MANAGING CAPACITY AND

DEMAND
Chapter 11
Agenda
o Why is there a need to manage capacity and
demand?
o Strategies for managing demand
o Strategies for managing capacity
o Yield management

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Why Manage Capacity and Demand?

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Strategies for Matching Capacity
and Demand for Services
MANAGING MANAGING
DEMAND CAPACITY

Segmenting Increasing
demand customer
Developing participation
Sharing
complementary
capacity
services
Offering
Scheduling
price
Reservation Cross- work shifts
incentives
systems and training
Overbooking employees
Promoting Creating
off-peak adjustable
Using
demand capacity
Customer- part-time
induced employees
variability
Yield
management

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Customer-Induced Variability
o Arrival: customer arrivals are independent decisions not
evenly spaced.
o Capability: level of knowledge and skills vary resulting in
some hand-holding.
o Request: uneven service times result from unique demands.
o Effort: level of commitment to coproduction or self-service
varies.
o Subjective Preference: personal preferences introduce
unpredictability.

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Strategies for Managing
Customer-induced Variability

Type of
Variability Accommodation Reduction

Arrival Provide generous staffing Require reservations

Capability

Request

Effort

Subjective
Preference

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Managing Demand: Segmenting
Demand at a Health Clinic

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Managing Demand: Discriminatory
Pricing for Camping Experience
Experience
Days and weeks of camping season No. of days Daily Fee
Type
Saturdays and Sundays of weeks 10 to 15, plus Dominion
1 14 $6.00
Day and civic holidays
Saturdays and Sundays of weeks 3 to 9, and 15 to 19, plus
2 23 $2.50
Victoria Day
Fridays of weeks 3 to 15, plus all other days of weeks 9 to
3 43 $0.50
15 that are not in experience type 1 or 2
4 Rest of camping season 78 Free

EXISTING REVENUE VS PROJECTED REVENUE FROM DISCRIMINATORY PRICING

Existing flat fee of $2.50 Discriminatory fee

Experience Campsites occupied
Campsites occupied Revenue Revenue
Type (est.)
1 5,891 $14,727 5,000 $30,000

2 8,978 $22,445 8,500 $21,250

3 6,129 $15,322 15,500 $7,750

4 4,979 $12,447 … …

Total 25,977 $64,941 29,000 $59,000

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Other Strategies for Managing
Demand

1. Promote off-peak demand

2. Developing complementary services

3. Reservation systems and overbooking

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Reservation Systems and Overbooking
o Airlines/hotels practice overbooking due to “no shows”

o Need to strike a balance between the opportunity cost of

vacant room vs cost of not honoring a reservation

o Assume room that remains vacant due to no show results

in loss of $40 = Cu (cost of underestimating #no shows)

o Penalty of not honoring reservation = $100 = Co (cost to

place customer at adjacent hotel+ loss of goodwill, etc. )

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Hotel Overbooking Loss Table
Opportunity loss of no shows = Cu = $ 40
Opportunity loss of overbooking = Co = $100

Number of Reservations Overbooked

No- Proba
0 1 2 3 4 5 6 7 8 9
shows bility
0 0.07 0 100 200 300 400 500 600 700 800 900
1 0.19 40 0 100 200 300 400 500 600 700 800
2 0.22 80 40 0 100 200 300 400 500 600 700
3 0.16 120 80 40 0 100 200 300 400 500 600
4 0.12 160 120 80 40 0 100 200 300 400 500
5 0.10 200 160 120 80 40 0 100 200 300 400
6 0.07 240 200 160 120 80 40 0 100 200 300
7 0.04 280 240 200 160 120 80 40 0 100 200
8 0.02 320 280 240 200 160 120 80 40 0 100
9 0.01 360 320 280 240 200 160 120 80 40 0
Expected loss, $ 121.60 91.40 87.80 115.00 164.60 231.00 311.40 401.60 497.40 596.00

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Overbooking Using the Critical Fractal
Model
x = number of rooms overbooked
d = number of no shows based on past experience
Cu = loss due to underestimating number of no shows
associated with having too few rooms overbooked =$40
Co = Loss due to overestimating number of no shows associated
with having too many rooms overbooked = $100

Cu 40
P(d < x) ≤ ≤ ≤ 0.286
Cu + Co 40 + 100

Overbook 2 rooms since cumulative probability P(d<x) = 0.07+0.19=0.26

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Hotel No-show Experience
No-shows Probability Reservations Cumulative Probability
d P(d) Overbooked x P(d<x)
0 0.07 0 0.00
1 0.19 1 0.07
2 0.22 2 0.26
3 0.16 3 0.48
4 0.12 4 0.64
5 0.10 5 0.76
6 0.07 6 0.86
7 0.04 7 0.93
8 0.02 8 0.97
9 0.01 9 0.99

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Strategies for Managing Capacity
o Increasing customer participation

o Creating adjustable capacity

o Sharing capacity

o Cross-training employees

o Using part-time employees

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 Principles of Queue Design
1. Unoccupied time feels longer than occupied time

2. Pre-process waits feel longer than in-process waits

3. Anxiety makes the wait seem longer

4. Uncertain waits are longer than known, finite waits

5. Unexplained waits seem longer than explained waits

6. Unfair waits are longer than equitable waits

7. The more valuable the service, the longer people are willing to wait

8. Solo waiting feels longer than group waiting

9. Uncomfortable waits feel longer than comfortable waits

10. New or infrequent users feel they wait longer than frequent users

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Discussion Question
o Queues normally works on a first come, first serve
system. What are implications of a last come, first serve
system? Will it work?

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What is Yield Management?

Yield management attempts to allocate the fixed

capacity (of seats on a flight) to match the potential
demand of various market segments (e.g., coach, tourist,
supersaver) in the most profitable way.

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Ideal Characteristics
for Yield Management
o Relatively Fixed Capacity
o Ability to Segment Markets
o Perishable Inventory
o Product Sold in Advance
o Fluctuating Demand
o Low Marginal Sales Cost and High Capacity Change Cost

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Airline Pricing for a Coach Seat
Traditional Fixed Price

Price
Demand Curve

Consumer Surplus

Seats Available

Quantity

Total Revenue = PQ

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Airline Pricing for a Coach Seat Multiple
Pricing Using Yield Management
Price
Total Revenue = P1Q1 + (Q2-Q1)P2 + (Q3-Q2)P3
Demand Curve

Consumer Surplus

P1

P2 Seats Available

P3

Quantity

Q1 Q2 Q3

Full Advanced Internet

Coach Purchase Special

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Seasonal Allocation of Rooms by
Service Class for Resort Hotel
Percentage of capacity allocated

20% 20% 20%

to different service classes

First class 30%

30%
50% 50%
Standard
60%

50% 30%
Budget 30%
10%

Peak Shoulder Off-peak Shoulder

(30%) (20%) (40%) (10%)
Summer Fall Winter Spring

Percentage of capacity allocated to different seasons

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Yield Management Using the Critical
Fractile Model
X = seats reserved for full-fare passengers
d = demand for full-fare tickets
F = full fare price = $69
D = discount fare price = $49
Cu = lost revenue associated with reserving too few seats at full
fare (underestimating demand).
Co = cost of reserving one too many seats for sale at full-fare
(overestimating demand). Empty seat could be sold at discount
price
Cu ( F − D)
P(d < x) ≤ ≤
Cu + C o F

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What did you learn today?
o Due to variability in demand, two generic
strategies are level capacity (manage demand) and
chase demand (manage capacity)
o Yield management (hybrid strategy) maximizes
revenue through price discrimination and capacity
allocation in real time

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