In my post yesterday about the future value of airline miles, I caveated that “the story is a little different for hotels” and naturally commenter “I would be interested in a few words about the hotel chain point/miles situation.”

I guess I couldn’t get away with punting on that one!

The overall analysis about an increasing number of points chasing a relatively fixed pool of hotel rooms holds true in strong economic times. And the point about a proprietary currency and the temptation for that issuer to inflate the currency without constraints holds as well. But the economic model of hotel programs differs from airlines, as does the ability for a hotel chain to adjust capacity with the same degree of fluidity as the airlines, leading to somewhat different results.

There’s little question the the overall direction of hotel programs is to raise the requirements to redeem awards, and this seems to be the case regardless of the overall economic conditions that loyalty programs face. Customers earn points through past activity, and redeem them in the future. Programs are in control of the value of those points. And they have the option of reducing their redemption costs at will, simply by deciding that it takes more points in order to redeem an award. With a metaphorical single stroke of the pen, their balance sheets improve. That’s incredibly tempting.

Since programs generally write into their terms and conditions that they can make changes at will (some programs require a small amount of notice), and except for airline programs without such loosey goosey terminology fifteen years back or so, programs have generally been held to have the power to make such changes with impunity.

The only constraint, then, is competition. They don’t want to alienate their loyal (and presumably profitable) customers. And they remain concerned that competitors will not similarly devalue their own currency, offering customers a better value proposition.

Historically each major program has made significant changes, and each other program follows in the not to distant future. Given a reliable competitor response, the constraints on raising award pricing are quite slim.

Nonetheless, the economic pressures don’t work in quite the same way as with airlines.

First, hotel capacity is fairly fixed in the short run. During good economic times hotel rooms are being booked by paying travelers, which constrains redemption. During tough economic times rooms are empty which makes redemption far easier and less costly for a program to provide.

Airline reward redemption is getting tough now precisely because of the difficult economic times. Airlines are downsizing their capacity meaning they have fewer seats going unsold. Award redemption is thus challenging. Hotels can’t pull down capacity quite as quickly.

Meanwhile, airline program economics generally work the same across carriers. Airlines offer a ‘saver’ award level (the most common being the 25,000 mile domestic award) and most carriers offer a ‘rulebuster’ type of award, usually for roughly double the mileage which buys out of capacity controls. In the former case, the program pays the associated airline only the marginal cost for adding an additional passenger to a flight. They can do this because those awards are only available for seats that are expected to go unsold.

Hotel programs all have different models. A program compensates a hotel for an award night, but the way they do this varies tremendously.

Starwood was able to offer its members ‘no capacity controls’ (aka “true redemption”) by varying its payments to hotels based on the actual occupancy rate at the time the award night is consumed. If a hotel is less than 90% full on a given night, Starwood Preferred Guest pays the hotel a substantially discounted rate for awards redeemed on that night. If a hotel is 90% occupied (or greater), Starwood Preferred Guest pays that hotel its ‘average daily room rate’. (Cash & Points awards work differently — those are capacity controlled and a hotel doesn’t get the bonus payment on nights when it turns out to be full.)

What this means, and since hotels don’t just add rooms during good economic times when they’re operating close to capacity, is that awards redeemed at full hotels begin to happen much more frequently and they cost Starwood a whole lot more money. That was the major driving force behind Starwood’s substantial revaluation of its currency at the beginning of 2007.

(Starwood reassigns hotels to different point categories each year based on the hotel’s average daily room rate for the previous year, since that factor also determines how much the program will pay for award nights. But 2007 saw a much more drastic revision than ever before, or in this writer’s view than justified solely by increases in average room rates but instead also due to increases in occupancy which were driving up Starwood’s costs.)

The flip side of this is that — while there’s always a temptation to raise redemption pricing — during economic downturns you’re much less likely to see it from Starwood, since their redemption costs are correspondingly lower (from both lower average room rates and lower occupancy rates which mean that Starwood is paying the higher rates to hotels for award nights far less frequently).

Meanwhile, I actually know much less about the models of other programs. I’ve been told that Marriott compensates hotels on a sliding scale based on the number of award nights that they accept in the year, incentivizing them to take on a higher number of awards. Hilton’s new ‘no capacity control’ redemption model surely must change the way that they are compensating hotels, but I haven’t spoken with anyone about the economics of it.

But the broader point about fixed capacity in the short run certainly holds, and one can expect either difficulty redeeming (especially in programs other than Starwood and Hilton) during good times or substnatial increases in the the number of points required to redeem for an award. And far less economic pressure to make similar moves during challenging economic times.

In the current environment, and while I always expect the trajectory of award pricing to be upwards, I expect to see far more stability from the hotel programs than from airline mileage offerings.