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Dirty little secrets about NET rates.

Dirty Little Secrets About NET Rates

I am working with a new client and we are analyzing moving their hotel contracts from a commission rate-contracting model to a net rate-contracting model.

Here are my thoughts about NET rates and why I think NET rates are the best contracting model for travel companies.

1. Your company can make more money with NET rates. Travel Companies earn more money with NET rates vs. Commission rates due to how the hotel taxes the rates.  Let’s assume first that you are currently contracting on a commission rate model. It’s easier to see how this works.

Your company sells a $100 hotel room for 1 night, you earn a 20% commission and tax is 12% on the $100 room rate.

I am working with a new client and we are analyzing moving their hotel contracts from a commissionable rate-contracting model to a net rate-contracting model.  Here are my thoughts about NET rates and why I think NET rates are the best contracting model for travel companies. 1.	Your company will make more money with NET rates. Travel Companies earn more money with NET rate vs. Commissionable rates due to how the hotel taxes the rates.  Let’s assume first that you are currently contracting on a commission rate model. It’s easier to see how this works. Your company sells a $100 hotel room for 1 night, you earn a 20% commission and tax is 12% on the $100 room rate.

In the commission contract model the hotel sends you a check for $20 (20% commission on the hotel room only) if the hotel is charging your customers credit card. If you charge your customers credit card you owe the hotel $112 ($100 + $12 in tax, you keep the $20 commission.)

With NET rates and the same 20% margin, you contract with the hotel for an $80 NET rate for the room only, you pay $9.60 for the tax of 12% on the $80 NET rate for a total of $89.60. The tax you owe on the NET rate is less than on the Commission rate. You still pay the tax but at a lower cost to the hotel.

The profit difference isn’t much but when you start doing thousands of transactions $2.40 per booking adds up quickly. There is controversy and pending litigation regarding the NET rate model as state governments feel that the travel companies and OTAs should be paying the 12% tax on the $100, the retail rate sold to the consumer and not the $80 NET rate. Some states are changing their laws so you should check with the hotel about how they are collecting the tax when contracting NET rates.

2. Most major hotels in the USA use NET rates for contracting with travel companies, wholesalers and OTAs. It’s just easier to work within their current model.

3. In most NET rate business models your company collects the payment from the customer then pays the hotel when the guests check in or after they checkout. If you collect the booking amount in full you can pay the supplier later. You can earn interest on the money or float. Interest rates are low now but in 3-5 years after your travel company has become more mature you might be able to earn a good return on the float.

4. Breakage is a “Dirty Little Secret” not many people talk about that is present in the NET rate model. To understand breakage in its many forms, think a travel product that is;

Purchased but not consumed.

Is when the customer buys the travel product and then does not travel or show up to consume the purchase so you earn revenue without having to pay the supplier for the expense. When my wife and I were operating our boutique lodging property the Yellow Breeches House I remember times when guests would just not show up to check-in. One time we had a couple buy a $1,500 weekend getaway then not show up. We even called them and emailed them. Nothing. We never heard from them ever.

Purchased but only parts consumed.

Is when you are selling a vacation package with multiple activity components and the customer consumes only two of the three activities thus you don’t pay on the activity that they didn’t attend.

Purchased, consumed but not billed.

Is when your travel company receives a booking, the traveler consumes the purchase but the travel supplier doesn’t bill your company. Non-invoicing is the controversial and dirty little secret. Traditionally non-billing may not be considered breakage but in my book this is serious breakage.

If your travel supplier partner forgets to invoice your company do you pay it?

I believe overall total breakage, all of the three areas above combine to be anywhere from around 0.25%-4% of revenue in the travel industry.

What does that mean for you as a startup travel entrepreneur? It could mean 0.25%-4% of your revenue you generate with no expense, so basically pure profit.

When we were operating our ski travel company breakage was around 1%. If a customer purchased a ski package but never showed up we kept the revenue and did not have to pay the supplier because this was in our contracts. It wasn’t our fault the customer didn’t fulfill their travel. The majority of the 1% came from the customer purchasing a ski vacation package, then for whatever reason the customer did not pick up their lift tickets. The customer consumed the lodging portion but not the lift ticket portion of the vacation package.

When it came to paying suppliers that forgot to bill or invoice us we always paid. I remember many times calling hotel partners telling them that we have invoices outstanding over 30-60-90 days that we want to pay, we just need you to send us an invoice for our records.

Can you imagine pleading to pay your travel supplier?

I remember one time we had a $50,000 outstanding lodging bill that needed to be paid. Close to 5 months had passed. I called the hotel partner and told them about it. The hotel actually had lost the invoice. Just like that poof it was gone!

Can you imagine pocketing $50,000?

Were we tempted?

To be honest, a little sure, but because this totally went against our entire business philosophy and beliefs we did the right thing and always called the hotel to let them know.

I could never understand how a major hotel could loose a bill and not invoice for $50,000.

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