years, premium hotels have cut down debt. Lower revenue and profitability notwithstanding, interest cost as a percentage to sales has come down. Some are even strategically increasing the share of food and beverages in the business as it is less capital-intensive when compared to the addition of rooms. But, with occupancy levels stagnating at an average of 56-60% for the last three to four years, one cannot expect a drastic turnaround in the sector’s fortunes.

Economic explanation of demand supply mismatch By decrease in demand of hotels due to poor economic conditions:

As economy is showing sign of decline in current scenario we expect that demand of hotel room will come down in recent future and primary reason for this is low earning of consumers. Recent time sees the decline of commodity market and macroeconomic indicators of most of the economy is showing recessionary trend. According to the figure we can see that when demand of a product reduces its equilibrium prices also reduce. Page | 14

P

D’

D S

Pe P’e

Q’e Qe

Q

Increase is number of rooms offered or increase in supply Due to higher demand forecast in previous year many big players added more no. of rooms in their portfolio. But sudden decrease in demand coupled with high supply of rooms will further reduce the equilibrium pricing.

P

D’ D

S

S’’

Pe P’e Q’e Qe

Q

Page | 15

Pricing Strategies The pricing strategy followed by the tourism industry is a mix of following price strategies: 1. Second degree price discrimination: All the majority of five-star hotel provide variable room tariff depends on the number of days a person stays or number of rooms a person is willing to book. This kind of behaviour can be explained

by

second

degree

price

discrimination where price of product is depending on quantity demanded. In this type of strategy company cannot differentiate between different types of customers and hence, depending on their demand of the product the pricing is set for each customer. Thus, bulk orders attract more economical prices, this is evident in event planning sector, where more is the audience, less is the per person cost for the whole event. Due to bulk order, economies of scale are benefitted to the producer, who then passes a proportion of this benefit to the final customer in form of discounted rates. Here, in the screenshot below second degree price discrimination is provided by an online event planning merchant based on the group discounts.

Page | 16

2. Third degree price discrimination: In this sort of pricing strategy, costumers are divided into various segments based on the frequency of their visits/ usage of services or based on demographics. Each customer segment is provided with different kind of benefits in form of discounts or special rates/ services. This can be understood from the depiction above, where the discrimination is done for senior citizens and military and/or government employees. At many places, like amusement parks and even transportation services student discounts, company discounts, corporate discounts are given by the service providers. Based on the history and frequency of availing the services from the service provider, discrimination could be done as premium customer and regular customer or also, special pricing could be done for the 1 st time users so as to convert them into permanent ones. On a broader perspective the strategy for a customer segment is done based on the response to price elasticity of demand. Hence, if we see, student and senior citizen discounts are given as these customer segments are more elastic to price elasticity of demand. 3.

Tying and Bundling: To increase the revenue of hotels, sometimes we see that a hotels are offering price which include complimentary breakfast and sometimes a

Page | 17

complimentary meal with the stay. By doing this kind of offering they are bundling two services into one so that they are able to extract more and more consumer surplus. Also we see in tourism industry is rampant phenomena that tourist agencies are offering tour package of some of the preferred tourist destination such as Malaysia, Europe, Thailand, Africa etc. In these kind of offerings they are again bundling all the services like stay, transportation etc. so that they can able to maximize their profit margin. Another bundling pricing practice that we have seen is combo deals on booking flights and hotels together.

Page | 18

On the home page of Make my trip, one of the India’s leading online hospitality services booking website, it is evident that one can get better deals if one books hotels for their stay along with their flight booking for travel purpose. 4. Competitive pricing: As tourism industry can be classified into monopolistic competition so producer has little influence of pricing. Due to ever increasing competition and free availability of information over the internet, producers are engaging in price war to lure the prospective customers. 5. Value based pricing: This is only applicable in case of monopoly. There exist some of the hotels like Raj Vilas palace in Udaipur where price is charged by the perceived value of the customers. This can also be applicable in case of trekking package of the Mount Everest, where price goes into millions for single individual. 6. Dynamic Pricing: dynamic pricing is very evident in hospitality industry. Based on the seasons and market demand, the prices of rooms and services are decided. For example, if we consider Goa, then November to January is considered to be peak season for tourism and all the hotel and hospitality services industry charges a lot more for same services and rooms when compared to rest of the off season charges. The reason being simple, as in the peak season, the demand increases and so it shift the equilibrium to new increased prices as depicted in the diagram below. Also we can see that the equilibrium quantity also increases and thus, there is also, complete utilization of market resources. The overall effect is increase in producer surplus.

Page | 19

The same trend is evident in the travel industry also, where airlines and now, even IRCTC (under premium tatkal scheme) follow dynamic pricing strategy based on the demand. To overcome the week demands during off seasons of off timings, service providers can follow Special – Event pricing strategy, to attract more demand of customers. This strategy is evident in restaurants during lunch time on weekdays, when the demand is usually low, many restaurants provides buffet system and special menus, wow Wednesdays at this time to attract customers.

Target of pricing The Internet has dramatically changed hospitality pricing. Its speed and transparency have removed most barriers between customers and suppliers, one need not be an industry insider to find the best pricing to suit your needs. Sites like OYO Rooms, makemytrip.com offer various options to the buyer to choose from. Yet, hotels and restaurants still need to make pricing decisions.

High price Low quality

High price High quality

Pric Low price Low quality

Quali

Low price HighPage | 20 quality

Many factors influence the prices, including your competitors’ rates and products. Our goal is to develop a pricing strategy that places one's brand and its products in a certain position relative to your competition. One way to visualize this is the price-value matrix. The position of hotel rooms within this matrix is a function of one's brand proposition, competitors, and pricing objectives.   

Are you looking to maximize short-term revenues or profit? Are you seeking higher profit margins in a luxury market with sporadic sales? Do you need to differentiate more to penetrate the market?

Once pricing objectives are identified, prices of the company and those of competitors are plotted on the price-value matrix. Rates need tweaking if current prices do not convey the brand positioning relative to competitors or is not synchronous with the pricing objectives of the company. Following strategies can be employed to correct prices relative to competitors: Skim This strategy clearly positions the company above the rest; it tells consumers something is special (i.e., worth paying more for) about your products. To skim, set your prices higher than the competition does in order to “skim off” customers who are willing to pay more. This strategy can be highly profitable. Though high prices imply high quality for many customers, it’s still critical that they understand why they’d pay more to stay or eat at the establishment.

Match This strategy puts one's pricing on par with the competition, but not necessarily for all rates. To match, set one rate comparable to competition and of another type of room slightly higher.

Page | 21

This allows one to stay competitive for a larger pool of customers, yet doesn’t undercut the competition. Surround This strategy positions the first room type as the cheapest in the market, but offers other rooms with better options at a price that’s close to your competitors’ first available rates. Hence, you’re “surrounding” the middle market, hoping to capture customers willing to pay in those ranges. Undercut By undercutting your competitors’ rates in some categories, you can potentially attract more customers. To undercut, offer a price that’s comparable to your competition and another that’s lower. Take this example from the hotel industry. Both hotels located near airport. But one hotel bundles airport dropping services in the hotel room rate has a clear advantage over the other. Customer does not mind paying a slightly higher price for the same. Penetrate Being the low-priced option in your market has benefits and drawbacks. The strategy is primarily designed to get people in the door and in seats. For new establishments, low prices often seem the best way to entice consumers to try the hotel. But this strategy also can depress market prices, lower margins, and set a poor precedent as the business grows. Though in online markets, this strategy is highly successful as people generally go for cheapest options.

Page | 22

Bibliography 

http://www.wttc.org/-/media/files/reports/economic%20impact%20research/countries



%202015/ http://www.livemint.com/Politics/h3ejs6Bz6NJ0BOW86ar1VL/Travel-and-tourism-industry-

   

to-grow-75-in-2015-report http://www.statista.com/statistics/314326/monthly-occupancy-rate-of-hotels-in-india/ http://www.statista.com/topics/2076/travel-and-tourism-industry-in-india/ http://www.xotels.com/en/revenue-management/revenue-management-book/hotel-pricing HVS Indian Hotel sector Outlook

Page | 23