Introduction to Revenue Management

What is Revenue? Revenue The total amount of sales achieved in a specified time period. Revenue is calculated as: Number of units sold x Unit Price =Revenue

The Purpose of Business Achieving Profits Generating returns on investment For whom? Company-centric ⟶ Customer-centric

The Profit Fallacy The Profit Fallacy Accountant’s Profit Formula Applying basic algebra, the accountant’s formula becomes: Sales = Cost + Profit Profit = Revenue - Expense

Buyers also seek profits Three Business Propositions Related to a Ten-dollar Buyer/ Seller Transaction Seller’s Proposition Resulting Profit Informed Buyer’s Willingness to Accept and Repeat the Trade #1. Trade nine $1.00 bills for the buyer’s $10.00 bill. $1.00 to the seller Zero #2. Trade ten $1.00 bills for the buyer’s $10.00 bill. $ 0.00 to seller and buyer Possible, but unlikely #3. Trade eleven $1.00 bills for the buyer’s $10.00 bill. $1.00 to the buyer Highly likely

The Profit Fallacy In any rational business transaction, both the buyer and the seller seek a profit. Dual Entitlement Theory = consumers believe that (1) they are entitled to a reasonable price, and business are entitled to a reasonable profit.

The ROI Fallacy Economist’s Profit Formula Return on investment (ROI) The Return on Investment Fallacy Economist’s Profit Formula Return on investment (ROI) Profit = The reward for risk U Owner’s return Owner’s original investment = Return on Investment

The Return on Investment Fallacy The ROI Fallacy The Return on Investment Fallacy If an owner invests $ 800,000 in a business, and achieves $200,000 in investment returns (defined as revenue in excess of all expense), that owner’s ROI would be 25 percent. $200,000 investment return $800,000 original investment = 25% ROI

The Return on Investment Fallacy The ROI Fallacy The Return on Investment Fallacy The purpose of business is to create and keep a customer. ~Drucker Businesses do so by ensuring that each customer transaction results in an increase in wealth for the customer.

What is Revenue Management? To provide profits to its customers along with sellers and to increase customers’ wealth in addition to the business’ wealth Revenue Management (≈Yield MGMT) The application of disciplined tactics that predict buyer response to prices, optimize product availability, and yield the greatest business income. (Selling the RIGHT product to the RIGHT customer at the RIGHT time for the RIGHT price)

The Purpose of Revenue Management Customer-centric revenue management A revenue management philosophy that places customer gain ahead of short-term revenue maximization in revenue management decision making. Revenue Manager Using customer-needs driven techniques, RM is responsible for ensuring that a company’s prices match a customer’s willingness to pay. => To make your company, its owners, and you prosper by FIRST making your customers prosper Chapter 1: Introduction to Revenue Management

Why RM matters in service business? Goods Tangible Homogeneous Production/distribution consumption different Can be kept in stock Services Intangibility Heterogeneous (variability) Production/distribution consumption the same (Inseparability) Can’t be kept in stock (Perishability) RM works in service biz because: Capacity is fixed (constrained supply) Inventory is perishable Demand varies by day of the week, months, seasons; or leisure vs. business )

Services (vs. Products) “I” of Service Characteristic Intangibility A service cannot be touched or seen before it is purchased. Variability Uneven performance results from variations between the skills of those who are actually delivering the service. Inseparability It is often impossible to make a distinction between the individual delivering the service and the service itself. Perishability Unsold inventory vanishes if not sold.

Constraint management Hotel/Resort example # of rooms each day cannot vary (=constrained supply) Demand for rooms varies, based on time of year (demand fluctuation) Any room night not sold on a given day disappears forever at the end of that day (perishability)

RM Matrix

RM in service businesses Airline industry RM initially started (results of Deregulation Act of 1978) “Pay more when demand is higher” – not pay more for first class than coach How many seats to make available at each of the listed fares, depending on time of year/week, remaining seats available, remaining time until departure (American Airlines) 30’10-38’32

RM in service businesses Seat (Capacity) Price/seat Revenue Fare type Without Yield M 100 $ 100 $ 10,000 60days discount 20 $ 100 $ 2,000 60days discount 20 $ 200 $ 4,000 30days discount With Yield M 20 $ 300 $ 6,000 15days discount 40 $ 400 $ 16,000 Full fare (Biz traveler) 100 (Total) $ 28,000 (Total revenue) Assuming that all seats sold out Better job!!!! not YM($10,000) vs. YM ($28,000) Separating four segments (20, 20, 20, 40) by demands Business traveler = promising segment

RM in service businesses Hotel industry How much to charge for a room depending on the location, type of room, time of year, time of week, duration of stay Restaurant industry How much to charge for lunch vs. dinner Golf industry Variable pricing: time of day, day of week, season of year Cruise industry Variable pricing: time of year, type of cabin… (Cruise pricing)

Misuse of RM Fall 2000, Amazon conducted experiment to try to determine price sensitivity of demand for DVDs Depending on previous purchases, discounts between 20-40% offered ($33.97, $27.97 or $25.29) – thanks to Cookies! Customers who went back to Amazon saw the price had jumped! Furious response by customers and press, suspecting Amazon varied price by loyalty “Amazon apparently offers good discounts to new users, then once they get the person hooked and coming back to their site again and again, they play with the prices to make more money”

The Revenue Management Process Step 2 Forecast Demand Step 3 Manage Inventory Step 4 Manage Distribution Step 5 Evaluate Results Step 1 Establish Prices