Spa revenue management. Part II
By Sheryl E. Kimes & Sonee Singh

Perishable inventory. One might think of a spa's inventory as its rooms and therapists, but instead, spa inventory should be thought of as time--or, in this case, the time during which the spa's capacity (both rooms and therapists) is available. If the spa is not fully occupied for a period of time, that part of the spa's inventory perishes. This is the key to the strategic revenue management framework, and it is the element we believe has been missing in most approaches to spa revenue management. Instead of measuring costs or revenue for a given month, spa operators should measure revenue or contribution per available treatment-hour (RevPATH). This measure captures the time factor involved in the spa business. Revenue can come from a variety of sources, including regular and upgraded treatment fees and surcharges for particular rooms or therapists.

Many spa companies evaluate operations based on sales volume. This is equivalent to hotels' measuring effectiveness by recording occupancy without paying attention to average rate. While a high volume is desirable, volume alone does not provide the information regarding revenue that RevPATH would give.

Appropriate cost structure.
Revenue management works best in industries that have a relatively high fixed cost and a relatively low variable cost. This describes spas, with their sometimes elaborate facilities and essentially fixed labor costs (or at least a fixed labor-cost percentage). Spa sales generally must generate sufficient revenue to cover variable costs and offset at least some fixed costs. Depending upon the spa's geographic location, labor can be considered either a fixed or a variable cost. For example, as explained by spa analyst Andrew Gibson (personal communication, 2008), in Asia, where most therapists are on salary and labor costs range from less than 20 percent to nearly 60 percent of the treatment price, labor is often treated as a fixed cost. Conversely, in North America, said Gibson, most therapists are paid an amount per treatment and labor is considered a variable cost, although the labor cost is a known percentage. Other variable costs include treatment costs of sales, ranging from virtually nothing (in treatments where no products are used, such as Thai Massage or Shiatsu) up to an average of 15 percent. Thus, spas have some pricing flexibility and can reduce prices during low-demand times.

Since revenue management has more potential in operations with a cost ratio of high fixed costs to low variable costs, it offers more revenue opportunity in spas that treat labor as a fixed cost. This is not to say that revenue management cannot increase revenue in spas that treat labor as a variable cost, but it cannot provide the same level of return. We say this only because, when labor costs are variable and therapists are paid per treatment, the opportunity cost of an unsold treatment time mostly comes from an empty facility and not the cost of paying staff.

Varying customer price sensitivity.
The spa industry, like most other industries, has some customers who are extremely price-sensitive. These customers may be willing to plan for a treatment at a less attractive time or in a less desirable room if they can get a discounted price. Conversely, other customers may be price-insensitive and be more than willing to pay a premium to get their preferred treatment time, treatment room, or therapist. Having raised the issue of discounting, we note its dangers. When deciding to offer lower prices, operators must pay particular attention to the effects that any price adjustments may have on the patronage of regular guests. Not only might price reductions annoy regular guests who have paid full price, but an influx of guests attracted by off-price opportunities may also interfere with regular customers. A spa is a place of sanctuary for most guests and unless care is taken, having a larger (and different) market segment in the spa may adversely affect the traditional spa experience.

Time-variable demand.
Customer demand varies by the time of year, by the week, by the day, and by the time of day. Depending on the type and location of the spa, demand may be higher on weekends, during high season, or during late afternoons and evenings. Each spa's managers must be able to forecast their operation's time-related demand so that they can make effective pricing and capacity-allocation decisions to manage the shoulder periods.

In addition, the length of the treatment can vary. Some treatments may last for an hour, others for forty-five minutes, and still others for ninety minutes, depending on the treatment and the customer's preferences. Beyond that issue, guests can combine treatments in a long visit to the spa, with packages starting at two hours and including half day (three to four hours) and full day (up to six hours).

Spa operators must also be conscious of their definition of treatment time. Often, an hour treatment only lasts fifty minutes, allowing for a ten-minute turnaround of the room between guests. Some guests are quite aware of the treatment duration and are conscious about whether they are getting a fifty-minute treatment or a full sixty minutes.

Measuring Success
Focusing on RevPATH has major implications for the way in which a spa is operated and evaluated. Many managers currently measure their spa's success by tallying the number of customers served; average spent per guest; utilization of therapists and treatment rooms; percentage of retail revenue; revenue per square foot; revenue per treatment; and, in the case of hotel and resort spas, hotel guest capture rate or spa revenue per occupied guest room. While such measures are valuable for many purposes, they do not explicitly reflect the spa's revenue-production performance. RevPATH, on the other hand, combines information from the average customer expenditure and treatment room use (or occupancy) to provide a measure of the flow of revenue through the system and to indicate how effectively a spa is using its productive capacity. Revenue streams vary by location, business model, and type of spa, but typically a spa will generate 70 to 85 percent of its revenue from treatments (face and body services and others); 5 to 20 percent from retail; and up to 15 percent from other sources, such as fitness, wellness, nutrition, seminars, and workshops.

Because it embraces capacity use and average expenditures, revenue (or contribution) per available treatment-hour is a much better indicator of the revenue generating performance of a spa than are the commonly used measures that we just mentioned. RevPATH indicates the rate at which revenue is generated and captures the trade-off between average expenditure and facility use. If occupancy percentages increase even as the average expenditure decreases, for instance, a spa can still achieve the same RevPATH. Conversely, if a spa can increase the average expenditure, it can maintain a similar RevPATH with a slightly lower facility use. The balance between average rates and facility use depends in part on the type of spa. High-end spas, for instance, may wish keep rates high to ensure low facility occupancy and thus maintain a quiet ambience and relaxed guest experience, as well as use price to signal the spa's luxury positioning.

RevPATH can be calculated by multiplying the treatment room occupancy by the average treatment-related expenditure per person or by dividing the revenue for the time period in question (e.g., day part, day, or month) by the number of treatment-hours available during that interval. For example, assume that a ten-room resort spa has a 70 percent treatment room occupancy and a $200 average expenditure per person on treatments (excluding retail). Its RevPATH is $140 (calculated by multiplying the 70 percent occupancy by the $200 average expenditure per person). Alternatively, assume that a twenty-room day spa makes $1,600 on Fridays between 6:00 and 7:00 p.m. Its RevPATH would be $80 ($1,600/[20 rooms x 1 hour]). Similarly, if that same twenty-room day spa made $8,000 over a four-hour treatment period, its RevPATH would be $100 ($8,000/ [20 treatments x 4 hours], or $8,000/80 available treatment room-hours).

Exhibit 1 gives a hypothetical illustration of this principle. The four spa operators have the same RevPATH ($72, calculated by multiplying the occupancy percentage by the average expenditure per person), but each achieves it in a different manner. Spa A has a facility use of 40 percent and an average expenditure of $180, while Spa D has a use ratio of 90 percent but an average expenditure of $80. Spa operators B and C also achieved a RevPATH of $72, but with varying facility-use and average-expenditure statistics.

The numbers for Spa A are typical of a high-end spa where the operator prefers to have a lower occupancy so a relaxed ambience can be offered, but must compensate for this lower occupancy by having a higher expenditure per guest. Conversely, Spa D's numbers are common for a day spa that has a relatively low average expenditure per guest. To compensate for the lower rates, the operator of this spa must achieve a high volume of business. The trade-off between occupancy and average expenditure is a strategic one, and one that must be carefully considered when positioning one's spa.