How Price Elasticity Can Impact your Hotel’s Average Daily Rate

Today’s hotel revenue managers are exposed to massive data enabling them to assess how consumers react to price change. Indeed, it is becoming a must for hotel professionals to adjust the rates with dynamic pricing tools that allow to determine the best rates to compete in the market. In addition, human psychology is an important aspect to understand as it affects booking decision. As a hotelier, you must understand that lowering the price is not always seen as the best deal for potential guests. This is when the concept of price elasticity comes into place. Here is more in-depth about how price elasticity can influence your revenue management and marketing strategies.

What is Price Elasticity?

Price elasticity in the hotel industry can be defined by the reaction of consumers to room pricing. In that matter, pricing decisions are related to consumer behavior. It is important to be familiar with the market dynamics and your hotel segment to determine whether the demand in your hotel is elastic or inelastic. According to the Director of Revenue Management, Rhett Hirko, (Links to an external site.) at the largest independent hotel company in the world, Preferred Hotels and Resorts, “price elasticity is an important tool but should not be used in isolation; an understanding of a hotel’s market is critical to understanding the total impact of price elasticity.” Once determining the elasticity of demand in different cases, you will see that decreasing the ADR (Average Daily Rate) does not always mean driving more room bookings at your property.

How to Compute your Hotel’s Price Elasticity?

Price elasticity is how positively or negatively a room rate change correlates with the demand. When the number is more than 1, the demand is elastic. In this case, guests would react sensitively to a room price change. For example, if you increase the price, it will reduce the demand. Inversely, when it falls below 1, the demand is inelastic and guests will not be affected by a price change. For instance, if you increase your room rate, it will likely increase the demand at your property.

Image taken from: http://link.springer.com/article/10.1057/s41272-021-00290-6

Below is the formula that revenue managers use to identify how a room rate change would affect the demand:

Price Elasticity= % Change in Demand/ % Change in Price

Let’s assume that your hotel is lowering the price by 6% which is increasing the demand by 9%. By applying the formula above (9%/ 6%= 1.5), the price elasticity would be equal to 1.5 which means that the demand is elastic and thus, a strong reaction in demand is caused by your room price change.

Three Factors Affecting your Property’s Price Elasticity

Seasonality

When it is high season for the hotel industry, the demand is likely to be inelastic. For example, people are likely booking a room in a ski resort during Christmas season regardless of the price. As hotels get fully booked and there are limited options during this time period, the willingness of customers to pay high prices is significant as they are likely interested in experiencing this season whatever the price.

Hotel Scales

There are different scales in the hotel industry according to Smith Travel Research (Links to an external site.) which are the Luxury, Upper Upscale, Upscale, Midscale, and Economy. In the Luxury and Upper Upscale hotel categories which include higher-end properties, the demand is likely to be inelastic. Indeed, a higher rate generates more demand as customers targeted in these hotels are attracted by high prices that add value and meaning to them. Those guests usually associate high prices with sophistication and quality. In fact, they are likely to pay a high price to stay in a hotel to live a premium experience. In contrast, when decreasing the room rate in midscale and economy hotel types, it is likely increasing the demand which in this case is elastic.

Booking Time

Several research found that guests are not really price-sensitive when proceeding with short-run bookings. Indeed, when guests are making decisions to book a hotel close to their vacation time, the demand is likely to be inelastic as they have limited time to look for alternatives. However, when looking at hotel options long in advance, potential guests are more price sensitive as they have the time to explore several offerings.

Once mastering the concept of elasticity of demand, you will be able to make well-founded pricing decisions and maximize the sales potential of your hotel. Whenever looking at price elasticity of demand, do not neglect fundamental elements for efficient revenue management. Indeed, it is important to understand well your customers, the competitive set and the market pricing. Finally, do not forget that low prices do not always win!