Hotel rate: More complex than a simple UPC analysis without adjustments
The hospitality industry is volatile. Workloads and the rate per night change exponentially from week to week. This is the result of a vortex caused by seasonality in the hospitality industry. The annual planning of a hotel is directly related to this variable, therefore, the way in which a hotel prepares to face the different seasons will have a direct impact on its financial performance, which must be taken into account in particular when its income, defined by its nightly rate, is controlled in an inter-company transaction.
Tourist areas around the world have two seasons: high and low. The high season is when the number of tourists tends to increase in large proportions, which means that the occupancy rate of hotels reaches up to 100%. On the other hand, the low season is when the occupancy rate of hotels fluctuates between 60% and 70% depending on the destination, generally during the periods when most people are working or studying.
The low season is present three times a year: from January to March, after the Christmas holidays and before the spring holidays; May to June, after Easter and before summer vacation; and from September to November, rainy and hurricane season in the beach areas.
However, it is important to mention that with the presence of COVID-19, the seasonality has changed as the home office has become a constant, which has allowed people to travel at different times of the year and for longer periods.
As mentioned earlier, seasonality is a key variable in determining occupancy-related hotel rates. These rates can be reduced during the low season by up to 50% from the highest price in the high season.
Whatever the seasonality, the determination of hotel rates is based on a complex algorithm which takes into account:
- The destination’s offer at the time of booking (occupancy), which is measured by the number of rooms available. Derived from hotel closures due to the presence of COVID-19, this supply has contracted, representing an opportunity for price increases for players able to keep their doors open;
- Market supply and demand, where capacity is the key variable;
- Travel sentiment reports that let hotels know what travelers think of the destination;
- Control of the reservation window and room inventories;
- The hotel’s category and online reputation, and its customer satisfaction rating;
- Competitive prices (by brand, by destination and by level of activity);
- Marketing investment;
- Customer volume by geographic precedence and target market;
- Sales market as well as guaranteed quotas; and
- Government regulations regarding COVID-19 for the country of destination and the country of origin, including safety, hygiene and infection protocols.
From a transfer pricing (TP) perspective, when the sell / buy tariffs are documented, the benchmark method is the uncontrolled comparable price (UPC).
The CUP method compares the prices of goods and services transferred in a controlled transaction (affiliates) with the price charged for goods and services transferred in a comparable independent transaction (third party) under similar circumstances. Thus, since a hotel provides the same service to third parties and related parties, the internal comparables can be used to document the transaction in a direct and reasonable manner.
However, there may be differences to adjust, particularly due to volume, level of production associated with the sales channel and seasonality.
Existing sales channels in the hospitality industry include tour operators, OTAs (online travel agencies), travel agencies and the direct channel.
In traditional chains, agencies and tour operators typically set annual fees and discounts in their agreements based on seasonality. New channels, like OTAs, are based on dynamic net rates, and the contract only establishes the agency’s profit margin.
The difference in the price of the tariff oscillates between 25 and 10% approximately for the end customer (operator’s commission), depending on the level of production of each chain. In addition to this differential, marketing support is agreed (investment quotas) to reinforce a stay, a promotion or a campaign, which can represent on average between 5 and 10% of the total sales of the chain. Finally, there are additional discounts that vary between 2% and 8% depending on the price level and occupancy at the time of the discount.
Although the market shows definite trends, when the B2B tariff is documented, it usually does not reflect these trends, and on the contrary, an average annual tariff linked to a quota or a guaranteed minimum amount is agreed.
As a result, our challenge as consultants is to correctly identify and measure internal comparables so as to consistently reflect the supply and demand behavior between third parties considering all of the aforementioned variables, and by therefore, to adjust the external comparables to the analyzed transaction. .
In addition, it should be verified that the price sold to the end customer covers the market profit margin associated with each of the operational and marketing functions of the value chain of the company or hotel group, even when there is a guaranteed quota. .
Obviously, the TP and associated issues of determining a market value hotel rate pose considerable challenges, but also opportunities for hotel groups, who should consider substantial and economic risk management strategies and use them to balance three important and unnecessary competing objectives:
- Maintain the economic substance of the different tariffs based on supply and demand at different times of the year;
- Manage the economic risks arising from inter-company structures not agreed between independents; and
- Comply with local TP requirements while proactively using TP to achieve their own business goals.
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