During off-peak times, many hotel managers will discount room rates to help attract customers to stay at their property – a price setting strategy long shunned by industry researchers. However, a new study published in the September 2012 issue of the Journal of Travel Research has provided empirical evidence that supports the hotel discounting strategy. The study “Does Discounting Work in the Lodging Industry?” addresses economic theory within the lodging industry’s inconsistent market demand, a component overlooked in research that supported price stability for hotels.
“We were surprised to learn that previous studies were oblivious of the concepts of marginal productivity and a clear understanding of cost within decision-making rules of price setting,” said the study’s co-author, Dr. Robertico Croes. “The literature stated that discounting in hotels does not work, and therefore the recommendation was to stick with stability in pricing. However, this recommendation is inconsistent with economic theory, which claims that the ideal pricing scheme is one that eliminates excess demand during peak times while serving guests at cost during off-peak times.”
Croes, a professor at the Rosen College of Hospitality Management at the University of Central Florida, along with the University of Florida’s Dr. Kelly J. Semrad, argued in their study that demand in the lodging industry is highly uncertain and that its core product – room nights – is perishable; and therefore, price stability would not add to the profitability of a hotel.
The new study suggests that in order to cope with uncertainty and information overload from the market, the best strategy for hotel managers is to look at the immediate past. In other words, the price of last week’s rooms would be the best predictor for the next week. If the price of the previous week is above average it will revert to the mean; if, on the other hand, the price is below average, the prediction is that the price will increase in the next week. The study demonstrated this simple idea of reversion to the mean with a so-called cobb-web model.
According to Croes, this study also departs from previous research, as it embraces hotel manager’s decisions for discounting.
“Science is premised on explaining and predicting behavior, and this study investigates the behavior of managers in hotel room price setting,” said Croes. “Previous studies were preaching more to managers on how they should behave in price setting rather than trying to understand how managers behave when setting prices.”
Ultimately, the study provides the rationale for why discounting works, as well as a simple decision making rule for practitioners: apply marginal productivity.
According to Croes, this study bridges the gap between the industry, which has been practicing discounting, and the lodging empirical literature, which thus far has eschewed discounting as a viable pricing strategy.