A recent survey says that Nairobi has some of the highest hotel room rates in the world.  Customers in Lagos and Luanda complain about the “crazy” prices charged there.  Hotel rates in Cape Town and Johannesburg soared by almost 50 per cent in the 12 months to August 2010.

Why does the price of a hotel fluctuate so much, and why can it cost double the amount to stay in a Hilton or Sheraton or any other branded hotel in one country than it does in the same brand in another place?

In simplistic terms, a hotel’s profitability is driven by room occupancy and room rate, so investors are particularly interested in those two metrics.  So what influences a hotelier’s decisions on the price of a room?

Ultimately, of course, the intention is to produce a return on investment to the owners of the hotel.  So there are various models which start with the investment in the hotel, and from that calculate how mush to charge per night, on average, to produce the desired return.  One such model is the “1,000 to 1” rule of thumb, which says that for every one thousand currency units spent per room on building the hotel, one needs to achieve an average price of 1 currency unit in room sales.  Thus a hotel which cost US$10 million for 100 rooms, or US$100,000 per room to build, needs to achieve an average room rate of US$100.

Like any rule of thumb, it’s a little simplistic, but it does, with an acceptable margin of error, work – if the market says that the average customer will only pay US$50 per room at that hotel, it is unlikely that it will be a profitable venture.  If the market is at US$90, then we’re in with a fighting chance.  And if the market is at US$150, then go for it!

But what is “average”?  Because it is on average achieved price (known as average daily rate, ADR) that investors make their decisions, not the advertised rate.  And what does the customer care about the owner’s return on investment?

There is immense confusion regarding the “price” of a hotel room.  In the industry, we talk about “rack rate”, which is the published price that is written on the board behind reception.

In practice, the average city centre hotel charges that rack rate to less than 5% of its guests, and the average resort hotel never charges rack rate.  Because this rate is really a marketing statement – it means “this is where we believe this hotel sits in the market, we’re a US$500 a night stay, better than a hotel that says it is a US$400 a night room”.

These days, most hotels have adopted a yield management approach to pricing, and virtually every transaction on the internet uses this technique.  It is what the airline industry has been doing for many years, with the price of a ticket, or a hotel room, varying according to the actual or anticipated strength of demand.  That is why the answer to the question “how much is a room at your hotel?” is often “when do you want to stay”?

The use of technology in the pricing process is essential, but so is the experience and skill of the hotel management.  A hotel room is the ultimate perishable product, and the aim is to sell all rooms, every night, at the best possible price.  An aeroplane can be shifted from one route to another if demand is low, a hotel cannot be moved – sell that room tonight, or lose it for ever.  Management will be looking at various things when pricing, such as the value of the customer’s business over time, the likely demand on the night of the booking, and of course competitors’ pricing strategies.  What other hotels are doing at any particular time can be the deciding factor, but this tends to be short-term tactics rather than a long-term strategy to maximise shareholders’ returns.

Ultimately, the market decides the price.  Nairobi has witnessed a renaissance since the post-election troubles three years ago, and higher demand means higher prices.  New hotels opening there are will seek to take advantage of the curve.  Prices in Lagos and Luanda are still, however, far higher than those in East African cities, because construction costs are that much higher, with a need for hotel owners to install infrastructure that is normally provided (but isn’t) by government.  There is therefore a dual-pronged push on prices – high demand from the oil and other sectors, and the requirement to make a return on high construction costs.

Supply and demand is supposed to be the final arbiter on pricing, which is why in over-supplied markets – and there are several markets in Africa which are facing a temporary oversupply situation, as investors pile into under-supplied locations – prices tend to drop, as hotel fight for market share.  Purists will tell you that dropping prices is self defeating and there is research to prove that in a competitive market, those hotels that do not succumb to the temptation of heavy discounting to attract customers actually increase

their returns compared to those who do.  But that need to sell tonight, or lose it, means that customers will get deals, and investors will need to have the ability – and the financial strength – to ride through the peaks and the troughs of the hotel world.

Trevor Ward

W Hospitality Group, Lagos

trevor.ward@w-hospitalitygroup.com