3 signs of pricing recovery

In thinking about the series of events that ultimately will lead to a recovery in pricing power for the U.S. hotel industry, it seems to me that three intertwined but separate things will have to happen:

1. Demand will have to recover. By that I mean there will have to be a sustained period where there is meaningful growth over previous periods.
2. Absolute levels of occupancy will need to be above a critical floor, which, of course, will vary by market and nationally.
3. Booking windows will have to lengthen to allow revenue managers to achieve desired levels of occupancy without having to practically give rooms away.

Let’s take a little more in-depth look at each of these three areas …

I start first with demand because, regardless of all the other factors, this is the first measure that needs to show sustained recovery. Historically, the industry has been able to maintain or even slightly raise room rates when the demand for hotel rooms is growing; basically, there are more guests in the market than the same time of the previous period. However, real pricing power has been elusive until that demand growth is consistently over the 2-percent range. When demand growth is at or above that rate of improvement, pricing power shifts from the buyer to the seller.

But there is an increasing school of thought that this historical standard may not repeat itself this cycle because the occupancy rates in most markets are too low. The thinking goes that no matter how great the level of demand growth, pricing power will not return until minimum levels of occupancy are achieved. This is an interesting point and one that needs considerable consideration. But I suspect this occupancy effect will be very market specific, mostly depending on the hotel mix and product quality in each market.

A couple of interesting developments in the current hotel cycle may have an unexpected effect on this level-of-occupancy effect. First, compared to historical levels, virtually no hotels are currently closing. Inherently, that means a considerable amount of inferior product remains in supply, and basically the question is whether these properties will stay in customer decision mix in a more robust economy.

Second, during the past several months there has been a meaningful demand recovery in the higher price segments, specifically in the luxury, upper-upscale and upscale chain-scale segments. This, unfortunately, has not been the case in the other three segments. Since pricing power starts at the high end, the fact that demand is indeed beginning to rebound there is an encouraging sign.

The last link in the pricing stability chain is the length of the booking window, which appears to be at all-time low levels. This, in concert with significant declines in the group and meetings business, has left hotels with a very uncertain and uneasy feeling regarding their short-term occupancy performance. With very low visibility in regard to bookings, the typical response is to lower the rate to attract guests. The real problem with this strategy is that it seldom significantly increases share but rather lowers the price point for the entire market as everyone follows suit. This is easily checked at Smith Travel Research because we have the unique ability to examine the performance effect of this behavior. So while it makes for a good story that this behavior “steals share,” the reality is it’s mostly not true.

Additionally, it trains the buyer that waiting until the last possible minute to book a room yields considerable benefit. This buying pattern seems unlikely to change until guests start to get burned by this behavior with either very high-priced rooms or no rooms available.

In conclusion, while we are beginning to see the light at the end of the tunnel, a few more key pieces have to fall into place before a pricing recovery is imminent.