Given its
widespread adoption, revenue management (RM) approach is now an industry
benchmark in airline, hospitality, and car rental industries for pricing. Over
the past decade, revenue management approaches have gained popularity in other
industries, most notably electricity (for dynamic pricing in conjunction with
adoption of smart grids and smart meters), sports tickets (for pricing of both
seasonal passes and individual game tickets), restaurant (for dynamic menu pricing
to adjust for demand variations), and digital advertisements (for dynamic pricing
of digital advertisement space in alignment with the demand across
advertisers).
While there is a
consensus on the potential offered by revenue management (RM) in achieving
revenue goals, however in my interactions with business leaders across
industries I have encountered few myths associated with RM approach. The three
most common of these are:
- Myth 1: Revenue management increases the average price paid by customers
- Myth 2: Revenue management is useful only in competitive markets
- Myth 3: Revenue management systems reduce the significance of the role of the revenue managers
Myth 1: Revenue
management increases the average price paid by customers
Whenever the available inventory (of
airline seats, hotel rooms, etc.) is greater than the demand at high price, revenue
management will allocate a portion of the inventory for selling at low price.
This maximizes the capacity utilization, and also brings down the average price
paid by customers.
Revenue
management dynamically allocates the available inventory for selling at
different price points. As a result, if the future demand at high price points
is lower than the inventory available, RM will allocate a part of the inventory
for selling at lower price points, which will pull down the average price paid
per customer.
For
illustration, let’s consider an airline ticket pricing scenario for a flight on
July 2nd, 2015 from NYC to SFO, with 100 seats in the aircraft,
which can be sold at the following four price points: $360, $440, $520, and $600.
Assume that the airline starts accepting reservations from one year in advance,
and the demand is uniform over the one year booking horizon. The total demand forecast
over the year and the corresponding revenues at each of the price points in consideration
are shown in Figure
1 below.
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If the airline adopts
an optimal single price policy for the July 2nd flight, it will pick
$440 because at this price its revenues are maximized at $37,840. However, notice
that only 86% of the flight capacity is utilized at this price. If it prices at
$360, it will fill-up all the seats, however it will generate only $36,000 in
revenues.
If the airline
adopts a simplistic revenue management approach, and for the first 237 days in the
booking horizon (from July 2, 2014 to Feb 25, 2015) sells July 2nd, 2015
flight tickets at $360, and for the balance 128 days (from Feb 26, 2015 to July
1, 2015) sells the tickets at $600, it can expect to sell 78 (=237/365*120) seats
at $360, and 21 (=128/365*60) seats at $600. In this manner, for the July 2nd,
2015 flight the airline can expect to generate revenues of $40,680 ($360*78 + $600*21).
In comparison to
the optimal single price policy ($440), the RM approach here has contributed
7.5% higher revenues ($40,680 vs. $37,840), lead to a better flight capacity
utilization (99% vs. 86%), and lowered the average price paid per customer from
$440 to $411 (= $40,680 / 99).
Truly a win-win proposition!!