As is the case with any business, hotels compete against each other for customers. A hotel will typically refer to its competitors as the Comp Set. There are no hard and fast rules for determining who should be in your comp set, but it’s usually hotels that are located nearby to your hotel, have a similar star rating and provide similar amenities. Typically, hotels within a destination, or a particular comp set within a destination, are friendly with each other. They share information about their occupancy, rates, and even banquet dishes if a neighbor runs short. By being cooperative with one another, each hotel within comp set knows its pricing itself appropriately so it can capture its natural market share.
Let’s look back at How Things Used to Be. Previously, consumers would pick a destination and then search within a particular comp set to find a hotel at which to stay. It was pretty straight forward. Hotels would try and capture a larger percentage of their natural market share by providing great and personalized service or by offering better amenities than the competition. These are both good things for consumers.
There are certain things hotels within a comp set did not do, namely, start a price war. The reason is simple. By lowering prices, a hotel within a comp set may temporarily win a bump in business, but as other hotels within a comp set learned of the lower prices, they too would follow suit and business would then re-distribute across everyone’s natural market share at lower prices. This would hurt the profitability of the entire comp set, and lead hotels to cut corners. This would result in poorer service and fewer amenities. Obviously, these are both bad for consumers.
Decades of data have shown that demand is price inelastic. Simply stated, lowering your price will not generate more business. Wouldn’t every product on the planet simply just lower their pricing to generate more business? It doesn’t work.
Although consumers want the best possible price, they want excellent service and great amenities more. However, the situation has changed suddenly, and in a very negative way for hotels.
Online Travel Agencies, better known as OTAs, have learned that it’s actually quite easy to manipulate consumers by applying what is known as “share-shifting” tactics within a comp set. When you visit an online travel agency website, the order in which you see hotels is not arbitrary, but rather, carefully orchestrated by the OTA.
First, hotels that pay the OTA the highest commission typically rank first. The average OTA charges a hotel between 15-25% of the value of the booking. That means an OTA can get up to 25 cents out of every dollar you spend on the booking. Some hotels pay even higher to rank first. The data has shown that hotels that rank first get booked more often, which is why they do it.
Next, hotels are encouraged to show discounted pricing on an OTA’s website. The OTA again ranks hotels based on these discounts, thereby forcing a hotel to reluctantly lower its prices if a single member within its comp set has done so.
This tactic is known as share-shifting. OTAs cycle business from one hotel to the next within a comp set by encouraging hotels to discount their pricing at different times. This is why consumers sometimes see better pricing on an OTA versus a hotel’s own website. Sadly, many hotels do not have these these discounting features to be able to do the same on their website.
It’s not that hotels want you to book on the OTA versus their own website, it’s that they have no choice. Moreover, if the hotel drops off of the OTA, the OTA will simply steer business to other hotels within the comp set. Hotels are trapped and in a very negative way.
So let’s do the math. If a hotel typically sells its room at $100/night with more and more of its business moving to OTAs, which charge a 25% commission, a hotel’s real average room rate starts to drop closer to $75. That’s a 25% drop in revenue.
Now imagine if a hotel had to drop its rate by $25 to compete with a member of its comp set. This means the hotel would only keep 75% of the reduced $75 room rate. This would drop a hotel’s real average room rate further to $56. That’s a 44% drop in revenue!
What business can maintain service standards and quality being faced with a 44% drop in revenue? Over time, the OTA model hurts hotels, and it hurts consumers.
We’ll discuss this topic in more depth in our next blog post.