The first reason is to make the hotel attractive to the guest by creating an offering that satisfies the guests' needs when traveling for a specific reason to the destination. Hotels must understand that guests have different needs when traveling for business and leisure and target segments with other offerings. The second reason is to maximize guest spending (both the willingness to pay and buy more products and services) at the hotel by carefully selecting the segments that spend the most during their stay to increase revenue and maximize profitability. The third reason is to minimize the customer acquisition cost by targeting the segments that likely will stay at the hotel. Targeting will cost less and therefore maximize the return on marketing spending.
Two approaches to market segmentation
There are two ways hotels segment the market. The first is an inside-out approach where the hotel thinks they are the center of attention. This approach aims to maximize the utilization of the capacity, primarily the hotel rooms, or fill the hotel rooms with any guest willing to pay the current room rate to stay at the hotel. A second way is an outside-in approach where the hotel wants to attract the correct type of guests, not just any. This approach aims to maximize the total revenue by selling to a segment willing to pay a higher rate and spend more on additional products and services.
In this blog post, we dig into the details of the different approaches to market segmentation and how it works. We look at how hotels segment their markets and the challenges and benefits of using the two methods.
Inside-out segmentation
This approach is all about capturing the demand for room nights, and it works for the generic hotel with no differentiators nor ambition to cater to different guest needs. The offering is the same for all segments. No frills, just accommodation. It is comparable to an economy airline seat or a fast food meal. The generic hotels have different brands, like airlines and fast food restaurants. The hotel room is a perishable commodity, so the hotel must sell all rooms every day; otherwise, the hotel loses the revenue opportunity. To maximize the hotel's occupancy, the hotel must play with the rate. These hotels need a revenue management system to capture the maximum number of rooms at the best possible rate. Since the rate is the only variable important to the hotel, the hotel can segment by rate category or level. The most common segmentation is a BAR segment, corporate negotiated rate segment, discounted rate segment, and wholesale segment. The generic type of hotel is like a stockbroker and sells the room to the guest who is willing to pay the most. The hotel will sell rooms at lower rates if there is no demand for higher rates.
Key performance indicators
Traditional hotel KPIs work well, such as RevPAR, ADR, Occ %, RGI, ARI, and MPI. The game is to capture the demanded volume in the market and, if the demand is low, steal as much as possible from the competition. Therefore, these KPIs indicate whether the hotel is successful or not.
Challenges
The hotel believes that demand is only a function of rate and will therefore keep lowering the rate until someone makes a reservation. Unfortunately, many destinations do not have enough demand to fill the hotel all 365 days per year. Another challenge is that a strategy built on rate will, over time, drive the average rate down when desperately trying to maximize occupancy. As a result, total revenue will start to decrease when the ADR falls. To keep profitability, hotels need to save on costs and simplify the product and services, making the hotel even more generic.
Pro-tip
Use a revenue management system (RMS) to set and update rates to maximize room revenue by maximizing occupancy. Do not touch the RMS; just let it find the best sell rate at any given time. The RMS will also track the data it needs and secure the data quality. The RMS works well for the generic hotel, where there is no need to understand anything about the guest except for the willingness to pay.
Outside-in segmentation
This approach is about capturing the guests' money, and it works for hotels with an ambition to cater to a selected clientele to fulfill their customized needs. These hotels still believe in genuine hospitality and are passionate about making guests happy. To satisfy guests, hotels need to understand why they travel to the destination, where they come from, their behavior, and many other characteristics of the guests. These hotels have a broad spectrum of facilities, products, and services to attract the proper guests. The ambition is to maximize the guest spending in the hotel, and it is, therefore, more essential to attract the high spenders than maximizing occupancy. A guest with a bad fit for the hotel and its audience will annoy other guests and risk impacting spending. This type of hotel uses segmentation to learn more about the guests and to understand how and where to target more guests in the same segments. The first segmentation criterion is why the guest comes to the destination (the reason for travel). When the hotel has this information, the hotel can customize the stay based on needs derived from the travel reason. For example, business travelers have different needs from families with small kids. The second segmentation criterion is from where the guest comes. Depending on the culture in the guest's home country, the guest has different needs and behaviors. Asian travelers have other food preferences than western travelers. The distance from the guest's home to the destination affects the length of stay and booking patterns. The third and following segmentation criteria depend on what the hotel needs to learn about the guest. To maximize total guest spending, the hotel needs to know more about guest behavior, such as preferred booking channels, booking windows, stay patterns, and other behavioral data.
Hotels focusing on understanding the guest will be able to provide the products and services that the guest is willing to pay for, get higher guest satisfaction, and get higher review scores from happy guests. Therefore, guests will be ready to pay a premium rate for staying at the hotel.
Key performance indicators
KPIs that measure total revenue, such as TrevPAR, average spend per stay, average spend per guest/customer, and Customer Lifetime Value (CLV), will better reflect how successful the hotel is in maximizing the total revenue. The game here is to satisfy more guests' needs than just a generic hotel room. Therefore, KPIs measuring total revenue and guest satisfaction will show whether the hotel is successful or not.
Challenges
Sometimes it is difficult to determine the reason for travel from the reservation. Therefore, train front desk staff to get the reason for travel from every guest. Most guests do not mind sharing their reason for traveling while chit-chatting during check-in. If the chit-chat does not work, finding the reason for travel and reinforcing that the hotel wants to provide exemplary service during the stay could be done by asking: "We'd love to know what brings you to our destination to help ensure that we provide you the best service possible."
The hotel industry traditionally focuses on volume and using its capacity, so another challenge is to convince the owner that going after the guests' money will maximize the profit rather than focusing on maximizing occupancy.
Pro-tip
Focus on three to five segments, including "Other," for the discounted brand or employee rates, complimentary rooms, or other industry rates.
The hotel also has the rate for each reservation and can quickly analyze the rate sensitivity for each segment. In this approach, it is more important to focus on the total guest spending, but it is also valuable to understand the willingness to pay from time to time.
Do not mix the two approaches
Now that you know more about the two approaches to hotel market segmentation, it is time to pick the best approach for your hotel. Mixing the two methods will not end well. If a hotel using the outside-in approach all of a sudden starts to sell rooms at a lower rate, the hotel will destroy its brand and reputation and the trust of its guests. On the other hand, if a hotel uses the inside-out approach and tries to sell more products and services to its guests, it is a waste of time since the guest only cares about getting the lowest possible rate.
