An interview with Mark Lomanno: Why everyone in hospitality needs to pay attention to distribution costs

Mark Lomanno, CHR fellow and partner and senior advisor for Kalibri Labs, and Kelly A. McGuire, MMH ’01, PhD ’07, a CHR fellow.

Today’s post features an interview with Mark Lomanno, a CHR fellow and partner and senior advisor for Kalibri Labs, and previous president and CEO of STR, as well as a member of the CHR Advisory Board.

I’m back!!! After my recent job change, I’m really excited to continue to collaborate with the Cornell Center for Hospitality Research (CHR), as a research fellow and author of this blog. Our plan is to deliver a blog at least monthly that contains research-driven content about timely issues in hospitality. I will be speaking with industry experts and academics to bring you a view into how to handle some of the very real challenges faced by the hospitality industry today.

Those of you who followed me at the SAS blog, the Analytic Hospitality Executive, might remember that my very first blog was an interview with Mark Lomanno about his research into hospitality distribution costs. That was five years ago. Mark and Cindy Estis Green ’79, who co-authored the original report, recently reevaluated the findings. It feels very appropriate to have the privilege of kicking off this new blog with another conversation with Mark.

Distribution costs, an update

According to this recent research update from Kalibri Labs, which was founded by Estis Green and where Mark serves as partner and senior advisor, distribution costs are rising at two times the rate of room revenue. In 2011, the median U.S. transient direct-to-indirect booking ratio was 4.3 to 1. Just four years later, in 2015, the ratio had fallen to 2.7 to 1. Online travel agency (OTA) share of bookings is growing across all segments, but particularly in the economy segment, where OTA share grew from 5.6% in 2011 to 16.5% in 2015. As of the publication of this blog, Kalibri Lab’s Hotel Industry Database has guest-stay and cost-of-sales information from over 25,000 (and growing) hotels primarily in North America, representing 100+ brands, over three million rooms, and over three billion transactions. These statistics are quite remarkable. It seems pretty clear that hotels need to do something to halt or reverse these trends, or profitability will suffer.

It is really easy to blame—and vilify—the OTAs. I believe this is the absolute wrong attitude, and I think Cindy and Mark would agree. The answer to this problem is not to eliminate all third-party distribution channels from your pricing strategy. I think we all realize that the OTAs are not going away. A certain segment of guests rely on the OTAs, and the OTAs invest significant marketing dollars in attracting guests that a hotel would never be able to reach on its own. At the same time, a whole new type of intermediary is emerging, with Google, Facebook, and similar sites—which we will refer to as ETAs—entering the booking arena. OTAs and ETAs can be good partners in an overall revenue and profit strategy, particularly to generate incremental demand, demand that the hotel could never get on its own. The point is that because third-party distribution costs can be high, you need to think very strategically about the role of third-party distributors in your overall strategy, and carefully craft your distribution-channel-management goals. It’s not simple, but it’s important.

When I talked to Mark, I really wanted to know whether there was some result from the research this round that he felt should get more attention from industry. I was particularly interested in something that would drive home the point about distribution costs in a new or different way.

Changing metrics for a changing landscape

Before I get into that, I want to make sure that we are all on the same page with the work that Kalibri is doing. Cindy and Mark have been advocating for new bench-marking metrics for the hospitality industry, specifically, NetADR (average daily rate) and NetRevPAR, or revenue per available room net of all commissions. This metric has been surprisingly difficult to define, because distribution costs are not always accounted for on the P&L, or in the ADR metric. The OTAs frequently send revenue net of their commission, so the cost is not visible, or accounted for anywhere by the hotel. The point is that simply tracking (and incentivizing) RevPAR or RevPAR index, as we traditionally have done, masks some very real acquisition costs.

“RevPAR was a very useful performance calculation fifteen or twenty years ago, when revenue was the primary measure of effectiveness,” says Mark, “These intermediaries did not exist then, so the cost of acquisition wasn’t an issue. The shift to digital has changed the landscape, and the metrics we use to measure effectiveness need to evolve along with the way we do business today.”

Cindy and Mark use the term “revenue capture” to refer to the amount of revenue that hotels capture net of acquisition costs; this is then divided by the hotel capacity to derive the NetRevPAR metric.

Distribution costs and hotel asset value

So, on to Mark’s result. Mark explained to me that the Kalibri data shows that revenue capture in the U.S. in 2015 was three tenths of a percent less than in 2014 because of the shift towards higher-commissioned business. This does not seem like a lot on the surface, and revenue did grow 6.8% during this time. However, if you calculate that -0.3% in dollars of lost opportunity, it represents about $406 million that shifted from the hotels to the third-party distributors. Mark calculated that at a cap rate of 8%, this shift in revenue capture resulted in about a $5 billion loss in asset value to the hotel industry as a whole.

OK, I’m the first to admit, I don’t have much experience with real estate finance. So, I had to follow up on this idea of loss of asset value. For the uninitiated like me, the value of the asset, the hotel, is calculated on the profits it generates. Therefore, any increase in profits increases the value of the asset. To drive asset value (which owners, obviously, care a lot about), you need to increase profits. Profits are increased by reducing cost or increasing revenue (I know, that one is pretty obvious).

For hotels, this means finding operational efficiencies to reduce costs, or making capital investment to drive demand. Dramatic cost-cutting methods like layoffs or reduction in services might be employed in extreme circumstances. So, understanding that, think about this: any improvement in revenue capture drops right to the bottom line. Increasing revenue capture simply requires shifting the channel mix to “cheaper” channels, no investment, no need to generate new demand. You don’t even need to change any prices. While by no means simple, it is arguably a much easier way to drive profits than some of the traditional methods I described above.

Mark suggests that hotels figure out their revenue capture, and then run some “what if-ing” to understand the impact of improving revenue capture even by a small amount. This will really help them to understand the profit-generating capability of the hotel and the impact of their distribution strategy. They can set goals based on revenue capture to measure the success of their strategy.

What does this mean for hotels?

Success at managing to a metric like a revenue-capture goal will require coordination between functional areas in the hotel, which is not necessarily something that hotels are structured to do. Revenue management needs to fully understand the channel mix and associated distribution costs, as well as the demand by channel and the value of that demand. Marketing needs to design programs that incentivize direct bookings. The general manager and owners need to be prepared to look at metrics like NetADR, NetRevPAR, or GoPAR (gross operating profit per available room) and be patient with what might appear to be dips in index, occupancy, or share. Asset managers might need to get involved at a more detailed level than ever before, understanding revenue metrics and marketing strategies more granularly.

When I talk to revenue leaders and consultants, they do talk about having more, very detailed, conversations with their asset managers and owners helping them to really understand the value of revenue management, including goals, strategies, and tactics. Revenue management understands demand and price sensitivity, and knows that holding rate will drive revenue and profits. They also know that price is more than just a revenue-generating tool; it can also be a strong component of an overall business strategy, used to drive market share or signal brand value. Owners tend to view the hotel as a short-term asset, which needs to generate cash flow and profits. They have a tendency to want to drop rate assuming it will drive demand, and get nervous when they believe that rate is too high. This by nature creates conflicts between these functions.

I like that asset managers and owners are trying to understand the opportunities associated with revenue management, and how rooms are marketed and sold. I think revenue management also needs to understand how owners think about the hotel as an asset, including the metrics they use and how those are calculated. This can help them align the pricing strategy better with the overall operational goals. This joint understanding will certainly improve communication, and very likely profits as well.

Of course, none of this is possible without all parties speaking the same language, and managing to a metric that clearly expresses the right goals for the organization. This is why I was particularly interested in how Mark had positioned this revenue-capture result, targeting the interpretation directly to a particular function, and speaking their language specifically. This interpretation elevates the problem of distribution-channel management past a tactical issue for revenue management to deal with in their pricing capacity, or the brand to manage in their distribution contracts and marketing programs, and turned into a strategic issue that impacts value creation in the broader industry.