Last week I worked on a new campaign to launch on Expedia which I had estimated would bring incremental (net) revenue to our hotel. Once the topic came up for discussion my proposal was shot down by the Revenue Manager (RM) with the reasoning that “we can’t take more net rates right now due to ADR”. I then asked if it would be ok if the campaign was launched on and the answer was “yes of course”.

With “net rates” the RM was referring to bookings coming in under the merchant payment model that would normally apply to an Expedia campaign. The merchant model means that revenue would enter the hotel’s system net of commission. The reservation on the other hand enters the system with the full revenue amount and consequently also has a higher ADR.

The simplified example in the table explains the two models; A guest pays the same amount (€100) for both the Agency/Gross and merchant/Net reservations, but the merchant revenue gets recorded only at €84 since 16% commission was deducted before sent to the hotel. The Agency commission is invoiced later the end of the month. After removing the commission cost from the Agency both are equally profitable.

Why the merchant model is unpopular

So, assuming we know the merchant model is just as profitable, which is a good firsts step, why was the RM rejecting the campaign? Here are 3 reasons to help understand why net rated business is less favored:

1.    Budgets – The budget is gross revenue based, following industry standard. This means that the RM is more inclined to focus on actions that drive more (and reject net) revenue in order to make his hotels budget.

2.    Average daily rate – As per the example above, the RM sometimes prefer not to take merchant model revenue as it is simply not good for the ADR. In fact, many commercial decisions are still made based on the impact it will have on ADR. This is in many cases a result of pressure from above but also as ADR is associated with status and prestige. 

3.    RGI – The RM has targets (and bonuses) tied to benchmark KPIs which are based on gross revenue. More net rates mean a lower ADR and consequently a lower Revenue Generation Index (RGI). From a different perspective, if the RM’s hotel has a bigger share of the Expedia pie than its competitor set, the hotel may inherently be disadvantaged; even if the hotel was selling more rooms at a higher rate than its competitor set it will have poor benchmarking results.

The big issue with these three scenarios is that revenue opportunities are being ignored and money is left on the table. Basically, decisions are being taken to achieve old-school KPIs instead of generating more profit. There is clearly a mismatch between industry KPI reporting and how costs and revenue flow in hotels today. There is a need to re-evaluate the balance and prioritization KPIs and targets in the hotel organization. Does it really make sense to label a hotel a poor commercial performer because it gets more business with a certain commission payment model?

More problems

In addition to the revenue management issues, the merchant model also has an impact on other areas which are worth discussing:

1.    Revenue based fees – Booking fees’ in management, franchise, operator and lease contracts generally don’t take the net revenue aspect into account. Depending on which side of the invoice you are, chances are you are missing out. 

2.    Profitability ratios – There is no cost attributed for merchant model OTA revenue in the P&L (which is strange in itself). That means that if you have a high share of Expedia business your GOP % is likely to inflate and inaccurately signal higher cost efficiency. And vice versa, if bookings shift to the agency model alarm bells might ring all though the actual distribution cost haven’t changed.

3.    Credit Card Commissions – Every merchant model booking comes with a virtual credit card which is classified as a corporate credit card. This is important because the transaction fee of a corporate credit card is double as expensive as charging a personal credit card.

Moving Forward

Hotels can opt out and stop working with the merchant model, but that comes of course at a revenue risk, (on Expedia no access to affiliate network, no package path). The more sustainable, long term solution is to put in place a structure that can handle both models. Actually, all of the issues highlighted are not related to the commission model itself (except for CC commissions) but rather as to how we report and interpret the data associated with it. We can address this issue directly and efficiently by:

a)    Implementing a “markup” (in the PMS, CRS) on net revenue to reflect the sell revenue

b)   adding a virtual cost for the merchant model commission in the P&L.

This would align net and gross revenues, provide a fair and accurate reporting of hotel and industry KPIs and ultimately allow hotels to make better commercial decisions. It would also improve the transparency between key stakeholders when it comes to booking fees.

The American Hotel & Lodging Association (AHLA) issued new guidelines at the beginning of 2018 as to how accounting standards should take into account gross and net revenues. As per the statement the standards are to be in place for all hotels by the end of 2019. I would love to hear from American hoteliers on the impact so far (is it happening?) and of course from other markets on how merchant model revenue is recorded and reported.