Revenue Management in the Spa Industry: Party Two
By Josh Corman
IN THE AUGUST ISSUE of Pulse, we briefly explored the history of revenue management in other industries, identified terms and concepts important to understanding how revenue management works in practice and evaluated its applicability to the spa industry. Now, we’ll look closely at the steps that spa leaders should take as they determine how—or if— their spa should tailor a revenue management strategy, as well as detailing important questions they should ask and pitfalls they should avoid along the way.
LOOK BACK TO LOOK AHEAD
Performing a profitability analysis is one of the most basic ways to evaluate the performance of the various items on a spa’s treatment menus, but it’s also one of the most important. Conducting this kind of analysis is also an essential part of developing a revenue management strategy because to optimize the amount of profit a spa makes on the services it provides, those leading the spa must know definitively how profitable each individual treatment or service is.
Spa services have two primary costs tied to their delivery. The first is the cost of labor and the second is the cost of the products required to perform the service itself. However, linens (and their laundering), the space required for the treatment, cleaning products and special equipment may also need to be factored in to gain the most accurate picture of a service’s true cost.
To determine profit margin for a given service:
1. Calculate the total revenue earned from the service.
2. Calculate the total cost of delivering the service.
3. Subtract the service’s cost from its revenue.
4. Divide the resulting figure by the service’s revenue.
5. Multiply the resulting figure by 100 to reveal the service’s profit margin.
The resulting figure can then be represented as a percentage, making it easy to compare the profitability of your spa’s entire array of treatments and services. For example, a massage for which your spa charges $150 and which costs $110 to administer (between labor, product, linens, treatment room cleaning supplies and other costs) has a net income of $40. Divide that figure by the $150 earned on each massage, and that service’s profit margin is revealed as roughly 27 percent.
1. Revenue earned from the service ($150), minus the cost of performing the massage ($110), divided by the revenue earned from the service ($150).
2. Net income of the service ($40), divided by the revenue earned from the service ($150).
3. The profit margin for this particular service is then calculated by multiplying the resulting figure (0.266) by 100, revealing a margin of 26.6 percent.
Of course, every spa’s costs will differ, and the figures above are merely examples. It is important to remember that many spas capture additional revenue from retail sales of products used with treatments. Though earnings from these sales will vary from service to service, calculating the average or median revenue from retail sales per treatment type can give spa leaders another layer of costs and revenues to consider when calculating the net return on a given service.
Once the profit margin of each of your spa’s services have been calculated, those services should be sorted into high-, medium- and low-margin categories. Categorizing services in this way will make the process of determining service availability—more on that in the next section—much simpler.
WHEN AND HOW MUCH
After calculating the profit margin of each treatment on the spa’s menu and sorting them into the appropriate category, the next step in developing a revenue management strategy is analyzing bookings to determine (A) when the spa is typically at its busiest and (B) which treatments are most in demand from guests. Making these determinations is essential because effective revenue management often requires prioritizing the availability of services that combine a high ROI with high levels of popularity.
Consider the graphic below, which illustrates three different approaches to booking at a spa with three available treatment spaces.
● In scenario A, services are booked with no regard to the spa’s hour-by-hour demand nor the margin of the treatments being booked. The spa in this scenario simply fills each available unit of time as guest request specific treatments. The spa’s high-demand period is filled with a mix of low-, medium- and high-margin treatments, resulting in $975 in profit.
● In scenario B, low-margin treatments have been made unavailable during the spa’s high-demand period, so those appointments are filled only with more profitable treatments, increasing profits by more than 145% to $1,450.
● In scenario C, low- and medium-margin services have been made unavailable during the spa’s high-demand period, which increases the day’s profits even further, to $1,750.
In each of these scenarios, the spa books the same total number of services (23) on the hypothetical day in question. The difference in results comes, of course, from managing the availability of specific treatments so that high-margin treatments are booked more often, while lower-margin treatments are made available only during periods of lower demand.
A DYNAMIC APPROACH
The yield management strategy on display in the preceding example is called “dynamic availability,” which we defined in part one of this series as “adjusting the availability of certain services (massage or facial appointments, for example) based on customer demand, in real time.” By managing the mix of services being sold so that during high-demand hours only higher-margin services are sold, spas can increase their overall margin on treatments without adding therapists, treatment rooms or new services into the equation. Because the emphasis is on the services’ margin rather than its list price, dynamic availability may result in increased profits even if overall revenues remain similar.
The three scenarios represented by the example are, of course, simplified to demonstrate the basic possibilities of a yield management strategy that utilizes dynamic availability. In an actual spa, leaders will have to weigh a number of variables within their operation as they evaluate how such a strategy might work for their business. These variables include the spa’s peak business hours, its available staff, the use of its treatment spaces and the length of its services, in addition to the details about service margins discussed above. It’s also critical that spa leaders evaluate the spa’s current overall profit performance to establish the baseline against which future performance can then be judged.
Aside from the obvious potential boost to spa profits, dynamic availability has the added benefit of being essentially invisible to guests, unlike revenue management strategies that rely on adjusting service prices rather than service availability. For example, variable pricing—adjusting service prices based on the day of the week or time of day the service is booked—may allow spas to increase overall profits by increasing the margins on all services performed during high-demand periods such as weekends. However, that strategy may also require a high level of confidence that guests booking on weekends will not be deterred by paying higher rates for services and that higher prices will not reduce existing demand on those days. Spas with robust and predictable demand and a guest base with lower levels of price sensitivity, then, may benefit from a variable pricing strategy, although clear, persistent guest communication (including how service prices are listed and variations in price explained) will likely be vital to its implementation.
Dynamic pricing—adjusting service prices based on real-time demand—is a similarly challenging revenue management strategy to practice in the spa industry. Unlike airlines, hotels and ride-sharing services, spas’ offerings are less standard and feature lower margins than those businesses’ offerings. So, in addition to the challenge of satisfying guest expectations around service rates, spas practicing dynamic pricing would take on the added challenge of managing the impact that fluid pricing will have on the overall volume of services sold while simultaneously evaluating the effect of the strategy on each service’s margin and overall margins.
MORE TO CONSIDER
To be effective, a yield management strategy must be implemented with a thorough understanding of current operations and only after careful evaluation of the respective margins on each of the spa’s services. There are other important considerations as well, however.
One such consideration is the management software used by the spa, which must be able to accurately measure things like capacity over time and utilization of resources while also allowing operators to establish parameters on service types and times that streamline the booking and scheduling processes. Understanding the capability your software has to collect and report out key pieces of data can simplify the initial evaluation process and make executing a revenue management strategy far simpler, so make sure you are up to date on everything your spa management software can do.
Every spa is different, and as such, each of their approaches to revenue management will vary. There are, however, a handful of questions that spa leaders can ask themselves to determine the best approach for their spa, including:
● How complex is the mix of services offered at the spa?
● How many high-margin services and low-margin services share the same operational resources—rooms and staff?
● During high-demand periods, what is the typical mix of bookings for high-margin and low-margin services?
● How will performing a greater number of high-margin treatments during high-demand period impact the operation? Can the spa handle that shift?
● Are services performed during high- and low-demand periods typically standalone reservations or part of a service package?
● Which services typically contribute to additional revenue through add-ons or retail purchases?
Beyond all the relevant data, the right software and the answers to questions like the ones above, spas must also have buy-in from their teams and a plan for implementing any changes to operations necessitated by the adoption of a revenue management strategy. No amount of mathematical maneuvering is likely to be successful if guests’ experiences suffer as a result of poorly managed implementation. Be prepared, then, to track guest history, preferences, complaints and requests so that the new system’s impact can be measured by guest response in addition to dollars and cents.
In next month’s issue of Pulse, we will conclude this series on revenue management with an in-depth examination of the revenue management strategies and experiences of ISPA members.