Revenue Management

Nur Aini Masruroh

 Objectives
• Providing the basic concepts of revenue
management (RM) tools such as quantity based RM,
quantity based RM, pricing based RM, customer
behaviour model, and competition models in RM.
• Applying RM tools in the industrial engineering
domain.
Every seller of product or service faces a
number of fundamental decisions.
 1st Example
A child selling lemonade outside her house has to
decide on which day to have her sale, how much to
ask for each cup, and when to drop the price (if at all)
as the day rolls on.
 2nd Example
A homeowner selling a house must decide when to list
it, what the asking price should be, which offer to
accept, and when to lower the listing price-and by how
much-if no offers come in.
 3rd example
A stamp dealer selling on an Internet auction site has
to select the duration of the auction, how the rule
should be, what reserve price to set (if any), and so on.
 Complex Selling Decisions
• Providing different conditions and how to exploit their
(customers) buying behavior or willingness to pay
• Designing product to avoid cannibalization across
segments and channels
• Pricing strategy for each segment/channel, based on
seasonal factors
• Product allocation
• Product characteristics (complement-airline/substitutes-
car categories)
 UNCERTAINTY exists and makes such decisions
hard to decide.
We want to sell at a time when market conditions are most favorable

We want to bid the right price-not so high for potential buyers and not
so low that we lose out the potential profits

We want to know how much buyers value our product

Even if we succeed in making a sell, we still wonder whether we

should have waited for a better offer or whether we accepted a price
that was too low
 Alternative Method
• Revenue Management (RM) is concerned with such
demand decisions with the objective of increasing
revenue

• Synonymous names for RM: yield management,

pricing & revenue management, pricing & revenue
optimization, revenue process optimization, demand
management, demand-chain management.
 General Definition
• Netessine and Shumsky (2002)
“Revenue Management is the practice of selling the
right product for the right price at the right time to the
right customer”

• McGrill and van Ryzin (1999)

“The objective of Revenue Management is to maximize
profits…”
 History of RM
• RM was developed since 1978 (Airline Deregulation
Act)
• U.S. Civil Aviation Board (CAB) loosened control of
airline price

New low-
Recapture
Rash of cost and Demand
CAB leisure
innovation charter of leisure
loosened travelers
in airline airline travelers
control was
industry entered surged
needed
market
 Some early success stories
• American airlines
– developed a revenue management program based on
differentiating prices between leisure and business travellers (to
defeat PeopleExpress, the low-fare carrier)
– won the 1991 Edelman Prize for best application of
management science
• National Rent-a-car initiated a comprehensive revenue
management program whose core is a suite of analytic models
developed to manage capacity, pricing, and reservation.
– National dramatically increased its revenue and produced
immediate results and returned National Car Rental to
profitability. (Geraghty and Johnson 1997)
 People Express
2 problems revealed:
• How to identify “surplus” seats
• Cannibalization across segments and channels

2 strategies applied:
• Purchase restrictions
• Capacity-controlled fares
 Assumptions
• Customers are willing to pay different fare for the
same product
• Price is the solely factor influencing predicted
demand
• Quality and other business factors are excluded
 Where does RM apply?

In any business where tactical demand management is

important and the technology and management culture
exists to implement it
 Demand Controls (1)
1. Multidimensional Nature of Demand

RM claims three demand dimensions:

a. Product (type, characteristics, etc)
b. Customer (preferences, purchase
behaviors, costumer types)
c. Time

Other dimensions:
Location, channel
 How do these conditions affect the strategy
used in RM?

Conditions Case
Product Time Customer
Single Fixed Multiple Classical-auction design; price discrimination
Single Multiple Multiple Dynamic pricing
Multiple Multiple Ignored Capacity control
 Demand Controls (2)
2. Linkage among Demand-Management Decisions
Example:
- Production constraints-multiple product
- Production constraints-customer behavior
(substitute product)
Classical Revenue
Management
 The Conditions Where RM Become Beneficial
• Customer heterogeneity: variations in willingness to
pay, preference for different products, and variations
of purchase behavior over time
• Demand Variability and Uncertainty
• Production Inflexibility: delays, fixed cost/economies
of scale, capacity constraints
• Price is not a status symbol and not a significant
signal of value – high level of brand loyalty
 The Conditions Where RM Become Beneficial

Netessine and Shumsky (2002); Monroe (2007)

• Data and Information System Infrastructure
• Management Culture – industry’s culture and its
manager
• Perishable : cannot be stored as inventory, limited
selling period
• Having ability to make an accurate demand
prediction

• Three basic categories of demand-management
decisions:
Structural decision Price decision
Which selling format to use
(such as posted prices,
segmentations, or auctions)
Which segmentation or
differentiation mechanism to use
(if any)
Which terms of trade to offer
(example: cancellation, refund
options)
And so on
Strategic Decision
Demand-Management
Decisions
Quantity decision
How to set posted prices,
Whether to accept or reject an
individual-offer prices, and
offer
reserve prices (in auctions)
How to price across product How to allocate output or
categories capacity to different segments
When to withhold a product
How to price over time from the market and sale at later
points in time
How to mark down over the
product lifetime
Tactical Decision
 Demand-Management Decisions (2)
Of those decisions, which one is the most
important?

-depends on the context-

 Demand-Management Decisions (3)

Other strategies to gain more profits:

• Lowering production cost
• Increasing market share
• Price control

Of those alternatives, which one is the easiest way?

 Financial impacts
• “For most companies, better management of pricing
is the fastest and most cost-effective way to increase
profits.”

*analysis of 500 companies

analysis of 500 companies
 Demand-Management Decisions (4)
Price decision versus Quantity decision

Airline

Fashion Retailer
 Demand-Management Decisions (5)

Quantity decision may be as a function of flexibility of

the supply process and the costs of reallocating
capacity/inventory

Price decision is related with how costly the decision is

(price adjustment cost)
 Demand-Management Decisions (3)

Can a firm use both price and quantity-decisions?

-YES -
By doing innovation in the business process
• S&E ticketing Demand-Management Decisions (4)
 RM system
RM generally follows four steps:

collect and store Based on data, find the optimal

relevant historical develop demand solutions (i.e.
data model, discount rate,
estimate/forecast price, capacity
Estimation and forecasting

Optimization

Control
Data collection

demand or other control, booking

relevant limit, overbooking
conditions (i.e. limit, etc.) to apply
cancellation, no- until the next re-
show, etc.) optimization.
 RM system (2)
How frequently should the process be done?
• Volume of data
• The speed of business conditions change
• The type of forecasting and optimization methods
used
• The relative importance of the resulting decisions
RM process flow
 Example 1-Apparel Retailer
• Apparel items have to be ordered by size, type, color,
etc and are often new and unique every season.
- No/Little historical data available –

So, how to make decision in this case?

 Example 1-Apparel Retailer (2)
Set initial price
manually

What-if Anaysis

Decide the optimal timing

and depth of markdown

Other recommendations
 Example 1-Apparel Retailer (2)
• Set initial price manually based on brands, quality,
and design attractiveness
• Timing and depth of markdown are influenced by
sales trends (at the store or regional levels),
inventory levels, forecasts and managerial targets,
promotions, and business rules.
• Other recommendations : , initial buy
recommendations, store-level allocations, size
allocations, and replenishment recommendations.
 Example 2-Car Rental v.s Airline
• Both have same characteristics (i.e. fixed capacity,
high fixed cost, perishable, etc)
• Each has different strategy
Airline

Car rental
 What’s New About RM?
• Is not the demand-management decisions
themselves but rather how these decisions are
made.

• Innovation of RM lies in the method of decision

making – a technologically sophisticated, detailed,
and intensely operational approach to making
demand-management decision.
 Skills in RM
It is driven by two complementary forces:
• Scientific advances in economics, statistics, and
operation research now make it possible to model
demand and economic conditions, quantify the
uncertainties, and compute optimal solutions to
complex decision problems.
• Advances in information technology provide the
capability to execute complex algorithm, automate
transactions, etc.
 Method Limitation
• Still, RM cannot reason through the consequences of
a demand shock, new technologies, a sudden shift in
customer preferences, or the surprise price war of a
competitor.

• Models can detect only what’s in the data.

 Course Outline
1. Introduction
2. Quantity-based RM
1. Single resource capacity control: two-class model, N-class
model
2. Network management
3. Overbooking: static and dynamic models
3. Pricing-based RM: Dynamic pricing
4. Customer behavior and market response models
5. The economics of RM
6. Estmation and forecasting
7. RM implementations
 Referensi

Talluri, K., van Ryzin, G., 2004, The Theory

and Practice of Revenue Management,
Kluwer Academic Publishers, Boston

Phillips, R. L., 2005, Pricing and Revenue

Optimization, Stanford University Press,
California.