The Rearview Mirror, and Why it’s Hurting the Hotel Industry

October 5, 2011 in Journal by Hotel Compete

It’s always encouraging to find kindred spirits.  This is particularly true when industry commentators swim against the tide with controversial opinions that you also hold.  Last week we were delighted to read an excellent account of this year’s Lodging Industry Conference, provided by the hotel industry’s “Dr Doom”, Joel Ross, founder of Citadel Realty Advisors. 

The article, which can be accessed here, is a must-read for anybody who follows hotel industry performance.  It voices a mixture of skepticism and amazement at the forecasts provided by various industry “data people” at the event.  The presentations apparently found consensus on the following view: because July has been so wonderful for the industry, the outlook for 2012 looks rosy.

Mr Ross describes a similar scenario from 2008, when he predicted 18 disastrous months to follow.  At the time – when capital markets were collapsing – the same data people were predicting 5.7% RevPAR increases. The article does not present today’s outlook as being the same or even close to that of 2008, It did, however, list sufficient worrying financial indicators to make the 6-7% RevPAR increases being touted by the experts at the conference look giddily optimistic.

At the heart of this story is a serious, systematic flaw in the way that hotels approach performance analysis.   As the article puts it: “Life in the rearview mirror is great”.  Well, sometimes it is, and sometimes it isn’t, but it’s clear that what happened in the past is not always the best guide to what’s likely to happen in the future.  If our approach to predicting performance is to extrapolate history, then we are powerless to foresee changes in the marketplace.  

At Hotel Compete, we can relate to this view.  When we step away from the heady world of hotel development finance, and focus on the performance-related decisions that hotels make all of the time, we encounter the same problem.  Revenue Managers, Asset Managers, performance analysts and other actors in hotel performance have one important thing in common.  They all make or support decisions that relate to the future.  Yet the metrics available to support their decisions are firmly rooted in the past.

Trailing Indicators – like historical RevPAR Index – play a critical role in analysis.  They have the considerable advantage of being factual – ie the performance for the period that they measure has happened and can therefore be known in absolute terms.  The trouble is that the factors that affected the past are not always the ones that affect the future.  A strong July may persuade some that the good times will continue to roll through 2012, but Mr Ross’s assessment of some other, current factors should give us pause.

When we look at decisions affecting individual hotels and their direct competitors we can see many factors that alter the performance of hotels within a comp set from week to week and month to month.  Some factors are external, like the economic environment.  Some are to do with the characteristics of competing hotels.  And some are to do with the management decisions taking place at each competing hotel.  Without insight into these factors how can we be confident that what happened last month will happen next month? And so on.

This is a perverse characteristic of the hotel business, which is – of course – an advance reservations industry.  Today bookers are making decisions about which hotel room nights they will consume in the future.  And the information that influences them to go to one hotel rather than another – price, hotel characteristics, user review scores, branding, ecommerce strength, etc – are all there to be measured.

As readers of this blog will by now be sick of reading, performance is always a factor of two things: how many people book a hotel, and how much money they spend when they stay.  There is plenty of data that can tell us how hotels are likely to perform in the future.  We’ve found – through extensive client experience – that when we use this data to produce leading indicators, forward-looking decisions tend to get better.

The trailing/leading indicator dissonance is illustrated by one point in Mr Ross’s article.  In advising hotels to hunker down for a year or two (good advice by the sounds of it), he urges savvy hoteliers not to “cut ADR”. 

ADR measures the outcome of all of the pricing that a hotel does across its mix of business.  As such it is a fundamentally rearview mirror metric, and therefore not something that can be “cut”.  And while it is a critical bellwether of historical performance, it is a poor and often misleading metric when it features in pricing decisions.  The actions that Revenue Managers must take relate to price, and pricing is to do with competing for the best possible mix of business.  ADR is invisible to bookers, and hence is not a logical consideration in deciding which prices to charge. 

This may seem like a semantic point, but it isn’t.  Our own analysis – for example – frequently identifies hoteliers who set rates to a level that their product will not support because “we need to raise our ADR”.  These are usually the hotels whose inventory ends up being abundantly available through the most deeply discounted OTA sites when the desired high-rated demand fails to materialize.  Hotel Managers – like hotel investors, apparently – sometimes make bad decisions when they approach the future using rearview mirror metrics.  Nobody doubts the importance of trailing indicators, but in a market as unpredictable as today’s, smart operators will seek leading indicators of performance – a topic to which we will return in the coming weeks.