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Decision Models and Analytics

4. LP in Revenue Management

Professor Jiawei Zhang

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Agenda
Airline Revenue Management
– Background
– Problem Formulation
– Greedy Heuristic
– Value of Optimization
– Implementation of Model Solution

Reading from Optimization Modeling

– Chapter 2.5

Templates: VacationAir_template.xlsx
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Airline Deregulation (1978)
1938-1978, the Civil Aeronautics Board (CAB) set fares, routes, and
schedules for all interstate air transport
– Most major airlines favored this system due to guaranteed profits
– Led to inefficiency and higher costs

The administration of President Jimmy Carter passed the Airline

Deregulation Act in 1978

The Act encouraged

– Lower barrier to entry: 52 new airlines 1980-2000, including
low-cost carriers.
– New air routes: saved passenger an estimated $10.3 billion each
year in travel time
– Lower fares: ticket prices are 50% lower today than they were in
1979
– More passengers: 207.5 million in 1974 to 925.5 million in 2019.
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Impact of the Deregulation Act
More competition led to heavy losses by air carriers

More than 150 airlines went bankrupt between 1979 and 2008.

People Express Airline (a low-cost carrier)

– Operated from 1981
– $1 billion revenue in 1985
– Fifth largest carriers in the US
– Loss of $58 million in the first quarter of 1986
– Bankruptcy in 1987
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Discount Fares
On January 17, 1985, American Airlines launched its Ultimate Super
Saver fares to compete with People Express.
– Price significantly lower than regular fare
– 50% of the ticket is not refundable
– Must be booked 30 days in advance
– Must include a Saturday night stay-over

Fundamental assumption: Passengers have different valuations

– Business travelers value flexibility (last minute/refundable)
– People seeking gateways value good deals (early birds).
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How Many Seats to Sell on Discount
Business problem: How should American Airline allocate its seats among
customers to maximize its revenue?

Trade-off:
– When sell too many discounted seat, no enough seats for high-
valuation passengers
– When sell too few discounted seats, empty seats at takeoff
implying lost revenue
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A Simple Example
Vacation Air is a regional airline that offers flights to and from Pittsburgh,
Newark, Charlotte, Myrtle Beach, and Orlando.

Vacation Air operates with two Boeing 757-200 airplanes, with one based
in Pittsburgh and the other in Newark. Each aircraft has a seating capacity
of 198 seats.

It operates on a hub-and-spoke network.

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Daily Schedule
• Every morning, the plane based in Pittsburgh departs for Orlando,
with a stopover in Charlotte. Similarly, the plane based in Newark
flies to Myrtle Beach, also with a stopover in Charlotte.

Departs Arrives
Aircraft
Number City Time City Time
1 Pittsburgh 8:00 am Charlotte 9:30 am
1 Charlotte 10:15 am Orlando 12:05 pm
1 Orlando 3:00 pm Charlotte 4:50 pm
1 Charlotte 5:30 pm Pittsburgh 7 pm
2 Newark 7:30 am Charlotte 9:20 am
2 Charlotte 10:10 am Myrtle Beach 11:00 am
2 Myrtle Beach 4:10 pm Charlotte 5 pm
2 Charlotte 5:40 pm Newark 7:30 pm

• Passengers traveling from Pittsburgh to Myrtle Beach need to transfer

from Aircraft No. 1 to Aircraft No. 2 at Charlotte. Likewise,
passengers flying from Newark to Orlando must switch from Aircraft
No. 2 to Aircraft No. 1 at Charlotte.

• At the end of the day, both planes return to their respective home
bases.
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Morning Flights
We focus on the morning flights only.

How many origin-destination combinations?

The airline offers two fare classes:

– discount-fare Q class: must be purchased 14 days in advance; non-
refundable, non-changeable, and require a Saturday night stay-over
– full-fare Y class: can be purchased any time up until the departure
time; fully refundable and can be changed
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ODIF Combinations of Moring Flights
There are sixteen origin-destination-itinerary-fare combinations.

ODIF Origin Destination Fare Class Fare

PCQ Pittsburgh Charlotte Q $ 196
PMQ Pittsburgh Myrtle Beach Q $ 295
POQ Pittsburgh Orlando Q $ 251
PCY Pittsburgh Charlotte Y $ 418
PMY Pittsburgh Myrtle Beach Y $ 502
POY Pittsburgh Orlando Y $ 616
NCQ Newark Charlotte Q $ 219
NMQ Newark Myrtle Beach Q $ 274
NOQ Newark Orlando Q $ 384
NCY Newark Charlotte Y $ 424
NMY Newark Myrtle Beach Y $ 488
NOY Newark Orlando Y $ 638
CMQ Charlotte Myrtle Beach Q $ 197
CMY Charlotte Myrtle Beach Y $ 418
COQ Charlotte Orlando Q $ 246
COY Charlotte Orlando Y $ 640
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Structuring the Capacity Allocation Problem
Decisions to be made

Performance measure

Things that restrict your choices

Data needed
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Mathematical Formulation
Input parameters:

Decision variables:

Objective function:

Constraints:
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Spreadsheet Model for LP

Spreadsheet setup
– Input cells
– Changing cells
– Objective cell
– Constraint cells

Solver parameters

Open file VacationAir_template.xlsx

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Input Cells

A B C D E F
1 Vacation Air
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3 ODIF Origin Destination Fare Class Fare Demand
4 PCQ Pittsburgh Charlotte Q $ 196 49
5 PMQ Pittsburgh Myrtle Beach Q $ 295 66
6 POQ Pittsburgh Orlando Q $ 251 67
7 PCY Pittsburgh Charlotte Y $ 418 24
8 PMY Pittsburgh Myrtle Beach Y $ 502 9
9 POY Pittsburgh Orlando Y $ 616 16
10 NCQ Newark Charlotte Q $ 219 39
11 NMQ Newark Myrtle Beach Q $ 274 84
12 NOQ Newark Orlando Q $ 384 58
13 NCY Newark Charlotte Y $ 424 22
14 NMY Newark Myrtle Beach Y $ 488 11
15 NOY Newark Orlando Y $ 638 14
16 CMQ Charlotte Myrtle Beach Q $ 197 96
17 CMY Charlotte Myrtle Beach Y $ 418 12
18 COQ Charlotte Orlando Q $ 246 69
19 COY Charlotte Orlando Y $ 640 15
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21 Plane Capacity 198
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Decision/Changing Cells
• Changing cells: G4: G19

A B C D E F G
3 ODIF Origin Destination Fare Class Fare Demand Tickets Available
4 PCQ Pittsburgh Charlotte Q $ 196 49
5 PMQ Pittsburgh Myrtle Beach Q $ 295 66
6 POQ Pittsburgh Orlando Q $ 251 67
7 PCY Pittsburgh Charlotte Y $ 418 24
8 PMY Pittsburgh Myrtle Beach Y $ 502 9
9 POY Pittsburgh Orlando Y $ 616 16
10 NCQ Newark Charlotte Q $ 219 39
11 NMQ Newark Myrtle Beach Q $ 274 84
12 NOQ Newark Orlando Q $ 384 58
13 NCY Newark Charlotte Y $ 424 22
14 NMY Newark Myrtle Beach Y $ 488 11
15 NOY Newark Orlando Y $ 638 14
16 CMQ Charlotte Myrtle Beach Q $ 197 96
17 CMY Charlotte Myrtle Beach Y $ 418 12
18 COQ Charlotte Orlando Q $ 246 69
19 COY Charlotte Orlando Y $ 640 15
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Objective Cell
• Revenue: B23 =sumproduct(E4:E19,G4:G19)

A B C D E F G
3 ODIF Origin Destination Fare Class Fare Demand Tickets Available
4 PCQ Pittsburgh Charlotte Q $ 196 49 20
5 PMQ Pittsburgh Myrtle Beach Q $ 295 66 20
6 POQ Pittsburgh Orlando Q $ 251 67 30
7 PCY Pittsburgh Charlotte Y $ 418 24 10
8 PMY Pittsburgh Myrtle Beach Y $ 502 9 5
9 POY Pittsburgh Orlando Y $ 616 16 10
10 NCQ Newark Charlotte Q $ 219 39 10
11 NMQ Newark Myrtle Beach Q $ 274 84 10
12 NOQ Newark Orlando Q $ 384 58 10
13 NCY Newark Charlotte Y $ 424 22 20
14 NMY Newark Myrtle Beach Y $ 488 11 10
15 NOY Newark Orlando Y $ 638 14 10
16 CMQ Charlotte Myrtle Beach Q $ 197 96 50
17 CMY Charlotte Myrtle Beach Y $ 418 12 10
18 COQ Charlotte Orlando Q $ 246 69 50
19 COY Charlotte Orlando Y $ 640 15 10
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21 Plane Capacity 198
22 =SUMPRODUCT(E4:E19,G4:G19)
23 Max Rev $ 91,440
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Constraint Cells
• For each ODIF: tickets available should be no more than its demand forecast
– e.g. G4 <= F4, G5 <= F5, …
– simplified version: G4:G19 <= F4:F19

• For each flight leg, the number of tickets available should be no more than
its capacity
– Enter in Cell C26 = sum(G4:G9), total tickets available for P-C flight leg
– Enter in Cell C27 = sum(G10:G15)
– Enter in Cell C28 = sum(G5,G8,G11, G14,G16, G17)
– Enter in Cell C29 = sum(G6,G9,G12,G15,G18,G19)

The capacity constraint should be

C26<=E26, C27<=E27, C28<=E28, C29<=E29
Or
C26:C29 <= E26:E29
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Constraint Cells
The capacity constraint should be
C26<=E26, C27<=E27, C28<=E28, C29<=E29
or
C26:C29 <= E26:E29

A B C D E
25 LHS =SUM(G4:G9) RHS
26 Leg 1 (P-C) 95 <= 198
27 Leg 2 (N-C) 70 <= 198
Capacity
28 Leg 3 (C-M) 105 <= 198
29 Leg 4 (C-O) 120 <= 198
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Constraint Cells
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A Heuristic Solution
Before proceeding to solve the linear program optimally, let's attempt a
simple and intuitive approach.
– Begin by assigning seats to the origin-destination combination with
the highest fare, subject to capacity and demand constraints.
– Next, proceed to book the maximum number of passengers on the
itinerary with the second-highest fare, taking into account
capacity and demand constraints.
– Continue until no more bookings can be made.

How much revenue is generated from the morning flights in total?

By comparing the revenue obtained from the intuitive approach with the
optimal revenue, we can determine the value gained from the optimization
process.

The difference between the two represents the value of optimization.

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Solver Setup

• Set Obj: B23

• To: Max

• Change cell: G4:G19

• Subject to Constraints
C26:C29 <= E26:E29
G4:G19 <= F4:F19
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Add Constraints
Click “Add” button.

Enter C26:C19 in the “Cell Reference” box; enter E26:E29 in the

“Constraints” box. Choose “<=“ in the middle box.
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Some Important Options

Check the “Make Unconstrained Variables Non-Negative” box.

– It adds non-negativity constraints to all the changing cells.

Choose “Simplex LP” from “Select a Solving method”.

– It tells the Solver that this is a linear programming model.
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An Optimal Solution
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Value of Optimization
Simple heuristic: Sorting all the ODIFs in fare order and setting availability
based on total fare.

Optimal policy: optimal solution based on the linear programming model.

Difference is significant!
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Issues of the Model and How to Fix Them
Demand constraint
– What if the forecasts are not accurate?
– What if the full fares are sold out and there are still seats reserved
for discounted fares?

The capacity constraint

– Should we fix the capacity as 198?
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Complex Network
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Revenue Management (RM)
Selling the right products to the right customers at the right prices.

Robert Crandall, former CEO of AA

– RM is the single most important technical development in
transportation management since we entered the era of airline
deregulation;
– “We estimate that revenue management has generated $1.4 billion
in incremental revenue in the last three years.”

Companies prosper from RM

– Delta increased annual revenue by $300 million;
– Marriott hotels increased annual revenue by $100 million;
– National Car Rental was saved from liquidation with RM;
– Canadian Broadcasting Corporation increased revenue with $1
million per week