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.
W Hospitality Group, Lagos
CASA – not just the Spanish word for “house”, but also an acronym for Conflict Affected States in Africa, a two-year old International Finance Corporation (IFC) programme looking to promote economic recovery in four African countries, namely Central African Republic, the Democratic Republic of Congo, Liberia and Sierra Leone.
It would not be easy to find an African country which has NOT been affected by conflict in one way or another. Even South Africa, the leading economy on the continent, had its racial conflict under apartheid, whilst the former Rhodesia, and Ethiopia, each split into two separate nations following severe conflict. Sudan and Somalia still suffer from civil war. The DRC, one of the IFC’s target countries, is not totally “post conflict”, with the eastern region still occupied by several warring factions but is, all the same, in need of considerable assistance to develop both immediate and long-term solutions to help speed private sector growth and stability.
Hotels are an essential part of the infrastructure of any town and city. The damage to hotels in conflict-affected countries brings two problems – a shortage of accommodation for visitors essential to the social, political and commercial recovery of the country, such as aid workers and consultants, and a perception from the outside that the destination is not yet suitable for foreign investors.
The focus by the IFC to provide special assistance to these four countries is to be especially welcomed given the organisation’s work in the tourism industry, with investments in over 80 countries. And another World Bank member, the Multilateral Investment Guarantee Agency (MIGA), is providing political (i.e. non-commercial) risk insurance to investors and lenders, for projects and in locations where private sector insurers are not willing to provide cover. Rebuilding a country’s economy presents huge opportunities for the local and international private sector, and MIGA cover makes it more likely that a foreign investor will take up the challenge.
MIGA is also working with various national investment promotion agencies to promote projects to foreign investors and to develop national investment strategies.
Alongside the CASA programme and the support provided by MIGA, the IFC is active in the promotion of tourism investment in post-conflict states in other ways. In Sierra Leone, the IFC’s investment climate team has been working with the government and with the National Social Security and Insurance Trust, the owner of the Cape Sierra hotel in the Aberdeen district of Freetown, providing advisory services for the privatisation of the hotel. The process is ongoing, with various technical reports undertaken (including a market and financial analysis conducted by W Hospitality Group) and a tendering exercise to attract an investor and management company.
In Mozambique, the IFC has been managing the Anchor Investment Programme, effectively acting as project promoters for a number of resorts there, with the dual aim of attracting foreign investors, whilst at the same time building capacity within government.
The additional support provided to these and other conflict-affected states means, hopefully, that recovery will be that much quicker than without such intervention. Of course, the risk still remains, and any hotel development in such locations must have a sustainable and proven commercial rationale before proceeding, not a crutch to make it artificially viable in the short-term. The development or renovation of a hotel creates employment, not just in the hotel itself, but also in the rest of the economy, through indirect and induced multiplier effects in the supply chain and through increased spending in shops and elsewhere by newly-waged and self-employed individuals.
W Hospitality Group, Lagos
After 35 years in the hospitality industry, I still can’t tell you what a five star hotel is.
There. I’ve said it. This so-called expert in the hotel industry doesn’t know something as simple as that!
Think about it, however. Hotels are really complicated things, selling services (e.g. overnight accommodation), manufactured goods (steak pie and chips) and commodities (a bottle of beer) in multiple outlets, in hundreds, sometimes thousands of transactions per day, between invariably different human beings. How can you possibly categorise a diverse creature like that using just two words – five star? Did you know that, until very recently, there was no such thing as a five star hotel in Paris? The system there used one star to four star, four star deluxe and Palace hotels, for the top properties in heritage buildings.
The star rating system, which varies from place to place, was originally invented for consumer protection. In the absence of any other sources of information, other than the brochures produced by the hotels themselves (this was, of course, before the advent of the internet), the automobile organisations, such as AAA (in the USA), the RAC (UK) and Michelin (France) produced guidebooks for their members motoring around the country. Thee organisations gave their own opinion of the quality of each hotel, so that members seeking something of a high quality would know that the “five star” (according to the guide) Grand Hotel was a better quality than the “three star” Very Grand Hotel, before they arrived – because, as we all know, names can be misleading.
These systems of star ratings developed, and they do work to some extent – we all know that a one or two star hotel is likely to be pretty basic, a three star hotel will be kind of average, a four star hotel – well, that’s something better than a three star, and a five star is all about luxury.
But they are still not particularly good definitions, are they? Basic, average, luxury? One guest’s luxury is another guest’s average, after all. Take some of London’s hotels as examples – the Hilton on Park Lane, the Dorchester and the Grosvenor House are all five star hotels, but cater to quite different clientele – a regular guest at one probably would not in his or her lifetime want to stay at one of the others.
This lack of definition may be of little consequence to an investor in the hotel industry – or it may be of fundamental significance. I am involved in the development of a hotel in Nigeria, which ran into trouble because the owners agreed a joint venture arrangement with a contractor, and it was stated in the contract that the contractor, now part of the ownership of the hotel, would build a “three star hotel”. It had been assumed by all sides that there was a commonly-held definition of that term, but the quality of work produced by the contractor was far below that expected by the original owner. The result was, of course, disagreement after disagreement, and the joint venture collapsed, leading to delays and increased costs.
And consider also the developer who wants to create a very high quality, cosy and private boutique hotel in Ghana, with say 50 rooms, a fine dining restaurant and bar – but cannot qualify for a five star rating, as the Ghana grading system stipulates that a five star hotel must have at least two restaurants and a conference room for a minimum of 300 persons. The impact of this is that our creative hotel developer is unlikely to be able to achieve the required yield from the hotel because, with his four star grading, the perception of the guest will be that he cannot charge as much as the five star hotel across the street.
What’s the solution? It’s already there. Two relatively recent developments make star ratings far less relevant. One is the increased availability of information, from all sources but particularly on the internet, where sites such as TripAdviser.com provide guest feedback on hundreds of thousands of hotels, warts and all. In addition, hotels and booking agencies can provide pictures of their facilities, so that prospective guests can make a judgement regarding the quality of the hotel pre-arrival. Of course, the camera can lie, as can blogs, but still a great advance on a subjective assessment of “quality”.
The second solution is hotel branding, a subject which I have commented on before in this column. The Holiday Ins and Hiltons of this world have no interest in being classified as three, four or five star, they have already classified themselves – as Holiday Inn or Hilton! These chains commit considerable sums each year to product development and to consumer research, so that what they offer under their brand name is what the guest wants, and what the guest expects.
I mentioned earlier that star rating systems vary from place to place – there is no such thing (contrary to what many people think) as an international star rating system. The International Hotel & Restaurant Association (IH&RA) argues against any attempt at harmonisation – would it really be appropriate to specify the same level and extent of facilities and services at hotels in New York and Ouagadougou? Of course not, and travellers would not expect it. Even in Europe, there would be confusion between the French insistence on having a bidet in the bathroom, and the British not knowing quite what it was for!
The IH&RA doesn’t advocate scrapping the star rating system altogether, as this “common-sense approach” works for some, if not for me.
And no, I have no idea what a “six star” hotel is!
W Hospitality Group, Lagos