HB 302 Exam 4 Study Guide Importance of Pricing Major Determinant of profitability is prices Prices too low mean not maximizing revenue too high means won t achieve potential for profits Management s goal Profit Maximization Another factor is positioning within marketplace Profits occur from calculated decisions Price Elasticity of Demand Measures how sensitive demand is to change in price Demand characterized as elastic or inelastic Price elasticity of demand formula o Change in Quantity Demanded Base Quantity Demanded Change in Price Base Price Equation will almost always yield negative number however negative sign is usually ignored If inelasticity of demand is greater than 1 demand is said to be elastic sensitive to price changes If less than 1 demand is inelastic not sensitive to price changes When prices increase of reduction in quantity demanded is less than the of price increases therefore revenues will often increase Generally speaking demand for products services in hospitality is elastic Informal Pricing Approaches Several forms of informal pricing Intuition psychological and trial and error Intuition Based on what manager feels the customer is going to pay Psychological pricing Prices established on basis of what the guest expect to pay Trial and error monitors guest reactions adjusts price based on this All of these methods are best when supplemented with more calculated approaches to pricing Cost Approaches Four Modifying Factors Historical prices perceived price value relationships competition price rounding are all based on cost approach to pricing Have to take into account price changes customer value competition modifying price Markup Approaches to Pricing Designed to cover all non product costs labor utilities ext Two types are ingredient markup product costs and prime ingredient markup cost of major ingredient Four Steps of Ingredient Cost Approach 1 Determine Ingredient Costs 2 Determine the multiple to use in marking up ingredient costs a Multiple 1 desired product cost 3 Multiply ingredient costs by multiple to get desired price a Price Ingredient Cost x Multiple a 4 Determine whether prices seems reasonable based on market Prime Ingredient Cost Approach Differs only in that the cost of the prime ingredient is marked up o Price Prime Ingredient cost x Multiple Pricing Rooms Methods 1 1 per 1000 approach 2 Hubbart Formula 1 per 1000 approach Sets price of room at 1 for each 1000 of project cost per room Fails to consider current value of facilities services Example Average cost of renovations is 80 000 results in price per room of 80 using 1 for each 1000 rule Hubbart Forumula Bottom up approach to pricing Considers costs desired profits expected rooms sold Called bottom up b c the first item net income is at the bottom of the income statement 8 Steps of the Hubbart Formula 1 Calculate desired profit by multiplying desired rate of return ROI by owners investment 2 Calculate pretax profits by dividing desired profit step 1 by 1 minus the tax rate 3 Calculate interest expense fixed charges and mgmt fees Also includes estimated depreciation property taxes insurance amortization and rent 4 Calculate undistributed operating expenses Includes admin and general sales and marketing property operation maintenance energy costs 5 Estimate non room operation dept income or losses 6 Calculate required rooms dept income Sum of pretax profits Step 2 interest expense fixed charges and mgmt fees step 3 undistributed operating expense step 4 and other operated dept losses minus other operated dept income step 5 equal req rooms dept income 7 Determine rooms dept revenue Step 6 other direct expenses 8 Calculate average rooms rate Divide Step 7 by rooms expected to be sold Discounted Room Rates Rack Rate maximum rate a hotel will charge For lodging company to maximize profits equivalent room occupancy ERO can be determined as follows o ERO Current Occupancy Percentage x Rack Rate Marginal Costs Rack Rate x 1 Discount o ERO Current Occupancy x current contribution margin revised contribution margin marginal cost Revenue Management and Dynamic Pricing Revenue Management understanding anticipating and reacting to buying trends 3 components to maximize revenue profit the revenue channels supplying demand the accurate forecasting of purchase patterns of customers types of customers or market segment Strategies based on where customer buys revenue channel and who the customer is Measuring Revenue Management Yield Steps 1 Determine the potential average single rate of rooms x rack rate rooms 2 Determine the average double rate 3 Calculate the multiple paid occupancy percentage multiple rooms total rooms 4 Determine the rate spread Average single rate average double rate 5 Calculate the potential average rate Multiple paid occupancy x rate spread Potential avg single rate 6 Calculate the rate achievement factor actual average rate potential average rate 7 Determine the yield statistic Paid occupancy percentage x Rate achievement factor Bottom up Approach to Pricing Meals 1 Determine Desired Net Income Investment x ROI 2 Determine Pretax Profit Desired Net Income 1 tax rate 3 Determine Interest Expense 4 Determine Operating Expenses 5 Determine Food Revenue Add Steps 2 4 divide this by 1 desired food cost percent 6 Determine meals to be served Days open x seats by seat turnover for day 7 Determine price of average meal Food Revenue Estimated meals served Food Sales Mix and Gross Profits Formula Gross Profit of mix 1 Gross margin of other sales mix alternatives Menu Engineering Stars High Profitability High Popularity Puzzles High Profitability Low Popularity Plow Horses Low Profitability High Popularity Dogs Low Profitability Low Popularity Integrated Pricing Integrated Pricing Having several revenue producing departments that sets prices for goods and or services to optimize net income Types of Budgets Operations budget management s plan for generating revenue and incurring expenses for a period 2 other types of budgets cost budget and capital budget Budgeting Horizons Annual budget must be divided into months Every month expenses and revenues are analyzed 4 4 5 plan consists of two 4 week plans and one 5 week plan Long range budget of up to 5 years is also common Strategic planning aka long term planning is essential to growth 1 3 of private clubs prepare long term budgets Personnel Responsible For Budget Preparation Major Purpose of budgeting planning execution control Board of