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Quantifying Latent Demand in Hotel Industry
The build-up approach is a method of estimating demand based on the analysis of the lodging activity. It utilizes the principle that the existing demand for hotel services can be quantified by summing up the number of hotel rooms occupied. This method entails surveying the existing lodging facilities and determining their room count, their percentage of occupancy and their market segmentation. The total is then properly adjusted for latent demand, which consists of induced and unaccommodated demand.
Latent demand operates on the principle that an increase in supply leads to an increase in consumption of a commodity (Brent , 2012). In this context, it can be basically used to mean that an increase in bed-spaces in a given hotel leads to an increase in the percentage of occupancy. In order to quantify the build- up approach, the two types of the latent demand will be analyzed.
Unaccommodated demand refers to a type of latent demand that arises when transient travelers are not able to find accommodation within the existing market because the hotels in the area are all full (Brent, 2012). The said travelers thus end up postponing their trips, choosing a cheaper accommodation or lodging at hotels outside of the competitive market area. Unaccommodated demand is likely to exist in a given hotel if it reaches an occupancy level of 75% or more on a single night.
Addition of new hotel rooms to the existing supply converts unaccommodated demand into accommodated demand. This means that the increased room supply is there to absorb unaccommodated demand. However, much care must be taken to ascertain that the volume of unaccommodated demand converted into accommodated demand is justified by the increased supply of the hotel rooms.
When room nights are attracted to the market, they constitute induced demand. When new demand generators are opened, room night demand is induced. These demand generators may include such factors as an industrial plant, convention center or opening of a new hotel. Opening a new hotel might bring a new franchise, facilities unique to the area, thus, attracting new guests. Such factors result into new guests visiting the market area.
Challenges always arise when trying to accurately quantify the level of latent demand when forecasting hotel market occupancy. To clearly understand the build-up approach by employing the latent demand analysis, a hypothetical example is necessary.
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Various assumptions are made;
A land is to be improved with a 100 unit hotel. The property is located north of an international airport. Three hotels are currently in the market area. These hotels accommodate a number of market segments (Rice, 1980).
First segment: corporate travelers
Second segment: airport personnel and transients
Third segment: conventional travelers
A hypothetical data of the number of room night occupancy of the four hotels in the four segments in a three-year period can be represented in the following tables;
|Accommodated demand||Unaccommodated percentage||Unaccommodated demand|
|Corporate travelers||293 523||8%||23 482|
|Airport personnel and transients||97 309||3%||2919|
|Conventional travelers||117 317||5%||5866|
Opening of the hotel is expected to cause an induced demand in the conventional travelers segment. Let us assume that the new hotel will have an estimated 15, 000 room nights of additional demand per annum. The induced demand will be attracted to the proposed hotel over the first three years of its operation on the following;
First year: (2015) 20% 3000 room nights
Second year: (2016) 60% 9000 room nights
Third year: (2017) 100% 15000 room nights
Limitation of the Approach
- Possibility of an error occurring when converting unaccommodated demand to accommodated demand is very high.
- The process of a new hotel entering the market is complex.
- The process is tedious.
Fixed and Variable Component Approach
Variable costs and fixed costs in hotel operations management are used to differentiate between the costs that have direct relationship to percentage of hotel occupancy and those that have no relationship to the occupancy and the management process (Rushmore1992).
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Fixed costs are those that are not affected by the volume of occupancy. They do not change significantly with the change in sales. Some of the fixed costs include: employee wages, fixed internet, building, sales and marketing, payroll, cost of advertising, and music entertainment among others.
Variable costs are those that are directly related to percentage of hotel occupancy and operations management. An increase in the hotel occupancy results into an increase in the variable costs. The variable costs related to hotel industry include: food and beverage, guest room supplies, stationeries used in front desk, flowers, chemicals for laundry etc.
The fixed and variable cost approach is aimed at determining the future revenue due to future percentage of hotel occupancy. It starts by determining the base level. The future projections are then made from the base levels as outlined below:
- The base year revenue is adjusted according to the inflation rate
- Determine the fixed portion of the adjusted inflation revenue component
- Determine the variable portion of the same. The variable portion is adjusted considering the percentage change between the future occupancy and the base level of occupancy already set
- The variable and the fixed components are then added to determine the summation of the revenue item.
The implementation of the fixed and variable cost approach for a new proposed hotel can be achieved through the following steps;
- First, the financial operating statements from the existing hotels in the area are obtained. The proposed hotel has no financial base hence a hotel`s financial statement is obtained. Few adjustments to the base levels can be done to account for the differences between the comparable and the proposed hotel.
- An adjustment is then done to the comparable financial statement to resemble any operational or locational deviations between the proposed hotel and the comparable one.
- The base revenue is then inflated to reflect forecasted nominal currency in each projected year.
- An approximation is then done for the fixed and variable percentage for each revenue and expense set.
The fixed and variable cost approach is quite appropriate in forecasting hotel revenue and expenses as it follows distinctive steps. The steps take into account inflation, which is a very significant aspect of the economy. As the variable costs change with time, this approach is highly accurate for forecasting future expenses and revenue.
Despite its appropriateness there are various potential drawbacks in the use of this approach;
- The method is quite complex as it involves numerous calculations hence care must be taken to minimize errors.
- Choice of a comparable hotel needs time and proper attention so as not to make a wrong choice which may lead to incorrect projections of revenue and expenses.
The market penetration can be defined as the percentage demand for rooms that are actually accumulating to a given hotel (Rushmore, 1992). Mathematically, it is calculated as the ratio between the total rooms occupied in a hotel and the total rooms collectively present in the given market set.
The competitive index is used to determine new market shares of hotels within the competitive set when there is a new entrant to the market. It reveals the number of times a given room has been occupied by a visitor in a specific market segment, which may compose of tourism, transients, meetings and conventions etc.
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The market share, however, is the number of rooms in a hotel calculated as a percentage of the rooms in the competitive market set where it is found. The market set here refers to the total number of rooms the hotel is in direct competition with, within its area`s market and/or segment.
Steps for Determining Market Penetration Factor
Step 1: The size of the total targeted market is determined.
Step 2: The total number of room occupancy in the hotel is determined.
Step 3: The number of people who have occupied the rooms are divided by the room occupancy in the target market to find the penetration factor.
Penetration factor is a pointer showing the hotel`s penetration of its fair market division. A hypothetical example can be used to illustrate this.
For a new hotel entering the competitive market, analysis of a comparable hotel is first carried out to determine the hotel, which reflects the characteristics of the subject.
Assume that a given hotel has total market set of rooms equal to 1000, which reveals aggregate market occupancy of 70%.
Total number of days the rooms will be occupied = 365 days
Assuming the market set= 255, 500 rooms
The market share = 20%, which implies that the goal room occupation is 51,000.
We assume that the hotel experiences an actual occupancy of 65%.
Converting to the number of rooms result into 47, 450. Dividing this actual number of rooms by the goal occupancy of 51,000 we find a market penetration of 93%.
This hypothetical example reveals that the penetration strength of the hotel is not good because the market penetration must be at least 100%. This can be attributed to many factors such as: wrong franchise, wrong data for base analysis, inadequate sales, poor room mix, poor amenity, and wrong reputation among others.