The Urban Hotel Market Challenge

The U.S. hotel industry finished 2015 at its highest occupancy ever. Hotel demand continues to outpace supply, and although the industry is experiencing firmer headwinds from the weakening global economy, the hotel industry’s macro fundamentals remain sound.

Despite these positive factors, urban markets are continuing to underperform against the U.S. industry due to a combination of the decline in inbound international travel—largely resulting from the strong U.S. dollar—and the increase of Airbnb supply and presence in urban markets. In addition, booking windows continue to shrink and short-term cancellations have been rising significantly in urban markets, putting downward pressure on average daily rates.

There are several variables causing this increase in short-term cancellations, which are impacting urban market performance. The structure of the brand redemption programs, combined with a lack of cancellation fees, is creating a negative dynamic in many urban markets.

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A Primer on Brand Redemption Programs
Branded hotels allow customers who have accumulated enough “points” to redeem these for free stays at a hotel in the respective brand family. Originally developed by American Airlines, this has been an effective strategy by branded operators to create additional brand loyalty.

When a customer redeems their points for a stay at a branded hotel, the respective brand pays the hotel owner a set redemption rate, which is designed to cover the cost of the guest’s free stay since the hotel owner is accepting points as compensation. During high demand periods, the brand will compensate the hotel owner with a higher redemption rate so that the hotel owner isn’t harmed by accommodating a guest who is redeeming points, versus a guest who is paying the market rate for a given night. The high occupancy redemption threshold set by the hotel brand is usually around 95 percent. Most brands today have a binary approach. With 95 percent occupancy and above, the hotel owner receives the high occupancy redemption rate from the brand; below 95 percent occupancy, the hotel owner receives the low occupancy redemption rate to cover the cost of the stay.

Given the record high occupancy levels across the United States and even higher occupancy levels in the major urban markets, there is a greater frequency when branded hotel owners are at or near the brands’ high occupancy redemption threshold. When a hotel is near, but still below 95 percent occupancy, hotels are effectively incentivized to aggressively sell the remaining rooms, many times at deep discounts, in order to surpass the threshold. Often, this discounting takes place during short lead times, which is one of the factors that is causing booking windows to shorten. When there are multiple branded hotels in a market, a race is created to reduce room rates to capture the remaining demand. This was not the original intended design of the brand loyalty programs, but given the high occupancy levels across the country, this phenomenon is happening with greater frequency than ever before.

Lack of Cancellation Fees Encourage Travelers to Cancel and Rebook
This is where the lack of cancellation fees in the industry makes matters worse. Unlike the airline industry, the hotel industry has provided free options to its customers that allow them to make a reservation, then cancel and rebook as much as they desire. In fact, Booking.com now has a television commercial that promotes canceling and rebooking as often as the traveler likes.

If a hotel discounts its rate, customers have the ability to seamlessly cancel and rebook their reservation at the same hotel or to the hotel across the street through metasearch websites like Kayak or Trivago. In turn, hotels are forced to further discount rates to gain any last-minute pickup that will help them hit the brand’s high occupancy redemption threshold.

In addition, hotel reservations made via the online travel agent (OTA) channels have become more relaxed, giving the customer greater flexibility to cancel a reservation short-term without penalty. In the past, OTA channels locked the guest into their reservation with nonrefundable rates. Rate parity now requires that hotels provide OTAs with access to all publicly offered rates, which include rates with flexible pricing that do not require a guest to prepay, and allows for short-term cancellations.

In recent past, last-minute demand for hotels was strong enough that hotels would strategically manage inventory to capture the highest rates for the remaining rooms left to sell. The majority of these bookings would typically come from premium rate segments such as BAR, negotiated, or consortia. However, with the growth in hotel and short-term rental room supply, and the increased access to all remaining inventory in the market through last-minute booking technology and mobile tools, the ability to sell rooms short-term has become exceptionally competitive. This causes a race to the bottom in room pricing.

Example: The Booking Window and Discounting in Times Square
To illustrate the impact to pricing and cancellations, the following table provides the lead booking windows during 2015 in Times Square (Manhattan).

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