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Find the most profitable segment

26 January 2023
All hotels would like to know which of their guest segments are the most profitable. The main reason is to dedicate more resources to finding more guests belonging to this segment to increase profitability. Here is a blog post about how to calculate profitability per segment.

Hotels rarely measure profitability by segment. One reason is poorly defined segments which lead to confusion about which segment a reservation belongs to. In addition, the low data quality will make it difficult for the hotel management to trust the information about the segment mix. Let's assume that the hotel has sorted out its segmentation and wants to calculate the profit per segment.

Three cost models

Start by defining all activities associated with acquiring and servicing the guests. An easy method to use is Activity Based Costing (ABC). The next step is to look at margins in products and services. For example, cleaning a larger room costs more than cleaning a small room. However, the cleaning cost per day is lower when the guest stays longer. In addition, the cleaning cost for a business traveler tends to be lower than for a family with small children. The final step is to factor in the size of the segment to understand the profit contribution in money since profitability in percent could be misleading.

Activity Based Costing (ABC)

Activity-based costing (ABC) identifies and assigns costs to specific activities or processes within a business. For example, the following steps could be taken to use ABC to evaluate the profitability of a hotel's guest segment.
  • Identify the activities or processes associated with acquiring and serving the guest segment. For example, these activities might include marketing, sales, housekeeping, and breakfast.
  • Determine the costs associated with these activities or processes, including direct and indirect costs. For example, direct costs would include wages for employees cleaning the hotel room, while indirect costs would include utilities.
Use this information to determine the total costs of acquiring and serving the guest segment and their revenue. Then, compare the revenue and expenses to assess the segment's profitability. By using this straightforward approach to ABC, hotels can have a more accurate and detailed understanding of which guest segments are the most profitable and where they should focus their efforts to increase revenue.

Contribution margin analysis

Contribution margin analysis: This method looks at the difference between revenue and variable costs for a specific product or service, such as a room type or package. It can be used to identify which products or services are most profitable and where to focus efforts to increase revenue.

Cost-volume-profit analysis

Cost-volume-profit (CVP) analysis: This method looks at the relationship between costs, volume (number of guests), and profitability. It can be used to determine the number of guests that need to be booked to break even or achieve a desired level of profitability.

Two separate activities

There are two distinctly different activities associated with each guest segment. The first is to capture the guest, which induces a customer acquisition cost. The second is the cost of delivering the guest experience.

Customer Acquisition Cost

Costs associated with getting a guest reservation, also known as customer acquisition costs, can include various expenses.
  • Marketing and advertising can include online and offline advertising, public relations, and social media marketing expenses.
  • Website development and maintenance: This can include the costs of developing and maintaining a hotel's website and costs associated with the booking engine, revenue management systems, and other technologies.
  • Distribution: This can include commissions paid to travel agents, fees for online travel agencies (OTAs), and other costs for making the rooms available in different channels.
  • Sales: Cost of maintaining a sales team, including travel and customer activities.
  • Loyalty programs can include costs associated with loyalty programs and other customer retention strategies.
  • Commercial team: Costs associated with maintaining other roles in the commercial team, such as revenue and commercial management.

Cost of delivering the guest experience

in ABC, it is generally recommended only to include variable costs that change with the level of activity or output. Variable costs vary directly with the number of units produced or services provided. These costs include direct materials, direct labor, and variable overhead costs.
Examples of variable costs that would be incurred when providing an overnight stay to a guest include:
  • Direct labor costs for housekeeping staff who clean the room before and after the guest's stay
  • Direct materials such as linens and toiletries are used and replaced with each guest's stay
  • Variable overhead costs such as electricity, water, and gas consumed during the guest's stay

The most profitable

The hotel must add the correct segment code to the reservation to measure the room revenue per segment. It is then easy to see the revenue per segment for any period. The next step is to deduct the customer acquisition cost. The information in the reservation is a good starting point to calculate the CAC. In addition, CAC that is not associated with a reservation has to be spread over reservations based on the market segment. After deducting the CAC from the room revenue, the hotel can see the net room revenue or the contribution to profit and other expenses. This KPI helps understand the profitability of the segment.
Finally, deduct the variable cost for delivering the guest experience. The best practice is to use standard costs based on the room type, number of guests, and segment. The hotel can now find which segment is the most profitable and which contributes most to the overall profit.

Take action

When hotels know more about the profitability per segment, they can set priorities by segment. Which segments should they go after, and in which order should they sell so they manage their inventory correctly to maximize total profit? Hotels that do not calculate and analyze profit by segment will never be able to maximize profit.