Cut-price tourism: the role played by hotel rate adjustments in the recovery
The collapse of tourism in Spain in the wake of COVID-19 has pushed the tourism industry to undertake major price adjustments and the hotel sector has been the greatest exponent of this trend. According to data from the National Statistics Institute, the price per room per day charged by hotels in the summer of 2020 was 16% lower than the previous year. However, this huge price cut does not seem to have played a decisive role in reviving demand in some regions. The change in travel preferences brought about by the pandemic has meant that tourists have opted for nearby, familiar and less congested destinations, focusing less on price and thereby limiting the success of big reductions in hotel prices.
The law of supply and demand is very clear: if demand decreases and supply remains the same, prices fall; if supply falls and demand stays the same, prices go up. But 2020 was a year in which both these movements took place. On the one hand, tourist demand fell sharply, even during the summer months when movement restrictions and infection rates were very low. On the other hand, severe restrictions were imposed on hotel capacity, which considerably limited the number of tourist places available in hotels and the number of customers that could be served in restaurants.
According to economic theory, the reduced capacity experienced during the second half of 2020 should have limited price reductions in many establishments. However, the slump in tourist demand was so severe that most businesses and shops that depend to some extent on tourism lowered their prices in the hope of reviving demand.1
- 1. Note that this price reduction occurred at a time of higher costs being borne by establishments to adapt to the anti-COVID safety measures (e.g. disinfectant gel, protective screens, more cleaning, signage, etc.), in addition to higher unit fixed costs (due to capacity restrictions and a fall in turnover).
was so severe that most tourism-dependent busi-nesses and shops opted to lower their prices in the hope of reviving demand.
According to data from the consumer price index (CPI), the largest price cuts after the March-June lockdown in 2020 occurred in the rates charged for tourist accommodation, highly dependent on demand from international tourists. During the second half of 2020, the prices for this type of business fell by an average of 18% year-on-year. Big cuts were also observed in the price of international and domestic flights, with year-on-year decreases of 14% and 3%, respectively, something quite remarkable in a sector where margins were already very tight before the pandemic.2 However, it should be noted that not all tourism-dependent businesses lowered their prices. This was the case for food and drink establishments which, in spite of suffering from a drop in turnover, were able to replace some of their tourist clientele with local customers, on average pricing their goods and services 1% above 2019 levels.
- 2. See the article «The need to take off in 2021» in this report.
The consumer price index for tourism-related goods and services
The big reductions in tourist accommodation prices were not homogeneous throughout Spain as a result of the diversity within the tourism industry itself. Some of the factors that explain the different impact in different areas are the composition of tourism demand, changes in tourist preferences after the outbreak of the pandemic and notable differences in pre-COVID prices between regions. As can be seen in the chart, there are clear differences in hotel prices between autonomous regions. One of the main determining factors for these differences is the relative share of international demand, tourists who traditionally have more purchasing power, compared with the share of domestic tourism demand, who tend to prefer more moderately priced destinations. Accordingly, in the Balearic Islands, an eminently international destination, the average daily rate (ADR) for a hotel room was 123 euros during the summer months, while the Principality of Asturias, a destination whose tourism is much more focused on domestic visitors, had an ADR of 70 euros, more than 40% lower than the Balearic Islands.3 It is therefore to be expected that those autonomous regions with the highest prices, also the most urban and international, should be the ones undertaking the largest price adjustments.
- 3. Part of the difference in prices is due to differences in each region's hotel supply in terms of star ratings. In the aforementioned case, the share of 4 and 5-star hotels in the Balearic Islands is 53% but only 31% in Asturias.
Share of foreign demand and hotel prices in the autonomous regions in 2019
Consequently, the autonomous regions that cut their prices the most during the summer months of 2020 were Madrid (–34.8% year-on-year), the Basque Country (–24.0%) and Catalonia (–20.2%), where Spain's main urban destinations are located. On the other hand, the Balearic Islands (–5.1%) and Canary Islands (–3.4%), two destinations that have been harder hit due to their dependence on foreign tourism, did not opt for such an aggressive strategy. Finally, in Asturias (+6.0%), Extremadura (+1.2%) and Aragon (+0.8%), three autonomous regions with a larger relative share of coastal and (less crowded) inland rural tourism that are traditionally more dependent on domestic tourism, did not choose to reduce their prices, taking advantage of their competitive edge in terms of social distancing.
Decline in hotel prices in Q3 2020
Year-on-year change in ADR
During the past decade, the growing demand for tourism in Spain has pushed up prices in the sector year after year. Despite this, Spain has remained competitive compared with other international destinations as its tourism industry has improved the quality of its services and has taken maximum advantage of the country’s appeal (in terms of culture, climate, hours of sunshine, etc.). This situation was completely reversed in 2020. The absence of tourists took the pressure of demand off prices and pushed suppliers to make large adjustments in order to become more attractive and stimulate consumption.
tourism demand did not respond to price adjustments during 2020.
One of the questions that arises after seeing these large price cuts is whether it was an appropriate strategy which attracted a larger share of the tourists travelling through Spain. On paper, such a strategy was logical given the drop in demand. However, the situation in 2020 was so unique that it raises the issue of whether tourists’ decisions were really mostly price-driven. One highly plausible hypothesis is that the few international tourists who came to Spain and did not have a second home in the country (i.e. who stayed at hotels, tourist apartments, campsites, etc.) were loyal consumers who choose the same destination year after year in Spain. As for domestic tourists, it is likely that relatives and nearby destinations also prevailed. If so, the relationship between demand and price was not so strong in 2020, reducing the effectiveness of price cuts.
To test this hypothesis, we have performed a series of quantitative exercises to estimate the price sensitivity of demand in the different channels. First, we calculated the correlation between the annual changes in ADR and the market shares of international and domestic tourists in the autonomous regions. The result is an almost zero correlation, suggesting that hotel price reductions did not manage to improve the percentage of tourists received by each region in 2020. After carrying out a more sophisticated analysis to estimate the price elasticity of demand, the results point in the same direction. As can be seen in the chart, according to our estimates hotel demand was highly inelastic in 2020 and did not respond significantly to the price changes carried out by a large number of hotel establishments. In contrast, we estimate that hotel demand was elastic between 2010 and 2019, with a price elasticity of 1.3, implying that a 1% reduction in hotel prices would result in an increase in tourist overnight stays of 1.3%.4 This shows that special offers and price cuts were clearly attractive before the outbreak of the pandemic. However, estimates suggest that, in 2020, the price cuts carried out in some regions did not significantly attract a larger proportion of the low tourism demand.
- 4. Price elasticity corresponds to the coefficient β estimated using two-stage least squares in the following log regression: Di,t = α+βPi,t +ϑXi,t +δi +ζt+εi,t, where Di,t are hotel over-night stays in province i in month t Pi,t is the hotel ADR instrumented using unit labour costs, X i,t is a control variable matrix and the variables δi and ζt are the unobservable time and regional fixed effects. Two province-level panel data samples have been used, one between Q1 2010 and Q4 2019 and the other between Q1 2020 and Q4 2020.
Effect of a 1% cut in hotel prices on overnight stays
- The collapse of tourism in Spain in the wake of COVID-19 has pushed the tourism industry to undertake major price adjustments. The hotel sector has been the leading exponent of this trend and, in some regions of Spain, has applied a very aggressive pricing strategy in an attempt to capture as much of last year's dwindling tourist demand as possible.
- Despite this, due to the changes undergone by tourism in 2020, the strategy of cutting prices has proved to be ineffective and the gains have been minimal in those regions where prices have been lowered the most. Tourists seem to have considered other factors over and above price, such as proximity and whether they are already familiar with the destination.
- Nevertheless, prices are likely to remain low in 2021, as tourism will have only recovered in part by the summer and there will still be a great need to attract demand among those businesses that are most dependent on tourism.
- Greater safety when travelling, thanks to the fact that part of the population will be vaccinated, may lead to a price adjustment strategy being more successful this year. We can only wait and see whether this situation will come about and, in the meantime, take advantage of the low-price environment to help to revive tourism ourselves.