Front Office Advanced

D2301-1-Establishing Room Rates for Hotels II

There are three methods of establishing room rates:

  1. Market Condition Approach

In this method, the management looks at similar hotels in the area and sees what they are charging for the same product. These properties are often called the competitive set, which is made up of a number of properties in a market that are a property’s most important competition. The competition can be based on location, type, brand or other factors. According to this approach, the hotels will charge only what the market will accept. This information is available through various public domain sources and periodic blind calls to competing hotels. A blind call does not identify the hotel making the call and simply asks for availability and rates on specific dates

  1. The Rule-of-Thumb Approach

This method sets the rate of a room at Rs.1/- for each Rs.1000/- of construction and furnishings cost per room assuming a 70 percent occupancy. For example, if the average construction cost of a hotel room is Rs.80000/-, the average room rate will be Rs.80/- according to this method. The emphasis on the hotel’s construction cost fails to consider the effects of inflation. It also fails to consider the contribution of other facilities and services towards the hotel’s desired profits.

The rule-of-thumb approach should also consider the hotel’s actual occupancy level instead of a fixed 70 percent occupancy.

  1. Hubbart Formula Approach

It is a bottom-up approach to pricing rooms. This approach considers operating costs, desired profits, and expected number of rooms sold to determine the average rate per room. It is considered a bottom-up approach because its initial item – net income (profit) – appears at the bottom of the income statement. The second item – income taxes – is the second item from the bottom of the income statement, and so on. The Hubbart Formula approach involves the following eight steps:

  1. Calculate the hotel’s desired profit by multiplying the desired rate of return (ROI) by the owner’s investment.
  2. Calculate pretax profits by dividing desired profit (Step 1) by 1 minus the hotel’s tax rate.

3.Calculate fixed charges and management fees. This calculation includes estimated depreciation, interest expense, property taxes, insurance, building mortgage, land, rent and management fees.

4.Calculate undistributed operating expenses. This calculation includes estimating expenses for the following categories – administrative and general, information technology, human resources, transportation, marketing, property operation and maintenance, and energy costs.

5.Estimate non-room operated department income or loss, that is, food and beverage department income or loss, telecommunications department income or loss and so on.

6.Calculate the required rooms department income. The sum of pretax profits (Step 2), fixed charges and management fees (Step 3), undistributed operating expenses (Step 4), and other operated department income (Step 5) equals the required rooms department income.

7.Determine the rooms department revenue. The required rooms department income (Step 6), plus rooms department direct expenses of payroll and related expenses, plus other direct operating expenses equals the required rooms department revenue.

8.Calculate the average room rate by dividing rooms department revenue by the expected number of rooms to be sold.

Example

Holiday Inn, a 200 room property, is projected to cost Rs.9900000/- inclusive of land, building, equipment and furniture. An additional Rs.100000/- is needed for working capital, bringing the total cost of construction and opening to Rs.10000000/-. The hotel is financed with a loan of Rs.7500000/- at 12 percent annual interest and cash of Rs.2500000/- provided by the owners. The owners desire a 15 percent annual return on their investment. A 75 percent occupancy is estimated. Thus 54750 rooms will be sold during the year (200 x 0.75 x 365). The hotel’s income tax rate is 40 percent and additional expenses are estimated as follows:

Property tax expenses                                                  Rs.250000/-

Insurance expenses                                                       Rs.50000/-

Depreciation expenses                                                 Rs.300000/-

Administrative and general expenses                     Rs.300000/-

Data processing expenses                                           Rs.120000/-

Human resources expenses                                        Rs.80000/-

Transportation expenses                                             Rs.40000/-

Marketing expenses                                                      Rs.200000/-

Property operation and maintenance                     Rs.200000/-

Energy and related expenses                                     Rs.300000/-

The other operated departments’ income (losses) are estimated as follows:

Food and beverage department                                               Rs.150000/-

Telecommunications department                            Rs.50000/-

Rentals and other departments                                                Rs.100000/-

The rooms department estimates direct operating expenses to be Rs.10/- per occupied room.

The Hubbart Formula is very useful in setting target average rates.

Item Calculation   Amount
Desired Net Income Desired Profit = Owner’s Investment X ROI
2500000 x 0.15 = 375000
Pretax Income = Net Income / 1 – T
Pretax Income =375000 / 1 – 0.4 625000
Plus: Interest Expense Interest Expense = Principal x interest rate
7500000 x 0.12 + 900000
Income needed before interest expense ans taxes = 1525000
Plus: Estimated Depreciation, property taxes and insurance + 600000
Income before fixed charges = 2125000
Plus: Undistributed operating expense + 1240000
Required operated departments income = 3365000
Departmental results excluding rooms
Less: Food and Beverage department income 150000
Rentals and other department income 100000
Plus: Telephone Department Loss + 50000
Rooms department income 3165000
Plus: Rooms Department direct expense 54750 X Rs.10/- + 547500
Rooms Revenue = 3712500
Number of Rooms Sold ÷ 54750
Required average room rate = 67.81

 

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