Price-based

Revenue
Management
Yun Prihantina Mulyani

Adopted from Talluri & Van Ryzin, 2005

Who am I?
Educational Background:
• S.T. in Industrial Engineering, UGM, 2012
• M.Sc. In Industrial Engineering, UGM, 2013
• Ph.D. in Management Science, University of Manchester, UK, 2020

Research Interests:
Operations Research, Machine Learning, Revenue Management, Decision
Analysis

Email: yun.prihantina@ugm.ac.id
Outline
• Price-based RM (1)
• Basic price optimization
• Price differentiation: customer segmentation
• Pricing with constrained supply
• Markdown management
or
• Customized pricing
Grading System
• Quiz/individual assignment: 25%
• Final exam : 25%
Course contract
• Tidak ada kuis susulan.
• Free rider dianggap tidak mengerjakan tugas kelompok.
• Komunikasi berkaitan dengan matakuliah ini melalui email atau
google classroom.
• Penyerahan tugas tidak sesuai dengan deadline akan ada
pengurangan nilai. Kuncinya, Time Management.
• Mahasiswa wajib membaca materi atau mendengarkan video materi
yang telah diberikan sebelum online meeting dimulai.
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…”
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
Demand-Management Decisions
• 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
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
Taxonomy Kannan and Kopalle (2001)
Price vs Quantity-based RM
• What the difference between price- and quantity-based RM?
In essence, it questions the extent to which a company is able to vary quantity or price in
response to changes in market conditions.
• It depends on the company’s commitments, its level of flexibility in supplying products or
services, and the costs of making quantity or price changes.
• Quantity-based RM → e.g. airlines, hotels, cruise ships, rental cars
• Price-based RM → e.g. apparel retailing, online retailers, business-to-business sales
• However, given the choice between price- and quantity-based RM, Gallego and van Ryzin
argue that price-based RM is the preferred option.
• Therefore, practical business constraints dictate which tactical response—price- or quantity-
based RM (or a mixture of both)—is most appropriate in any given business context.
Industry overview

• Retailing: Significant
improvements in revenues using
model-based markdown
recommendations
Industry overview

• The project, started in 1995, focused on identifying features

that customers were most willing to pay for and changing
salesforce incentives to focus on profit margins rather than
unit-sale volumes. Ford then applied pricing models
developed by an outside consulting firm to optimize prices
and dealer and customer incentives across its various product
lines. In 1998, Ford reported that the first five U.S. sales
regions using this new pricing approach collectively beat their
profit targets by $1 billion, while the 13 that used their old
methods fell short of their targets by about $250 million
 Industry overview
E-Business

E-business: Companies such as eBay and Priceline have demonstrated the viability of using innovative
pricing mechanisms that leverage the capabilities of the Internet. E-tailers can discount and markdown
on the fly based on customer loyalty and click-stream behaviour.
Examples of Dynamic Pricing
Style-goods markdown pricing
✓Inventory considerations
✓A form of demand learning
✓Segmentation mechanism: high vs low
willingness to pay
✓More price-sensitive demand during
peak periods
Examples of Dynamic Pricing

Discount airline pricing: Not all dynamic pricing involves price

reductions, however. Discount airlines use primarily price-
based RM, but with prices often going up over time.

Source: Etzioni et al. (2003)

Examples of
Dynamic Pricing

• Consumer packaged-goods (CPG) industry

Promotions are the most common form of price-based
RM in the CPG industry (soap, diapers, coffee, yogurt,
and so on).

Because customers are aware of past prices, promotions impact their subjective
“reference price”—or sense of the “fair” price—for products.
The motivations of the manufacturer and the retailer are different as well.
So in designing optimal promotions structures, one has to consider complex
incentive compatibility constraints.
Modeling Dynamic Price-Sensitive Demand
• Use of price as the control variable
• Modeling of demand as a price-dependent process
→ Customer behavior
1. Myopic- Versus Strategic-Customer Models
→ The state of market conditions
1. Infinite- Versus Finite-Population Models
2. Monopoly, Oligopoly, and Perfect-Competition Models
Myopic- Versus Strategic-Customer Models
• Myopic customers: those who buy as soon as the offered price is less than their
willingness to pay
• Strategic customers: customers will optimize their own purchase behavior in
response to the pricing strategies of the firms
• Strategic-customer model is more realistic, but it complicates the estimation and
analysis of optimal pricing strategies often making the problem intractable
• The myopic-customer model is much more tractable and hence is more widely
used. However, it may be very bad approach if optimized pricing
recommendations are radically different in structure from past pricing strategies,
then customers will adjust their buying strategies in response OR customers have
learned the price pattern to postpone the purchase, because they know prices
will be cut at the end of the season or during holidays.
Infinite- Versus Finite-Population Models
• In an infinite-population model, we assume that we are sampling with replacement when
observing customers – nondurable-good assumption (e.g. Coke)
- It is easier to deal with analytically
- is a reasonable approximation when there is a large population of potential customers and
the firm’s demand represents a relatively small fraction of this population
- It is also reasonable for consumable goods
• The finite-population model assumes a random process without replacement. That is, there are a
finite (possibly random) number of customers with heterogeneous willingness to pay values. If
one of the customers in the population purchases, the customer is removed from the population
of potential customers, and therefore future purchases only occur from the remaining customers
– durable-good assumption (e.g. car)
- If the firm’s demand represents a large fraction of the potential pool of customers or if the
product is a durable good, then past sales will have a more significant impact on the statistics
of future demand
Infinite- Versus Finite-Population Models
• The key factors in choosing one model over the other are the number
of potential customers relative to the number that actually buy and
the type of good (durable versus nondurable).
Monopoly, Oligopoly, and Perfect-Competition Models

• Monopoly: The demand a firm faces is assumed to depend only on its own
price and not on the price of its competitors. Thus, the model does not
explicitly consider the competitive reaction to a price change.
- Empirical grounds: an observed historical price response has
embedded in it the effects of competitors’ responses to the firm’s
pricing strategy.
- primarily for tractability
- not always realistic
- It may be wrong, if the optimized strategy deviates significantly from
past strategies because then the resulting competitive response may
be quite different from the historical response.
- Despite these risks, monopoly models have still proved to be valuable
for decision support.
Monopoly, Oligopoly, and Perfect-Competition Models

• Oligopoly: the equilibrium price response of competitors is explicitly

modelled and computed
- Realistic
- The increased complexity
- The difficulty in collecting competitor data to estimate the models
accurately
Monopoly, Oligopoly, and Perfect-Competition Models

• Perfect competition: many competing firms supply an identical

commodity
• Each firm is essentially a price taker—able to sell as much as it wants
at the prevailing market price but unable to sell anything at higher
prices.
• Firms have no pricing power means that the results are not that
useful for price-based RM. Nevertheless, they do play a role in
quantity-based RM.
See you at the online meeting!