Document Type

Article

Publication Date

9-1-2005

Abstract

With the growth of the internet, the increase in the volume of online bookings has altered and multiplied the hotel industry's distribution channels. While this growth has driven up the profits of online travel agencies, hotel operators are experiencing a loss of control over the pricing of rooms and a potential transfer of pricing authority to third-party internet-based companies. The popularity of such services stems from consumers' desire to obtain the lowest rate within their desired market segment. One possible cure applied by many hotel chains is to offer a best-rate guarantee on their own web sites. A calculation of the option value of such guarantees shows, however, that current rate guarantees have little value to consumers. Instead, an application of option-pricing approaches demonstrates how a hotel company can structure a best-rate guarantee that would provide value to consumers by offering the guest the option of purchasing a price guarantee. Such an option would give the guest the lowest price posted on a specified set of web sites, up to the time the guest arrives at the hotel. The pricing of this option would be based on a well-established exotic-option pricing formula. A demonstration of how to price this best-rate guarantee shows that its value (and its price) diminishes as the arrival date approaches, so consumers should be willing to pay for the option, because the price is set according to the likelihood that prices will change. Using this approach hotel companies should be able to eliminate the incentive for consumers to engage in search-and-switch behavior, reestablish the price integrity of their product, and simultaneously create a revenue stream from the sale of the best-rate-guarantee options to their customers.

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