Thursday, February 23, 2017

Hotel mergers increase output

Recent article by some middling economists who show that following mergers among hotels, occupancy goes up.  They identify two theoretical mechanisms that could explain the result:
  • The first is that mergers reduce uncertainty about demand. Less uncertainty means better forecasts, which means fewer pricing errors—and higher occupancy—as the hotels are better able to match realized demand to available capacity. 
  •  A second mechanism—that the merged hotels are better able to compete for group and convention business—could also account for price and/or quantity increases. If the merged hotels are large enough to host groups, but the premerger hotels are not, then the merger could increase convention demand for the merged hotels. However, our finding that occupancy increases only in markets with high levels of uncertainty and capacity utilization leads us to prefer the former explanation, although we cannot rule out the possibility that increases in group demand, particularly during low-demand periods, could account for the results.

1 comment:

  1. In a study of hotel mergers, the main empirical findings according to Kalnins, Froeb, and Tschantz is that hotel mergers raise occupancy, without reducing capacity. In some regressions, price also appears to increase. These effects are small, but statistically and economically significant. They occur only in markets with high capacity utilization and high uncertainty (2017). This begs the question: Why does the brand and not the property affect a hotel’s financial results? Like Froeb I too have a preference to one of the two theoretical mechanisms that could explain the empirical results (Froeb, 2017). The mechanism that mergers reduce uncertainty about demand. Less uncertainty means better forecasts, which means fewer pricing errors, and higher occupancy, as the hotels are better able to match realized demand to available capacity due to reduce competition (Froeb, 2017). Reducing the competition by acquiring the substitute make the lower margin product more elastic and facilitate a price increase on both products (Froeb et al., 2016). Brand is also a factor which speaks to the hotel’s intangible assets or goodwill. Case in point an independent hotel with top-notch amenities, including spa, fancy restaurant and a golf court would not attract clients on the scale that it would if it joins a famous luxury hotel brand like Hilton. This is due to Hilton’s Resource Based View, RBV. RBV explains that individual firms may exhibit sustained performance advantages due to their superior resources (Froeb, McCann, Shor & Ward, 2016).

    Hotel mergers take advantage of a brand RBV (mergers between low tier and high tier hotels). Two primary assumptions govern a brand’ RBV and that is resource heterogeneity and resource immobility, it cannot be moved or imitated. A merger facilitates the mobility of the superior brand RBV. The increase in price can be attributed to the value consumers associate with the brand and not so much the amenities. For example, a consumer is willing to pay tens of thousands of dollars for a Rolex watch but not for a Timex, all things equal, even though they perform the same function of telling time. The increase value consumers place on product offering the same value and amenities is due to branding. When shopping for hotels does the brand name on the hotel door really matters?

    In another study conducted by Tsai, Dev, and Chintagunta (2015) they seek to answer the following question: Does rebranding/mergers improve performance outcomes such as volume, revenues, or profits?

    Method: They examined the effect of re-branding on performance using a data set of 19,775 detailed annual financial performances from 3010 hotels over an 18-year period (1994-2012). They compare a set of 260 re-branded hotels (the “treatment” group) to a second set of 2,750 hotels that were carefully matched to the re-branded hotels, except that they did not rebrand (the “control” group). (Tsai et al., 2015).
    Findings: The research quantifies the potential upside of re-branding (a 6.31% increase in occupancy, a 4.43% increase in revenue per room, and a 2.85% increase in gross operating profits per room) and reveals some insights into what kinds of rebranding boosts the financial performance the most. (Tsai, et al., 2015).
    Mergers or re-branding is not a random decision but instead it is a decision by company executive to minimize profit erosion, fuel growth, or to generate superior economic performance. Hotel Mergers follow two of the three basic strategies namely product differentiation and reduction in competitive intensity. In addition, mergers facilitate more complex pricing; the acquisition of a substitute good facilitate an increase in price on both products more so on the low margin product (Froeb et al., 2016).