MIS and Management Science Applications for Revenue Management

MIST 8990 UGA Evening MBA Program

August 20, 2005
Presentation by:

Patrick G. McKeown

Revenue Management Defined

The application of disciplined tactics that predict consumer behavior at the micromarket level and optimize product availability and price to maximize revenue growth.
- Robert G. Cross
Revenue Management: Hardcore Tactics for Market Domination

Revenue Management Defined

Selling the right product to the right customer at the right time through the right channel for the right price

Revenue Management Core Concepts

1. Sell to micro markets. 2. Exploit product value cycles. 3. Save products for the most valuable customers.

4. Focus on market-based pricing.

5. Focus on price rather than costs when balancing supply and demand. 6. Make decisions based on knowledge, not supposition. 7. Continually re-evaluate revenue opportunities.

Nine Steps to Success

1. Evaluate market needs 2. Evaluate your organization and processes 3. Quantify the benefits (Use simulation)

4. Enlist Technology
5. Implement Forecasting 6. Apply Optimization (Use Linear programming)

7. Create Teams
8. Execute, Execute, Execute 9. Evaluate Success

Underlying Disciplines for RM

RM is based on two primary disciplines: Management Science (MS) Management Information System (MIS) It is a unique blend of these two disciplines

Management Science and MIS

Management science or MS (also known as operations research) is the use of mathematical models and solution procedures to solve organizational problems MIS refers to the systems that provide information to support operations, management, and decision-making functions in an organization

MS and MIS
MS is the older of the two fields of study dating back to the 1940s and includes:
Mathematical optimization, simulation, stochastic modeling, statistical analyses, forecasting, cluster analysis, queuing analysis, and so on

MIS has its beginnings in the late 1960s and includes:

Transaction processing systems (TPS), database management systems (DBMS), data warehousing systems, decision support systems (DSS), CRM, electronic commerce, and so on

Application of MS and MIS to Revenue Management

Lets look at some ways that MS and MIS are used in revenue management To do that, recall the RM process from previous presentations

The Revenue Management Process

Segment the Market

Predict Customer Demand

Optimize Price

Recalibrate Dynamically

Segmentation based on Forecasts of demand purchasing behavior, and capacity at not just current or past product/price level classifications

Mathematically determine capacity availability and price that maximizes expected profit

Continually monitor performance and update market response

MIS in the Revenue Management Process

Segment the Market Predict Customer Demand Optimize Price Recalibrate Dynamically

Use transaction processing to collect data, data base and data warehousing to store and analyze it

Use DSS to analyze data from DW to create demand model

Use database and DW to provide data for optimization

Use TPS, DBMS, and DW to continually monitor performance and update market response

MS in the Revenue Management Process

Segment the Market Predict Customer Demand Optimize Price Recalibrate Dynamically

Use cluster analysis to find market segments

Use simulation to validate demand model and forecasting to forecast future demand

Mathematically determine capacity availability and price that maximizes expected profit

Rerun LP model on daily basis to revise prices; rerun forecasting model and simulations less frequently

Using MS for Revenue Management

We will consider in this course four of the MS techniques that are used in revenue management Mathematical programming for determining the best set of prices to assign Simulation for determining the effect of pricing policies Forecasting to generate future demand for product Cluster analysis for segmenting the market Lets start with mathematical programming

Math Programming
Consists of ...
Objective function to be maximized Constraints - a system of equations that bind
Differential calculus (Linear) Algebra

Maximize z R ( x )

s.t. A j (x) b j , j 1..n

where l x u
assumes all relationships are linear

Draws upon mathematics from Linear Program

Enabling technology
High-speed, large scale computing Optimization software(OSL, CPLEX, Solver)

Maximize z c j x j
j

s.t.

a x
ij i j

bj

where l j x j u j

LP Example
The AHM Corporation has a small plant where they produce two products which we will call A and B. The profit contribution from the two products is $10 and $12 respectively. The products pass through two production departments each with restricted production time. The hours per product and time available in each department are shown below: Department A B Time Available per month 1 2.0 3.0 1500 2 1.0 1.0 600

LP Formulation
Maximize 10A + 12B Subject to 2A + 3B < 1500 1A + 1B < 600 A, B > 0

LP Graphical Solution
Add First Constraint

Units of B
750

500

250

250

500

750

Units of A

LP Formulation
Add second constraint
Units of B
750

500

250

250

500

750

Units of A

LP Formulation
Add Objective Function
Units of B
750

500

250

250

500

750

Units of A

LP Formulation
Determine highest profit feasible solution

Units of B
750

500

Optimum Solution A = 300, B = 300

250

250

500

750

Units of A

LP Applied to Revenue Management

LP is applied to revenue management in the sixth step to success It is applied because once you determine the prices to charge, you dont know how many of the scarce resource to allocate to each price group. By using LP, we determine the optimum allocation, ie, the highest revenue allocation

The OD Problem
Revenue management started in the airline

industry in the 1980's where price & availability were managed on a leg basis where a leg is a single takeoff & landing. The problem with this solution is that demand is at an origin-destination (OD) level. For example, on an Houston-Atlanta-NYC flight, there is only one OD pair (HoustonNYC) but two legs (Houston-Atl and Atl-NYC) Want to optimize the OD not the legs

OD Problem (Continued)
Today, airline's have inventory control systems that
can better handle OD controls and OD network optimization is now a core technology in Airline revenue management. Following is an illustrative problem, demonstrating the types of models used in the industry. The 'real' problems are extremely large with millions of OD products to forecast, and thousands of flights (courtesy of Jon Higbee of Manugistics, Inc.)

OD Example Problem
Trans-Europe Airways (TEA) services 5 cities in Europe Dublin (DUB) Madrid (MAD) Frankfurt (FRA) Rome (FCO) Moscow (MOW) TEA operates 8 flights per day using one type of aircraft that has a capacity of 180 passengers The routes are illustrated on the route map on the next slide. Note that all flights pass through Frankfurt with 4 going in and 4 going out.

TEA Route Map

Connections
The allowable connections and leg capacities are described in the following OD-leg incidence matrix.

The Problem
The pricing department has established fare values for five fare categories and the forecasting group has developed forecasts of demand at these prices for a departure date of November 1, 2005. You as the lead analyst in the optimization group need use the this data to determine the following: What is the optimal number of seats to set aside for each OD fare product on each leg?

The Solution
Use the Excel Solver to formulate and solve the problem: Maximize revenue Subject to: leg capacities Revenue = number on each leg x seat price Leg Capacity = 180 per leg. Note that a seat from DUB to MOW uses capacity on both DUB-FRA and FRA-MOW while DUB to FRA uses only the first leg. The data and setup for this example are available at http://www.terry.uga.edu/~pmckeown/RevMan05/TEA.xls