The swooning economy is putting a time-honored hotel industry argument — that slashing room rates does not actually boost revenues — to a high-stakes test.
If the notion is right, then the rampant price cuts now under way will only drag down revenue and profits further, putting some hotels under severe financial strain.
PKF Hospitality Research forecasts that one of the deepest and longest recessions in the industry’s history will lead to a 25 percent spike this year in full-service U.S. hotels lacking the cash flow to service their debt.
Statistics were not available for Manhattan, but PKF does not expect Manhattan to face the problem as severely as hotels elsewhere. Still, the overarching problems of falling revenue and profits are hitting New York City hotels hard. Profits are likely to plummet this year — and keep declining. Facing economic conditions many have never experienced, coupled with the general climate of price cuts across all retail sectors, hoteliers are plunging ahead with their own price cuts.
Business has slumped so severely that last month, nine of the city’s most luxurious hotels, including the Carlyle and the Plaza, offered customers who booked two nights the third night free.
Falling occupancy levels during the last several months underscore the challenges that are prompting rampant price cuts of 20 to 30 percent on Manhattan hotel rooms. Hoteliers are fighting a deteriorating environment, with New York City occupancy levels slated to hit 74 percent, down from 81 percent in 2008.
That number is still well above PKF’s forecast of a national average of 57.2 percent occupancy levels for 2009, but it represents a decline from the long-run average New York occupancy level of 77.5 percent.
PKF expects occupancy levels to stay below that long-term average for the next three to four years.
“The valleys in the marketplace as far as people wanting to rent hotel rooms in New York are becoming more frequent, and they tend to be deeper,” said Mark Woodworth, president of PKF Hospitality Research, a division of the Atlanta, Ga.-based firm, PKF Consulting.
The argument against price-cutting rests mainly on a 2003 study by Cornell University’s School of Hotel Administration and Smith Travel Research, “Price Discounting — Is It a Wise Strategy to Raise Revenues?” Six years ago, when the study was conducted, hoteliers were mainly concerned with battling the effects of the Web, which allowed customers to comparison shop for discounts across multiple Web sites.
The conclusion, however, was that room-rate price cuts erode revenues, since hotels in most industry segments don’t get enough increased demand from the lowered rates.
“The prevailing wisdom is that reducing room rates entices new customers to enter the market and buy more rooms,” said the study’s co-author, Cathy Enz, in a news
release when the report was announced. “This has never worked for the hotel industry … existing customers simply get more for less, and hotel revenues fall.”
Woodworth also noted that he does not believe hoteliers can lower prices enough to have a material impact on demand. He said that while the benefits of price cuts are uncertain, the hit to profitability is clear.
Mark Gordon, executive vice president, principal and head of the U.S. hotel group at Cushman & Wakefield Sonnenblick Goldman, is also outspoken against price cuts. He sees their main impact as increasing competition among hotels in the city.
Gordon acknowledges that hotels’ cash flow is down year-to-date, but he trumpeted New York’s status as a leading global city that is still attracting Middle Easterners interested in long-term investments.
“I think New York will be faster to recover than other markets,” said Gordon.
Whatever the long-term prospects are, hotels prices are down now, and are expected to keep falling. CBRE forecasts a 10 percent price drop in room rates, down from 2008’s Manhattan average of about $300.
Part of the reason for the drop is that price cuts are one of the few options available to Manhattan hoteliers as they struggle to endure the downturn. Hotel operators, along with managers across every industry sector, are slashing jobs, but the relatively high occupancy levels at Manhattan hotels means the hotels must maintain high staffing levels.
Luxury hotels in particular have high staff-to-guest ratios that are crucial for coveted four- or five-star ratings.
“These hotels need to accommodate their guests,” said Bradley Burwell, senior associate at CBRE.
Industry insiders are still tossing around boom-economy buzzwords like ‘maintaining brand integrity’ as the experiment in price-cutting continues.
What is becoming more apparent as the economy weakens further is that 2003, the year Cornell published its landmark study on pricing, is not the era economists are turning to as a useful benchmark for the business conditions the hotel industry now confronts. They are looking to Japan’s ‘lost decade’ in the 1990s and the Great Depression — yardsticks that call into question the relevance of boom-time best practices.
“I would say the financial crisis we’re in has fundamentally changed the hotel business model from a few years ago,” said Burwell.