SM: Session 7A Revenue Management in Services

Revenue Management

Revenue Management (Yield management) is the process of understanding, anticipating and influencing consumer behavior in order to maximize profits from a fixed, perishable resource. The goal of yield management is to produce the best possible financial returns from a limited available capacity. It attempts to allocate the fixed capacity of a service provider, such as airline seats or hotel room reservations.

Revenue Management is effective in the following conditions:

1. High fixed cost structure
2. Relatively fixed capacity
3. Perishable inventory
4. Variable and uncertain demand
5. Varying customer price sensitivity

Revenue management (RM) is price customization as it charge different value segments different prices for same product based on price sensitivity. It uses mathematical models to examine historical data and real time information to determine

• What prices to charge within each price bucket
• How many service units to allocate to each bucket
• Rate fences deter customers willing to pay more from trading down to lower prices (minimize consumer surplus)

Yield Calculation

Yield = Actual Revenue / Potential revenue
Actual revenue = Actual capacity used x average actual price
Potential revenue = Total capacity x Maximum price
A hotel has 200 rooms and the maximum possible price is $ 200 per room
Potential revenue is $ 40000
But if 200 rooms are rented at $ 150 each then,
Yield = 30,000 / 40,000 = 75%

Multiple demand and capacity management strategies help service firm to obtain optimal usage and hence maximize profits. However, determining an appropriate mix can be difficult as different parameters like service quality, customer loyalty and customer demand can be crucial in finding revenue buckets.

Relating Price Buckets and Fences to Demand Curve

Key Categories of Price Fences

Rate Fences	Examples
Physical (product-related) Fences
Basic product	§  Class of travel (business/economy class) §  Size and furnishing of a hotel room §  Seat location in a theater
Amenities	§  Free breakfast at a hotel, airport pickup, etc. §  Free golf cart at a golf course
Service level	§  Priority wait-listing §  Increase in baggage allowances §  Dedicated butler service §  Dedicated account management team
Nonphysical Fences - Transaction Characteristics
Time of booking or reservation	§ Requirements for advance purchase § Must pay full fare two weeks before departure
Location of booking or reservation	§  Passengers booking air tickets for an identical route from different countries are charged different prices
Flexibility of ticket usage	§  Fees/penalties for canceling or changing a reservation (up to loss of entire ticket price) §  Nonrefundable reservation fees
Nonphysical Fences - Consumption Characteristics
Time or duration of use	§  Early-bird special in restaurant before 6PM or 7PM §  Must stay over on Saturday for airline, hotel §  Must stay at least 5 days
Location of consumption	§  Price depends on departure location, especially  in international travel

Challenges in Revenue Management

On one side revenue management can improve revenues but it can bring many risk.

1. Loss of competitive focus: Overfocus on profit maximization can neglect the long term competitiveness of the firm. Price buckets gives number of price points to competitors.

2. Customer alienation: Customer may perceive price buckets unfair. In some cases customers are informed about unavailability of tickets for a particular flight two weeks prior because the tickets are kept for last minute bookings!

3. Overbookings: The success of revenue management system lies heavily on the accurate demand analysis. Due to some situational factors, if the demand is wrongly assessed and overbooking is done foreseeing some cancellations, the firm may face problems. In such cases, proper compensation mechanism should be devised.

4. Incompatible incentive and reward system: Employee may not any performance based incentives as they are not able to sell many.

5. Inappropriate organization of yield management system: Revenue management system requires a centralized booking and reservation system that may not be feasible for small firms.

Designing Fairness into Revenue Management

A service firm should design clear, logical, and fair price schedules and fences. They should use high published prices and present fences as opportunities for discounts rather than quoting lower prices and using fence as basis to impose surcharges. They can optimize revenue management by communicating consumer benefits. Bundling can be used to “hide” discounts so that customers don’t misunderstand reference prices. All the policies must be designed to take care of loyal customers. In case of overbooking due to inaccurate demand analysis there should be provision for compensation.

Reference: Services Marketing: People, Technology, Strategy - Lovelock, Wirtz & Chatterjee & Service Marketing - Zeithmal, Bitner, Gremler & Pandit