Revenue Per Available Room-Did you know it can enhance profit as well as revenue?

The Revenue Per Available Room Magic..

Recently, one of my course students, asked this question on Revenue Per Available Room:

Name the Top Key Performance Indicator (KPI) for hotels.

My response was instantaneous:

REVPAR or Revenue Per Available Room.

Student:

Why should RevPAR be preferred over ADR?

My response was this:

If you were an archer and granted a boon to choose strength (power) against distance, which would you choose? Which is best?

The best would be neither power nor distance individually but the two together. The two are complementary to each other. The two enhance each other.

Business is no different. If you were tasked with achieving a revenue target, you will need both quantity and price (power and distance comparably). Just one of them is good but not good enough. You need both. This is why you would choose REVPAR over ADR.

Revenue Per Available Room explained

One of the foremost features of the hotel industry is that it is primarily a seasonal business. This has tremendous implications for its revenue generation strategies. Each month of a 12 month cycle could see different business volumes at which the hotel will operate.

In this blog post, we will discuss the following concepts:

Hotel revenues are contributed by business volume and price.

Business Volume is represented by hotel occupancy. Price is represented by average daily rate.

Hotels calculate revenue in their Income Statement (or Profit & Loss Statement as it is also known as) using occupancy and average daily rate.

REVENUE CALCULATION

Revenue = Occupied Room Nights X Average Daily Rate

Occupied room nights are derived by taking the ratio of Occupancy % to Rooms Available. Rooms Available is the highest number of rooms that can be sold in a day. It represents the room capacity of the hotel.

Average Daily Rate is the average of all prices charged for various market segments and room types for the hotel.

OCCUPANCY CALCULATION

Occupied Room Nights = Rooms Available X Occupancy %

REVPAR on the other hand uses Rooms Available for its calculation.

REVPAR CALCULATION

RevPAR = Room Revenue / Rooms Available

You will notice some fundamental differences in the calculation of revenue, average daily rate and REVPAR which we will discuss in detail diving into the secrets.

Let us go!

Secret 1 - The Magic of Revenue Potential 

Let us go back to the question my student asked and my response:

Name the Top Key Performance Indicator (KPI) for hotels.

REVPAR or Revenue Per Available Room.

Why did I say that?

Let me introduce you to the first and probably the most powerful secret relating to REVPAR.

Remember what I said earlier about REVPAR using Rooms Available in its calculation.

What is the implication of that?

It simply means that REVPAR is using rooms capacity for its calculation.

Let me explain.

The calculation for revenue uses hotel occupancy and multiplies it by average daily rate.

Revenue is thus using business volume or occupancy or what can be called rooms actually sold.

In other words, revenue is what is earned at the current business volume or occupancy. Average occupancy can be 40% or 90% in a month depending on seasonality.

So, revenue really does not tell us anything about what COULD HAVE BEEN EARNED!

How do you get to that then?

Enter REVPAR.

In a way, RevPAR gives you an idea of the potential revenue that could have been earned. This is a strategic index having a powerful impact on your profit. That is why I said REVPAR is considered the Top Key Performance Indicator (KPI) in a hotel

The strategic nature of REVPAR will become even more clear with Secret 2. Read on...

Secret 2 - Occupancy - ADR Contribution

In Secret 1 you learned how REVPAR is a strategic KPI. Let us now elevate that to the next level.

REVPAR as a strategic KPI has the capability to tell you how much of the revenue earned is due to business volume and how much due to price.

What use is that you ask?

Let me explain.

Remember the calculation of REVPAR we saw earlier. Well, there is another powerful method to calculating REVPAR, the implications of which are lost even on many marketing professionals.

REVPAR CALCULATION

RevPAR = ADR x Occupancy %

This is a seemingly simple calculation but it has tremendous hidden power.

Remember our archer metaphor in the beginning of this post. Let us use that to rephrase.

If you were tasked with achieving a revenue target, you will need both quantity and price (power and distance comparably). Just one of them is good but not good enough. You need both. This is why you would choose REVPAR over ADR.

As we saw earlier, Average Daily Rate only takes into account the price factor while occupancy also only takes into account the business volume factor. These deal with single dimensions. They also depict the situation as it is not AS IT COULD BE!

REVPAR is different though.

See how RevPAR uses both ADR (power) and Occupancy % (distance), to achieve the best combination.

By combining the business volume element (occupancy) with a price element (average daily rate) and using capacity (rooms available), REVPAR uses a composite metric which is strategic.

How so you ask.

For that on to the next secret.

Secret 3 - REVPAR and Strategic Market Segmentation

We will utilize part of REVPAR Secret 2 in this secret. It has to do with how REVPAR is calculated.

Let us revisit Secret 2 and the REVPAR calculation.

RevPAR = ADR x Occupancy %

So, now you know REVPAR uses both business volume as well as price.

What good will that do for your hotel’s revenue and profit?

Tons I will say.

What is strategic about it?

It may mean the difference between the highest revenue and profit you have ever achieved and just making do with revenue increase and that too not all the time.

How does that magic happen you ask (sarcastically!)?

Well, first, you now know the impact on revenue of business volume and price SEPARATELY!

This, without exaggerating, I might say is the Holy Grail of revenue and profit maximization strategies!

How?

All in good time.

It is said that the devil is in the detail. Never more wisely said!

Look at the Rooms Summary above.

REVPAR allows you to see the effect of occupancy and average daily rate separately on revenue.

By doing this, it arms you with a powerful tool you can use in your market segmentation.

Market segmentation is the segregation of revenue into distinct target markets. Broadly you can talk about categories like business and leisure (and something between them that has gained prominence of late called bleisure!). But the real power is in identifying smaller, specific niches.

Calculating REVPAR for each market segment you operate in tells you what kind of pricing level you are at for different market segments compared to your competition. This indicates wheher you are a price leader or otherwise in your competitive set. Competitive Set refers to the 4 or 5 hotels you have identified as your direct competitors.

This can transform your market share for the better.

Moreover, REVPAR is powerful in boosting occupancy levels during lean periods. We talked earlier about how the hotel business is a seasonal one. The challenge in lean periods is to push up occupancy of the hotel. REVPAR can give a good indication of how you can target specific market segments to increase room nights.

For a deep dive into the full set of secrets of REVPAR and other Top KPIs, enroll in the Mastering Hotel Performance Analysis Online course (currently at a limited time offer of 50% OFF).

And now on to the next secret...

Secret 4 - Barometer of Revenue Yield

One foundational concept that hotels depend on for generation and management of room revenues is yield. Simply stated, yield is the ratio of room revenue actually earned to potential revenue. Remember, we briefly mentioned potential revenue in earlier secret.

YIELD CALCULATION

Actual (Earned) Room Revenue / Potential Room Revenue X 100

How is Potential Room Revenue arrived at?

All hotels of whatever type an size set something called a Rack Rate for every one of their room types. The Rack Rate is the highest, non-discounted room rate for each room type.

For example, say for a Deluxe King Bed Room Type in Paradise Hotel, the Rack Rate is $300. Assume further that this room is actually sold for $230 on any day.

In this case, Potential Room Revenue is $300 and Actual Earned Room Revenue is $230.

And Yield is: $230/$300 X 100 = 77%

Stated differently, this Deluxe King Bed Room Type has been discounted 23% (100% minus 77%).

Similarly, every day a hotel discounts different room types at different levels. Rarely does a rack rate get charged without any discounting other than exceptional circumstances.

To make it crystal clear to you, go back to the Rooms Summary table.

In the table, rack rate and discounting are not reflected. But you need to understand something critical.

The Average Daily Rate shown in the table is for the entire year. It averages all the rates charged at different discounts for different room types.

So, how can you know yield from this table.

Well, again, REVPAR to the rescue!

Look at the ADR, Occupancy % and REVPAR rows in the table.

Remember the REVPAR Calculation? - ADR X Occupancy %

So, for Paradise Hotel for the year 2019:

REVPAR = ADR ($125) X Occupancy % (50%) = $62.5

In a different way, REVPAR has just told you the yield. How?

REVPAR ($62.5) is 50% of ADR ($125).

In layperson language, REVPAR achieved for the Paradise Hotel shows a 50% yield (only half of the rooms available is being utilized).

If Occupancy % is 60% for 2019 instead of 50% as in the table, REVPAR will go up becoming $125 X 60% = $75.

The powerful lesson that comes out of this is:

And now to the fifth and last secret of this post...

Secret 5 - How REVPAR Maximizes Bottom Line

One question you may have had in your mind is how REVPAR maximizes profit or bottom line as the title of the post suggests.

Let me make that clear.

From Secret 4, you saw how yield could be ascertained through REVPAR and improved by increasing occupancy %. On the other hand, you could also increase your yield by boosting your price levels.

Say, for some or all your market segments, compared to the competition you have greater value room type offerings backed by industry leading service. You can command a better price then for your product in the market.

You ensure first that you have provided great value through your guest room and service levels via ambience, technology, exceeding guest expectations and so on. You can now raise your price levels for the different room types.

This will in most cases result in improved REVPAR levels which indicate your elevated yield levels.

When REVPAR goes up and is influenced strongly by average daily rate increases, this results in better profit. This is because any increase in price is not accompanied by increase in costs and thus flows to the bottom line totally. This is one of the most powerful effects of a REVPAR improvement.

Hotel Owners and stakeholders swear by REVPAR as it gives them an indication of how well their hotel guest room asset is being utilized.

WATCH this video to understand how REVPAR can make a difference from a Owner perspective.

Strategies You can Apply Right Now

Go back to your hotel Income Statement. See how REVPAR for a current period compares to the previous period.

Use the ADR X Occupancy % calculation to find out how well you are utilization the guest room asset.

Calculate REVPAR (your Hotel Revenue Manager should already have this information) for different market segments. Select market segments where you think you can push up price levels since your offerings are above competition levels.

See how much REVPAR has improved this year over last year. What are the reasons? Is it because of occupancy or average daily rate or both.

Be aware of price resistance challenges when you embark on increasing prices. As a general rule, price changes should only be made when actual and/or perceived value has become better for the customer. When value (even perceived value) falls below price, you may lose the customer forever.

What is your strategy going forward?

If you are an aspiring general manager, build The Ultimate 10 Tools in a Hotel General Manager Business Toolkit with the Mastering Hotel Finance Online Course.

Your Takeaways

What were the takeaways for you from the blog post? And from this video?

Are you leveraging REVPAR in your hotel to improve revenue yield and bottom line?

What topics would you like to see as future blog posts?

Tell us in the comments section below.

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