Every hotel owner faces the same big question: what should we charge for a room? Set the price too high, and you’ll scare guests away. Set it too low, and you won’t make any money.
Among all the methods for setting prices, one of the simplest is cost-based pricing. It’s a very straightforward approach: you figure out exactly what it costs you to run your hotel, and then you set your room rates from there.
The main benefit is that it guarantees you’re not losing money on every room you sell. It gives you a clear financial foundation. But here’s the thing: the hotel business moves fast. You have to deal with what your competitors are charging, how many people want a room, and what guests think a room is worth.
So, in today’s world, is just looking at your costs enough? Let’s break down what this strategy is all about and how hotels can use it without getting left behind.
What Is Cost-Based Pricing?
Cost-based pricing is a method of setting prices by adding a profit margin to the total cost of providing a service. In simple terms, a hotel calculates all its expenses—like cleaning, maintenance, staff salaries, and booking fees—and then adds a markup to make a profit.
For example, if running the room costs $80 and the owner needs 25 %, the rate is pushed to $100. The guest pays, the bills are covered, and the leftover is sure.
In the hospitality industry, costs are divided into two main categories:
- Fixed costs: These remain constant regardless of occupancy. They include rent or mortgage, insurance, salaries, licenses, and utilities.
- Variable costs: These change depending on occupancy, such as housekeeping supplies, guest amenities, breakfast ingredients, and booking commissions.
Understanding both types of costs is key. It tells you the break-even price—the minimum you must charge just to stay afloat. While it’s just a starting point, this formula gives you a logical foundation for all your pricing decisions.
Why Do Hotels Use a Cost-Based Pricing Strategy?
With all the talk about dynamic pricing and beating the competition, you might wonder why a modern hotel would use something as simple as cost-based pricing. The answer is pretty simple: stability, clarity, and security.
- Hotels use it mainly to set a financial floor. Think of it as a safety net. If you don’t know exactly what your costs are, you could end up in a terrible situation: selling out every night but still losing money.
- A hotel owner’s first job is to make sure the business stays afloat for the long run. This strategy forces you to be disciplined with your money. It makes you look at every single expense, not just the big ones like salaries and utilities, but also the smaller things you might forget, like replacing old towels or paying for your booking software.
- This approach is also a huge help for smaller hotels or those in markets that don’t have crazy seasonal swings. It takes the guesswork out of a complicated job and gives you a real, usable number that you know will keep the business running. Getting that initial cost calculation right is the foundation for everything else—your budget, your plans for the future, and making sure you have enough cash on hand.
Cost-Based Pricing Formula and Key Components
To apply cost-based pricing effectively, hotels need to calculate their total costs and then apply a markup percentage. The basic formula looks like this:
Let’s break this down:
- Calculate fixed and variable costs
Identify all recurring expenses such as rent, salaries, utilities, cleaning supplies, and booking commissions. For example, if a hotel’s total monthly cost is $90,000 and it operates 30 rooms with an average occupancy of 80%, you can calculate cost per room by dividing total costs by the number of rooms sold per month. - Add desired profit margin
Hotels typically apply a markup based on their financial goals or market positioning. A budget hotel might add 10–15%, while a boutique or luxury hotel could add 25–40%. - Review market alignment
Once the base price is calculated, hotels should compare it to market averages. If the calculated price is far above local competitors, the markup may need adjustment.
Example Calculation
Let’s imagine a small hotel with 20 rooms:
- Fixed monthly costs: $50,000
- Variable costs per occupied room: $20
- Average occupancy: 75%
- Rooms sold per month: 450 (20 rooms × 30 days × 75%)
Total variable cost = 450 × $20 = $9,000
Total monthly cost = $50,000 + $9,000 = $59,000
Cost per occupied room = $59,000 / 450 = $131
If the hotel applies a 20% profit margin, room price = $131 × 120% = $157.20
This formula provides a clear and consistent pricing baseline.
Advantages and Disadvantages of Cost-Based Pricing in Hotels
Advantages
- Ensures profitability
Every price set through this method covers operational costs and guarantees a margin, giving hotels a sense of financial security. - Simple and transparent
It’s easy for managers and owners to understand and explain. There’s no need for complex analytics or dynamic pricing systems. - Supports financial planning
Budgeting and forecasting become more reliable. Managers can adjust margins when expenses change, helping maintain profitability. - Reduces emotional decision-making
Instead of reacting to competitors’ prices, decisions are based on actual data and internal cost structures.
Disadvantages
- Ignores guest perception and demand
Cost-based pricing doesn’t reflect what guests are willing to pay. During high-demand periods, hotels may underprice, missing revenue opportunities. - Overlooks market competition
If competitors charge less, a cost-based rate could seem overpriced and reduce occupancy. - Relies on accurate cost tracking
Miscalculating expenses or ignoring hidden costs—like OTA commissions or seasonal maintenance—can lead to inaccurate pricing. - Lacks flexibility
The market changes constantly. Fixed margins don’t account for sudden shifts in demand, local events, or changes in traveler behavior.
For these reasons, hotels often use cost-based pricing as a baseline rather than a final rate. It’s the foundation upon which dynamic and value-based adjustments can be built.
Cost-Based Pricing vs. Other Pricing Strategies
In the modern hospitality landscape, cost-based pricing rarely operates in isolation. It serves as the grounding force against the often-fluid nature of other pricing models.
1. Value-Based Pricing (VBP)
- Cost-based pricing focus: What does it cost me to provide the room?
- Value-based pricing focus: What is the value of the room to the guest?
VBP is an outward-facing strategy. A luxury resort with an exclusive spa and private beach can charge a premium far above its operational costs because of the exceptional value and unique experience it offers. For high-end properties, VBP often supersedes cost-based pricing in revenue potential, but cost-based pricing is still needed to calculate the minimum acceptable rate.
2. Competitive Pricing (CP)
- Cost-based pricing focus: My internal financial data.
- Competitive pricing focus: The public rates of my competitive set (comp set).
CP involves constant monitoring of local competitors and setting prices based on their public offerings. This strategy is critical for staying competitive but is dangerous if used without a cost-based floor. If a competitor is running a low-cost promotion, matching their price without knowing your own costs could result in significant losses. Cost-based pricing ensures you never drop below your financial safety limit.
3. Dynamic Pricing (DP)
- Cost-based pricing focus: Fixed costs and desired margin.
- Dynamic pricing focus: Real-time demand, lead time, day of the week, and occupancy forecast.
Dynamic pricing is the core of modern revenue management, allowing rates to change minute-by-minute to capture maximum revenue. It is the most profitable strategy, but it requires a solid cost-based floor. The system knows it can drop the price low to boost occupancy during a quiet Tuesday night, but it also knows that price can never dip below the room's unit cost.
Conclusion
When it comes down to it, cost-based pricing is one of the most practical tools a hotel can have. It’s especially useful for smaller, independent places that want to be in complete control of their profits. It gives you a clear, confident way to set prices by focusing on the basics: your costs and making a sustainable profit.
But let’s be clear, it’s not a magic bullet. Today’s hotel world is shaped by what your competitors are doing, what guests expect, and new technology. A price based only on your costs can’t react to a sudden spike in demand or a big event in town.
The smartest move is to use cost-based pricing as your foundation. It’s your financial safety net. On top of that, you layer in other strategies—like dynamic pricing or checking what the competition is charging—to stay flexible.
When you mix these methods, you get the best of both worlds: you have financial control, but you can also grab every opportunity to make more money.
