What is cost-based pricing?

Cost-based pricing is one of the simplest and safest ways that a hotel can come up with its prices. The cost-based pricing method sees a hotel calculate the total cost of offering a service, such as a night in a room, then add a profit margin on top to arrive at a selling price.

A cost-based pricing strategy can be a relatively easy way for a hotelier to decide how much to charge their guests. This blog will tell you everything you need to know.

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Cost-based pricing vs other pricing strategies 

Cost-based pricing is one of a number of pricing strategies available to a hotelier. Here’s how it compares to a few of the most popular.

Cost-based pricingPrices are set based on how much a service costs to deliver, plus a profit margin markup.
Value-based pricingPrices are set based on what guests believe your hotel rooms and services are worth.
Market-based pricingPrices are set based on factors like consumer demand, economic conditions and other market forces.
Competition-based pricingPrices are set based on what relevant, local hotel competitors are charging.

Why should hotels use a cost-based pricing strategy?

The benefits of cost-based pricing for hoteliers centre on the financial stability it provides. Of the options listed above, the cost-based pricing strategy is the one that is always guaranteed to make your hotel a profit on each room and service, and a specific profit at that. It offers an independent hotelier much needed clarity and control over their hotel finances – you know that if you sell a room at this price, you’ll make exactly this much.

Cost-based pricing formula

The cost-based pricing formula is very simple to understand, though it can be a little more difficult to calculate. Here is the formula for working out the cost-based price for a room rate:

Total cost of running your hotel (per day) / Total number of occupied rooms + Profit margin = Average room rate

The complexity is in identifying and calculating all the costs of running your hotel, as there are a number of infrequent or ad hoc costs that are easily overlooked. You may have even built your hotel from scratch.

It’s also important to note that this example only offers an average room rate, and more calculations would be needed to find the true cost-based price for individual rooms.

How the cost-based pricing method works

There are three main steps involved in the implementation of a cost-based pricing hotel model:

Step 1: Understand your costs

The first and most important step is to identify all of your costs, as they will form the basis of your cost-based price. The simplest way is to check your total outgoings over the last year using your accounting software, then divide that total by 365 to get a daily average cost. You can then further divide that figure across the average number of occupied rooms and services you offer.

Step 2: Choose your strategy

There are two methods of cost-based pricing: break-even or cost-plus. A break-even strategy simply earns enough money to cover costs, and may be useful for a hotel over low season. A cost-plus strategy adds a profit margin to your prices, and should be the default.

Step 3: Identify your profit margin

If you choose a cost-plus strategy, what profit margin should you place atop your costs to arrive at your price? The answer will depend on factors such as your financial position, market conditions, your hotel’s reputation and what your competitors are charging.

Cost-based pricing example

Let’s take a look at a simple example of cost-based pricing.

A 5-room bed and breakfast is looking to employ a cost-based pricing strategy. Over the last year it has calculated that its annual costs total $200,000, and that rooms were occupied an average of 200 nights of the year. This means the cost worked out to $200 per (occupied) room per day, which is its room rate break even point.

It decides that a profit margin of 40% is appropriate given its circumstances, so sets its standard room rate at $280.

Advantages of cost-based pricing for hotels

What are the advantages of cost-based pricing? Here are five of the most compelling.

  1. Minimum level of profit

When you calculate and set your cost-based price, you’re guaranteed to make a minimum level of profit whenever a guest books a room.

  1. Structure for forecasting and budgeting

The process of setting cost-based pricing can offer real insight into your finances, and can be helpful for forecasting and budgeting.

  1. Consistency

While all hotel prices vary from low season to high and mid-week to weekend, a cost-based pricing strategy offers consistency to guests – they’re less likely to think they’re being price gouged.

  1. Competitive pricing

By using costs as your guide, you can be confident that your prices will be competitive (provided you don’t go overboard with your profit margin).

  1. Mitigate risks

Cost-based pricing is safe. It considers the unique circumstances of your hotel to come up with a price that’s good for business.

By Dean Elphick

Dean is the Senior Content Marketing Specialist of Little Hotelier, the all-in-one software solution purpose-built to make the lives of small accommodation providers easier. Dean has made writing and creating content his passion for the entirety of his professional life, which includes more than six years at Little Hotelier. Through content, Dean aims to provide education, inspiration, assistance, and, ultimately, value for small accommodation businesses looking to improve the way they run their operations (and live their life).