High Markup & Low Yield vs. Low Markup & High Yield
Understanding hotel rates is crucial to running a successful operation. Pricing strategy plays a vital role in this process. It’s not just about setting room rates; it’s about finding the right balance between price and occupancy to maximize both revenue and profitability.
Two common approaches that hoteliers use are the high markup, low yield strategy and the low markup, high yield strategy. While both strategies have their advantages and drawbacks, understanding their impact on Average Room Rate (ARR), overall revenue, and profitability is crucial.
In this blog, WebChef will break down these pricing strategies, explaining how they can affect the financial health of a hotel, and why a lower ARR doesn’t always mean less profit.
We’ll also touch on the importance of managing expenses, cross-selling opportunities, and maintaining a high level of service while maximizing occupancy.
High Markup & Low Yield Strategy
The high markup, low yield strategy involves charging higher prices for rooms, but typically results in fewer bookings. This is common in luxury or boutique hotels that emphasize exclusivity and premium experiences.
The idea is to generate a higher Average Room Rate (ARR) by targeting a smaller, wealthier market willing to pay more for top-tier services and unique experiences.
Pros of High Markup, Low Yield
- Higher ARR: The immediate benefit of this strategy is a higher ARR. Each booking brings in more money per room, contributing to higher revenue per guest.
- Exclusivity: Charging higher prices can elevate the hotel’s status in the market. It helps create a perception of luxury and exclusivity, which can be appealing to a niche audience.
- Lower Resource Consumption: Fewer guests mean lower operational demands. The hotel spends less on utilities, cleaning services, staffing, and other resources. This can help control operating costs while still earning high revenues from the limited number of guests.
- Targeted Marketing: Focusing on a specific, high-end market allows the hotel to invest in more targeted marketing campaigns. It becomes easier to establish a strong brand identity with a clear message for luxury travellers.
Cons of High Markup, Low Yield
- Lower Occupancy: One of the main drawbacks of this strategy is lower occupancy rates. Higher room prices tend to reduce the pool of potential guests, especially during off-peak seasons. As a result, more rooms remain empty, potentially limiting overall revenue.
- Vulnerable to Economic Downturns: High-priced hotels often suffer during economic downturns when travellers cut back on spending. The luxury segment may see fewer bookings, leading to higher volatility in revenue.
- Revenue Instability: With a smaller base of customers, hotels can experience significant fluctuations in revenue. If a few key guests cancel their bookings, it can have a substantial impact on the hotel’s bottom line.
- Missed Market Opportunities: By focusing on high-paying guests, hotels may miss out on attracting a wider range of travelers who are willing to pay lower rates but in larger numbers.
How ARR and Revenue Are Affected
In a high markup, low yield model, ARR remains high, but overall revenue may suffer due to lower occupancy. Even though each guest pays more, the revenue generated from room sales may not be enough to offset the number of empty rooms. The hotel becomes heavily reliant on a small group of high-paying guests, making it vulnerable to changes in market conditions or guest preferences.
Low Markup & High Yield Strategy
The low markup, high yield strategy is the opposite of high markup, low yield. In this approach, room rates are set at a more competitive level, which tends to attract a higher number of bookings. This strategy focuses on filling rooms, maximizing occupancy, and generating revenue through volume.
Pros of Low Markup, High Yield
- Higher Occupancy: By offering competitive pricing, hotels can attract a broader range of guests, resulting in higher occupancy rates. This is especially beneficial in a highly competitive market where guests are sensitive to price.
- Increased Revenue Potential: While ARR may be lower, high occupancy can lead to a substantial increase in total revenue. More rooms being filled means more money flowing in overall, which can offset the lower rates.
- Cross-Selling Opportunities: A larger guest base opens up opportunities for cross-selling and upselling. Guests who book rooms at a lower rate may still spend on extras like dining, spa services, and excursions, increasing the hotel’s total revenue per guest.
- Better Market Penetration: A hotel that focuses on high occupancy can capture a larger share of the market. This strategy helps build a steady flow of guests and can lead to positive word-of-mouth referrals and repeat bookings.
Cons of Low Markup, High Yield
- Lower ARR: The downside of this strategy is that the average room rate is lower, which may create a perception of less value compared to higher-priced competitors. It may also make it more difficult to position the hotel as a premium option in the market.
- Increased Operational Costs: With more guests comes more resource consumption. Higher occupancy means the hotel needs to spend more on cleaning services, staff, amenities, and utilities, which can erode profit margins if not managed properly.
- Risk of Overcrowding: Filling rooms at a lower price point can sometimes lead to overcrowding, straining hotel resources and staff. This can result in lower guest satisfaction if the hotel struggles to maintain high service standards with a large number of guests.
- Potential Brand Dilution: By offering lower rates, there’s a risk of the hotel being perceived as a budget option, which can dilute its brand. It may become more difficult to appeal to higher-paying customers in the future.
How ARR and Revenue Are Affected
In a low markup, high yield model, ARR decreases, but total revenue increases due to higher occupancy. Even though each guest is paying less per room, the sheer volume of bookings can drive up total revenue. However, operational costs will rise as well, so careful management of expenses is key to ensuring profitability.
Maximizing Profitability: Managing Revenue & Expenses
The key to success in both strategies lies in managing expenses and maximizing revenue beyond room sales. Here’s how hotels can do it:
1. Revenue Management
- Dynamic pricing strategies allow hotels to adjust rates based on demand. This helps maintain high occupancy rates during off-peak seasons and capitalize on high demand during peak times. Smart pricing adjustments can help maintain a steady flow of guests while optimizing ARR.
2. Cross-Selling & Upselling
- Even in a low ARR, high-yield model, hotels can drive revenue by cross-selling additional services like dining packages, spa treatments, guided tours, or other experiences. For example, offering packages that bundle room rates with dining or activities can help increase total spend per guest without inflating room rates.
3. Expense Management
- To ensure profitability with a high occupancy strategy, it’s essential to manage operational costs effectively. Labor efficiency is crucial—adjust staffing levels to match occupancy and use technology to streamline processes.
- Energy and resource management can help control costs as well. Hotels can invest in energy-efficient lighting, smart thermostats, and water-saving initiatives to reduce utility bills without sacrificing guest comfort.
4. Focus on RevPAR
- Rather than solely focusing on ARR, hotels should prioritize Revenue per Available Room (RevPAR), which measures the hotel’s ability to fill rooms and generate revenue. A higher RevPAR can often indicate better overall performance, even if ARR is lower. By focusing on filling rooms and maximizing ancillary revenue, hotels can achieve strong RevPAR and increase overall profitability.
Conclusion
Both high markup, low yield and low markup, high yield strategies have their advantages and disadvantages.
A high markup strategy can help maintain a higher ARR and brand exclusivity, but it may result in lower occupancy and unstable revenue. On the other hand, a low markup strategy increases occupancy and overall revenue, but it requires careful management of operational costs to maintain profitability.
Ultimately, the most successful hotels find a balance between these two strategies. They leverage dynamic pricing, cross-sell additional services, and carefully manage expenses to ensure profitability. By focusing on the right metrics—particularly RevPAR—hotels can thrive, regardless of whether they choose a high or low markup approach.