Optimizing hotel pricing: A new approach to hotel reservations

August 20, 2012 | Hotel Marketing

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A new Cornell report discusses the economic basis and provides a description of a new hotel reservation pricing approach. In addition, the report provides a step-by-step key to the screens and functionality of the companion Cornell Hospitality Tool - “Hotel Reservation Optimizer.”

The hotel industry is among many service industries that use reservations as a sales mechanism. In the past century, a hotel reservation often meant making a request for a room by mail, telegram, telex, or telephone. As technology improved, chains competed with each other to offer faster and more comprehensive reservation systems. Two principles supported these early reservation
systems. First, the room rates were relatively sticky, and unlikely to change from the time of the reservation to the time of guest arrival. Second, when the guest made the reservation the (quite reasonable) expectation was that the guest would, in fact, occupy the room. Thus, a reservation indicated a high probability that the room-night in question was sold.

In this century, both guests and hotels treat reservations in a far more sophisticated manner. Hotels may adjust their room tariffs many times between the moment a guest makes a reservation and actually occupies the room. Some of those adjustments occur on third-party sites that may not even identify the hotel in question. By the same token, the guest who makes a reservation (being aware of hotels’ practice of changing room rates) may continue to search for a different price or even a different hotel for the proposed travel dates. Moreover, even if the guest pays no particular attention to
the room rates, there is still the question of whether the trip will occur at all—a situation that typically applies to business travelers. So, hotels face a challenge of asymmetrical knowl- edge—that is, the guest has a much better idea than the hotel does of whether she will actually occupy the room she has reserved. Hotels, of course, use their revenue management systems to estimate these probabilities based on past history. Although the hotel industry has become quite adept at making such probability estimates, hotel operators still face substantial challenges, such as reservation cancellation and overbooking. The reservation method I explain here mitigates this problem by encouraging guests to disclose their trip probability and thereby reduce the information asymmetry. I call this method the Hotel Reservation Optimizer. First I will discuss how this approach operates, and then I offer a specific step-by-step guide to the Hotel Reservation Optimizer, which is a tool that will assist hoteliers in making the most of the value of a room reservation. Note that although I discuss this concept in the context of the hotel industry, it applies to other service businesses.

The concept discussed in this paper is that the room reservation is, in fact, an option to rent a room-night at a particular agreed- upon rate. The reservation is a thing of value for the guest, who is assured of a place to stay and has confirmation of the price of those accommodations. For the hotel, the reservation provides at least a small window into demand for the date in question. Although hotel and other service firms rarely charge guests expressly for the privilege of placing a reservation, rate fences and other practices (such as nonrefundable reserva- tions) implicitly account for a reservation’s option value.

Download the full report at Cornell University