Revenue Management Exam 3 Old stuff

Definition of RM
tactics that predict consumer behavior at the micro-market level and optimize product availability and price to maximize revenue growth; an integrated set of business processes that brings together people and technology with the goal of understanding the market
History of RM
• 1978 – airline deregulation
• 1980 – hotel manual inventory control
• 2007 – many industries use RM
Which firms/industries use RM?
• Airlines
• Hotels
• Vacations
• Car Rental
• Washington Opera
• TV Ads
• UPS
• Texas Children’s hospital
The origins of RM: the Bill Marriott Story
• Each room was a flat rate and each additional person was charged
• When there were only a few rooms left, Bill would only take groups that had 3 or more people to maximize revenue
Techniques of RM are applicable when these conditions are met:
• Capacity is limited and immediately perishable (ex. – empty hotel room)
• Customers book ahead of time
o This gives airlines the opportunity to track demand for future flights and adjust prices accordingly to balance the supply and demand
• Prices are changed by opening and closing predefined booking classes
o Airlines-establish a set of prices (fare classes) for each flight and then open or close those fare classes as they wish
Lessons learned from airline industry:
• Pricing and revenue optimization can deliver more than short-term profitability
• E-commerce enables pricing and revenue optimization
• Effective market segmentation is critical
o Create different products that appeal to different segments
o Charging different prices to different segments
4 characteristics of e-commerce that increased the urgency of pricing and revenue optimization:
1. The internet increases the velocity of pricing decisions – a typical major domestic airline needs to evaluate 500,000 price changes a week
2. The internet makes available and immediate wealth of information about customer behavior
3. It provides a unique laboratory for experimenting with pricing alternatives
4. May provide deeper information about cost and competitive prices
The Financial Impact of Pricing and Revenue Optimization: McKinsey Study???????????????????????????????
• Revenue enhancement is easiest to manipulate
Five Key Components to Revenue Management
• Demand analysis
• Competitive knowledge
• Strategic pricing and distribution
• Weekly strategy meeting
• The revenue manager
RM process flow:
• Segment the market, predict customer demand, optimize price, recalibrate dynamically
Produce value cycle: conditions of demand elasticity
• Less elastic
o Fewer options, inexpensive product, limited time frame
o More options, expensive product, unlimited time
Different types of demand
• Stable demand – groceries
• Seasonal demand – holiday items
• Perishable demand – perishable product
• Time sensitive demand – airline
3 traditional approaches to pricing
• Cost-plus – calculates prices based on cost plus a standard margin
o Finance departments prefer it bc it guarantees and adequate margin
• Market based – bases prices on what competitiors are doing
o Sales departments like it bc it helps them sell against all competition
• Value optimization – sets prices based on an estimate of how customers “value” the good or service
o Marketing departments support it because it’s priced according to how customers value product
Price waterfall: a graphical way of showing the discounts that occur between the list price and the pocket price
• Many discounts are the results of independent decisions made by different parts of the organization, without consistent measurement or tracking
• Management information systems most often do not report on transaction price performance, or report only average prices and do not show pricing opportunities lost transaction by transaction
• Smart buyers detect disorganized or dispersed pricing organizations and take advantage
• Management attention is often heavily concentrated on invoice prices or list prices
• Price waterfall illustrates that the majority of important pricing adjustments often take place after the invoice price and certainly after the list price
3 Dimensions of the pricing and revenue optimization cube
• To provide the right price to every product
• To every customer segment
• Through every channel
The Pricing and Revenue Optimization Process
• A consistent business process focused on pricing as a critical set of decisions
• The software and analytical capabilities required to support the process
4 activities are part of operational PRO – executed every time there is a price change:
• Continuously set and update prices
• Timing will depend on application
• Analyze the alternatives and choose best
• Execute pricing and monitor/evaluate
Supporting PRO activities – provide key input to operational PRO
• Set goals and business rules
• Segment the market
• Determine and update prime response
• segment
The Seven Core Concepts
-Focus on price rather than costs when balancing supply and demand
-Replace cost-based pricing with market-based pricing
-Sell to segmented micromarkets, not mass markets
-Save your products for your most valuable customers
-Make decisions based on knowledge, not supposition
-Exploit each products’ value cycle
-Continually re-evaluate your revenue opportunities
Different Methods of Market Segmentation
• Time of purchase (time segmentation: perishable products that age; demand goes down as products age, seasonality) – demand decreases as time increases
• Customer characteristics (seniors, AARP)
• Sales channel (online, offline)
• Offer a discount to large customers
• Offer a discount for a slow delivery – faults
Dilution/Displacement
Dilution: Selling a product to a customer at a lower price than they would have otherwise been willing and able to pay.

Displacement: In constrained capacity situations, the acceptance of a low value purchase that results in the denial of a higher valued purchase at a later point in time

Fences
• Revenue will disappear unless market segments are kept separate to limit “leakage” from high priced segments to low priced segments
• Tools to maintain segment separation
Critical 9 Steps to Success
Evaluate Unique Market Needs
• I plotted yield on the x axis and revenue on the y axis.
• As you increase yield, you can increase revenue
• If you keep increasing yield, you eventually lose revenue to competitors or other uses of the consumers’ discretionary dollar
2.Evaluate Your Organization and Process
• Define and document specific issues addressed to maximize revenues
• Interviews, documentation, and data gathering affecting the products offered, the prices, competition, and customer behavior
• It is important to understand what the customer is buying rather than what you are offering
3.Quantify the Potential Benefits
• A back-of-the-envelope calculation is a rough, simple calculation to test a hypothesis. It is not necessarily written on the back of an envelope. It is more trustworthy than a guess, but less definite than a mathematical proof
4.Enlist Technology
5.Implement Forecasting
• •Forecasting is the art and science of predicting future events
• •Three rules of good forecasting
o • The forecast must be at the right level of detail
o •An appropriate amount of data must be analyzed
o •Frequent reforecasting must occur
• •Once segments are created, the next step in the RM process is to forecast demand for each segment
• A two step process
o 1.Build an off-line demand model for each segment using various forecasting techniques, e.g., qualitative techniques, time series, and regression
o 2.Build an online updating system for keeping the demand model current (using data bases and data warehousing)
• •How do you know when your model is accurate (or not and needs to be updated)?
• •Measure with historical data
• •Measure error and look at charts

6.Apply Optimization
• forecasting suggests what customers are likely to do
• optimization suggests what you should do about it
• think optimization as the computer game of Tetris: the variety of customers with different needs and values are like the falling blocks that have different shapes
• cost information X market information and strategic goals = optimal price
7.Create Teams
• People will be the key to the success of RM
• Identify revenue management “champion”
• Create support organization
• Establish roles and responsibilities
• Communicate objectives to entire company
8.Execute, Execute, Execute
• Implementation is everything
9.Evaluate Success
• Were revenue gains achieved?
• What was competitive response?
• Where do additional opportunities lie?
Potential Pitfalls
• Paralysis by analysis
• Failure to quantify benefits
• Market segmentation errors
• Lack of well-defined plan
• Lack of senior management oversight
• Viewing the system as the solution
• Held hostage by techies
RM is applicable under 3 conditions
• Fixed stock or perishable capacity
• Pre departure booking
• A set of fare classes (rooms) each with a fixed price
3 levers of RM decision, p3
• Strategic: segment markets, differentiate prices, quarterly
• Tactical: calculate/update booking limits; daily/weekly
• Booking control: acceptance/rejection, real time
The three levels of revenue management decisions, p4
• Setting and updating limits
• Sold at a particular fare/rate
• Which segment
RM strategy
distinction between leisure/business customers
business vs. leisure customers
• Leisure
o Highly price sensitive
o Book earlier
o More flexible to departure and arrival times
o More accepting of restrictions

• Business
o Opposite

GDS definition and examples of GDS
provides a conduit connecting the reservation system and a number of important sales outlets – particularly travel agents; each distributes schedule, fare and booking availabilities to the agencies and transmits booking and cancellations from the agencies to the airlines
Booking control
• Real time face of RM
• Reservation system includes a booking limit for each fare class on each product
• When a booking request is received, the reservation system checks the booking limit for the associated fare class
Tactical RM
opening and closing fare classes to maximize returns – determine which fare classes should be open and which closed for all products in order to max returns from a fixed set of resources
3 Major problems of tactical RM
• Capacity allocations
• Network management
• overbooking
Capacity allocation, Network (LOS) mgmt, overbooking
• Capacity allocation – how many customers from different fare classes should be allowed to book?
o Important whenever a company sells the same unit of inventory for different prices
• Network Management – how should bookings be managed across a network of resources such as multiple night hotel stays
o Important for companies that sell products consisting of combinations or resources
o Most important component for business hotels
• Overbooking – how many total bookings should be accepted for a product in the face of uncertain future ho shows and cancellations
Updating booking limits/reoptimization/update
• Probabilistic forecasts are the primary input used to generate the booking limits
• Calculated by estimating the economic tradeoff between accepting more discount bookings now vs having more capacity available for future
• Automatically recalculated when the demand forecasts are updated
• 3 ways of updating
o periodic
o event-driven
o requested updates
RM decisions
maximizing expected net contribution
Ancillary products and services
• duty-free goods, minibar, room service, rental car
Measuring Revenue Management Effectiveness
• high RASM does not guarantee high profit since it is strictly revenue-based metric and ignores costs
Problems for airlines posed by the internet
• To much fare visibility for customers
• Online intermediaries – expedia
• Customers want lowest price ignorine fare issues
Definition of market segmentation
the general market is divided into distinct groups to direct sale and marketing effort; each segment will have a unique strategy for pricing, promotion, policies, distribution and sales
Examples of different market segments:
AAA, convention group, corporate, family, seniors, leisure, military, religion
Hotel distribution channels (Exhibit 1)
• Ex: contact center, walk in, global distribution system, internet
• Traditional hotel: hotel direct, central reservation office, travel agencies
3 Information needed to use market segmentation
• A clear customer definition
• Segments that apply to both corporate and property level applications
• Understanding of the source of business
Source of business
provides hotels with a breakdown of how the business arrived at the hotel or through which channel the business arrived
demand forecasting
involves the use of historical patterns and current trends to forecast future demand
Definition of unconstrained demand (UD)/ Constrained demand
• Unconstrained/ture demand – not constrained by the capacity of the hotel; the demand that could be sold if the hotel had an unlimited number of rooms available to sell
Denials vs. regrets; Is it easy to distinguish?
Denials are customers who are turned away because of capacity constraints or restrictions.
•Regrets are customers who are turned down because they are not inclined to pay the price of the space or a room (i.e., shoppers).
Reasons why hotels are not successful following their revenue strategy
• People override their system’s tactics with their own gut feeling
• Too little emphasis is placed on the accuracy of group forecast
• Inappropriate incentive systems (rewarding on volume instead of profit)
Definition of date warehouse and data mart:
• Data warehouse – collection of data created to support decision making applications
o Collect information that allows hotels to determine the total customer value to make decisions of the business – casinos
• Data mart – stores data for a limited number of subject areas, such as marketing and sales data; it is used to support specific applications; an independent data mart is created directly form source systems, a dependent mart is populated from a data warehouse
Elements of customer value
• total spending during the stay
• seasonal or day of week stay patterns
• cost of the booking venue of choice
• cost of sale
Understand cost of sales and distribution
• some distribution channels are more costly than other
• booking through hotel webpage is cheapest