March 10, 2022
Economic Origins of Revenue Management
Introduction: The Ultimate Guide to Revenue Management for Vacation Rentals
Welcome to Part One of the Guide, the Economic Origins of Revenue Mangement, you can download the full guide here.
You’ve heard talk about vacation rental revenue management at various industry conferences, from other vacation rental property managers, and from the software and service providers. (like ours!).
It’s a hot topic right now, and for good reason: With the right implementation, vacation rental revenue management can boost profitability for you and your homeowners while helping to maintain a steady inventory of vacation rental properties.
But how does vacation rental revenue management actually work? Why is it so important? And where did it even come from?
In this guide, we’ll take a deep dive into everything we know and understand about vacation rental revenue management, from its origin story within the hospitality industry as a whole to the ins and outs of how it works, including the best types of data for the most impact.
We’ll explain why incorporating revenue management strategies has been difficult for vacation rental businesses, and why implementing SaaS for dynamic pricing, or partnering with a full-service revenue management company like Rented can give you an edge while saving you time and resources.
And we’ll celebrate the successes of real-life businesses that have used vacation rental revenue management strategies successfully. Are you ready? Let’s dig in.
In order to explain what vacation rental revenue management is, we have to understand how revenue management works within the hospitality industry. Laying the economic groundwork of revenue management in the vacation rental industry helps us better understand why it’s so impactful—and so challenging to get right.
An Intro to Dynamic Pricing
In order to move to a revenue-focused model, some fundamental ideas had to change. The biggest shift? Moving away from fixed pricing—a set nightly rate that didn’t change for large swaths of time—to dynamic pricing. Dynamic pricing takes various factors into account, big and small, and adjusts prices accordingly to be the most attractive to the consumer.
When it comes to dynamic pricing in the context of revenue management in the hospitality industry, you want to look at whether the unit is correctly priced at the time and how it may adjust moving forward in order to attract potential guests.
Factors Influencing Dynamic Pricing
We price dynamically in the hospitality industry in order to account for a wide array of factors, some of which are unique just to us. Here are a few key examples:
- Pricing Pressure vs Pricing Power: Let’s use an industry example. Imagine that you have a 50-room hotel, and there are 55 people who need rooms. Here, you have the advantage and can set the price on your terms. That’s pricing power. But what if you only have 20 people who need rooms? Now the guest has the power, and you are adjusting prices in order to capture as many of those people as possible. That’s pricing pressure.
- Internal vs External Pricing Parameters: Pricing is just one piece of the puzzle, of course, because it only takes our own internal booking rates and the force of supply and demand into account. But there are external factors that can impact pricing, as well. The most influential factor is competition. It’s one thing if you’re the only 50-room hotel in an entire town, and 55 people are looking for a place to stay. But if there’s a 75-room hotel across the street? There’s more supply, and customers have their pick.
Supply and Demand
Ask pretty much anyone and they can tell you the basic tenets of supply and demand. And even while this formula can now be viewed through the prism of revenue management, it hasn’t changed these fundamental aspects. The reason for this dive into high school level economics is because the issue of supply and demand has some unique attributes within the hospitality and vacation rental industry. Unlike producers of consumer goods who have a tangible product, the product for our industry is more ephemeral. Though yes, the actual room in a hotel IS a tangible product, it’s a perishable one. Because even if you have a 50 room hotel, meaning you have 50 tangible rooms, with every night that passes, whether the room is booked or not determines your true inventory. In other words, the product is tangible, but the inventory is perishable.
Price Elasticity vs. Inelasticity
The final part of these economic foundations which ultimately contribute to our current dynamic pricing methodology assesses when, how, or even if pricing fluctuations can change demand. Pricing is considered elastic if there is a relationship between occupancy and a unit’s price. Going back to our 50 room hotel example, assume we charge $100 a night and have a 50% occupancy for that evening. If everything else holds the same, in a world of pricing elasticity we would expect that by decreasing the price by $5, we would increase occupancy by 5%. In this scenario, we assume that dropping the price will increase our occupancy.
But what if you could decrease the price by $5 and get a 10% increase in revenue? This would then be inelastic pricing as there is no longer a one-for-one relationship between occupancy and price. This is where we arrive finally at dynamic pricing. We seek the best ways to alter a unit’s price while still allowing us to increase occupancy without taking too much of a hit to our revenue. Now that we’ve covered the economic origins that led towards revenue management, it’s time to dive into what exactly constitutes revenue management itself.
Dynamic pricing works effectively when we can strike a balance between a competitive price that still encourages an increase in occupancy, and without taking too much of a hit on our revenue.
This article is the introduction to Rented’s Ultimate Guide to Revenue Management for Vacation Rentals – 2022 Edition. You can download the full guide here.
- What is Revenue Management? Revenue management, or rental price optimization software for vacation rentals allows agencies to manage the pricing and duration of reservations through automated rules. This can be achieved by scanning trends in supply & demand across various markets. This will then alter your property prices accordingly so that you always have enough reservations coming through without being too high priced compared with other nearby properties. It sounds complicated at first because there are lots going on behind the revenue manager’s calculations, or the software managing the pricing.
- What is Price Elasticity of Demand? Price elasticity of demand is the ratio of the percentage change in quantity demanded of a product to the percentage change in price. Economists employ it to understand how supply and demand change when a product’s price changes.
- What is Price Inelasticity of Demand? Inelastic is an economic term referring to the static quantity of a good or service when its price changes. Inelastic means that when the price goes up, consumers’ buying habits stay about the same, and when the price goes down, consumers’ buying habits also remain unchanged.