Ever wonder how hotels get reimbursed on award stays using points? Let’s spend a moment talking about the economics of how it works.

The logic of how hotels are reimbursed for award stays

Let’s say you want to start your own loyalty program. You get some hotels to sign up under your umbrella and you create a points program to entice customers. You may or may not own these hotels, but you plan to eventually deal with hotels owned by others. How do you go about reimbursing hotels for those stays?

Do you pay the hotels anything for stays from guests using points? At this point, yes, you would have to because every other loyalty program out there reimburses hotels. But take a half step back to understand why. Members don’t use points equally across each hotel. Some hotels have a higher proportion of points guests than others. To not reimburse these hotels anything wouldn’t be equitable.

Now that we’re reimbursing hotels, how should we structure the reimbursement? You might find yourself settling at the average nightly rate at that hotel. That seems logical enough, but the points quickly become very expensive. Guests using points are disproportionally leisure guests and these guests generally have an open choice for where they want to go. They might choose exotic locations like Hawaii rather than a low-cost hotel in Wichita. Cash rates tend to be higher at those exotic locations too. So, to keep costs down, you decide to pay a lower rate to hotels some of the time.

This is exactly how loyalty programs tend to reimburse hotels when members redeem points towards a free night.

The typical loyalty structure for reimbursing hotels on points stays

It’s generally accepted that most hotel loyalty programs are structured in the following manner:

• For nights when the hotel is near-capacity (think above 90% occupancy rate), loyalty programs pay out a rate to hotels based on the average nightly rate.
• For nights when the hotel isn’t near-capacity, loyalty programs pay out a rate that’s above the marginal cost of servicing the guest per night.

The assumption here is that the member staying on points is potentially displacing a cash-paying guest when the property it full or near-full.

What counts as marginal cost? The cost of electricity, water, housekeeping, and other variable expenses perhaps with a small recognition for fixed expenses.

Generally, hotels aren’t reimbursed based on the number of points the member redeemed. There can be correlation (a member might spend fewer points during the low season when the average daily rate is also lower) but not a direct relationship.

Do hotels prefer a points guest or a cash guest?

The “simple” answer is that the hotel prefers a cash guest over a points guest. When a guest pays cash, the majority of that cash stays with the hotel. But for a guest paying with points or a free night award, the loyalty program only “pays” the average daily rate if the hotel is nearly full. In other words, when the property isn’t full, the hotel keeps more money. Thus, simplistically, the hotel prefers cash guests.

However, the reality isn’t quite as obvious. Customers don’t view cash and points the same way. Points are a currency of the loyalty program and members cannot directly redeem into cash. Thus, a member might be able to afford a more expensive property booked with points than they would otherwise be willing to spend with cash.

For example, take a property like the Andaz Maui, which has incredibly high cash rates but points rates that might look more attractive than the cash rates do. In this example, maybe the person paying with cash wouldn’t overreach where they stay and opt for somewhere cheaper. But the points-rich customer might be more willing to splurge since they either perceive points as cheaper than cash or they like to convince themselves the points rate is a good deal.

Either way, the hotel is getting a customer it otherwise wouldn’t get. So in this case, hotels should like points guests because they otherwise wouldn’t get them. But it’s easy for the hotel to lose this perspective, especially if they offer something that can’t be beat (location, amenities, etc.). That’s why you sometimes see properties favoring cash guests, like giving them higher priority for elite upgrades.

How do devaluations fit into the equation?

This all brings to the question about devaluations of points programs. What drives the need to devalue points? Lowering the deferred revenue (a.k.a. liability) on the balance sheet. It’s a simple way to raise profits by lowering the value of those points. That makes sense at a program-wide level, but what about at an individual hotel level?

Why would a hotel devalue a single hotel or a class of hotels more than others? Loyalty programs generally imply they do not make decisions on individual hotels with those hotels themselves. For the most part, we think it’s true because they don’t need to.

The loyalty program can see exactly how many points members redeem for each hotel. They can also see how much they’re paying out to the hotel related to points redemptions or free night awards. In a perfect world, that would inform the loyalty program of what to do with points rates. As you might do for your own stays, the loyalty program is likely determining its price per point spent at each hotel, and then changes categories based on that evaluation. For programs without categories, it could then use that information to adjust points rates accordingly.

Loyalty programs need to book a value per point because the outstanding liability has to go onto their 10-K if they’re a public company (here’s Hyatt’s 10-K). Points are an obligation the loyalty program needs to pay out in the future when the stay is redeemed (or waived if expired).

What happens with a program-wide devaluation? They might be trying to get back to an average redemption rate in line with whatever target they want to achieve. Perhaps it’s a long-term target that got off track because of inflation, or it’s some new target they want to achieve for any other reason.

Does this all really matter to the end user?

No, knowing this shouldn’t impact what you decide to do. You, the points user, merely care about where to stay with your points. Knowing the underlying mechanism that drives points merely just satisfies your curiosity. Behavior on where you use your points and free nights won’t change based on the contract between the hotel and loyalty program.

That said, it might add some understanding on your part on why hotels may treat points guests as a second class of guests below those paying cash. Hotels have their own algorithm on who to favor for that suite upgrade and generally don’t disclose it anywhere. On top of that, some hotels have so many elite guests checking in that it’s hard to extend the same benefits to everyone.

So, when you go to a hotel on a points rate and complain about not getting an upgrade, you’ll at least know that the hotel probably isn’t prioritizing you. I doubt that adds any peace of mind but at least now you know.

Suggested reading:

• How to Get Started with Points
• Stop Thinking of Points as Free
• Can You Gift Free Nights to Others? A Guide By Hotel Chain