HB 302Exam #4 Study GuideImportance 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 elasticInformal 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 pricingCost 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 priceMarkup 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 Approach1. Determine Ingredient Costs2. Determine the multiple to use in marking up ingredient costsa. Multiple = 1 / (desired product cost %) 3. Multiply ingredient costs by multiple to get desired pricea. Price = Ingredient Cost x Multiple a4. 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 Methods1. $1 per $1000 approach2. 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 statement8 Steps of the Hubbart Formula1. 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 rate3. 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 losses6. 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 contributionmargin) – marginal costRevenue Management and Dynamic Pricing - Revenue Management – understanding, anticipating, and reacting to buying trends- 3 components to maximize revenue/profit: the revenue channels supplying demand, theaccurate 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 Steps1. Determine the potential average single rate: # of rooms x rack rate / rooms 2. Determine the average double rate3. 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 rate6. 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 alternativesMenu EngineeringStars – High Profitability, High PopularityPuzzles – 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