Pricing and Revenue Management in a Supply Chain 16 Pricing and Revenue Management in a Supply Chain

Learning Objectives Understand the role of revenue management in a supply chain Identify conditions under which revenue management tactics can be effective Describe trade-offs that must be considered when making revenue management decisions

The Role of Pricing and Revenue Management in the Supply Chain Revenue management is the use of pricing to increase the profit generated from a limited supply of supply chain assets Supply assets exist in two forms – capacity and inventory Revenue management may also be defined as the use of differential pricing based on customer segment, time of use, and product or capacity availability to increase supply chain profits

The Role of Pricing and Revenue Management in the Supply Chain Revenue management has a significant impact on supply chain profitability when one or more of the following four conditions exist The value of the product varies in different market segments The product is highly perishable or product waste occurs Demand has seasonal and other peaks The product is sold both in bulk and on the spot market

Pricing and Revenue Management for Multiple Customer Segments Differential pricing increases total profits for a firm Two fundamental issues must be handled in practice How can the firm differentiate between the two segments and structure its pricing to make one segment pay more than the other? How can the firm control demand such that the lower- paying segment does not utilize the entire availability of the asset?

Pricing and Revenue Management for Multiple Customer Segments Figure 16-1

Pricing and Revenue Management for Multiple Customer Segments Figure 16-2

Pricing to Multiple Segments Subject to For capacity constrained by Q

Pricing to Multiple Segments

Pricing to Multiple Segments Same price to both segments

Pricing to Multiple Segments Total production capacity is limited to 4,000 units Subject to

Pricing to Multiple Segments Figure 16-3

Allocating Capacity to a Segment Under Uncertainty Basic trade-off is between committing to an order from a lower-price buyer or waiting for a higher-price buyer to arrive Spoilage Spill

Allocating Capacity to a Segment Under Uncertainty Effective use of revenue management increases firm profits and improves service for the more valuable customer segment Create different versions of a product targeted at different segments Tactics for multiple customer segments Price based on the value assigned by each segment Use different prices for each segment Forecast at the segment level

Allocating Capacity to Multiple Segments Revenue from segment A, pA = $3.50 per cubic foot Revenue from segment B, pB = $2.00 per cubic foot Mean demand for segment A, DA = 3,000 cubic feet Standard deviation of demand for A, sA = 1,000 cubic feet

Pricing and Revenue Management for Perishable Assets Any asset that loses value over time is perishable Two basic approaches Vary price dynamically over time to maximize expected revenue Overbook sales of the asset to account for cancellations

Dynamic Pricing Effective differential pricing increases the level of product availability for the consumer willing to pay full price and total profits for the retailer Subject to

Dynamic Pricing Effective differential pricing increases the level of product availability for the consumer willing to pay full price and total profits for the retailer d1 = 300 – p1, d2 = 300 – 1.3p2, and d3 = 300 – 1.8p3 Subject to

Dynamic Pricing Figure 16-4

Dynamic Pricing Figure 16-5

Evaluating Quantity with Dynamic Pricing d1 = 300 – p1, d2 = 300 – 1.3p2, and d3 = 300 – 1.8p3 Subject to

Evaluating Quantity with Dynamic Pricing Figure 16-6

Overbooking Basic trade-off is between having wasted capacity because of excessive cancellations or having a shortage of capacity because of few cancellations requiring expensive backup

Overbooking Cost of wasted capacity, Cw = $10 per dress Cost of capacity shortage, Cs = $5 per dress

Pricing and Revenue Management for Seasonal Demand Seasonal peaks of demand common in many supply chains Off-peak discounting can shift demand from peak to non-peak periods Charge higher price during peak periods and a lower price during off-peak periods increases profits for the owner of assets, decreases the price paid by a fraction of customers, and brings in new customers during the off-peak discount period

Pricing and Revenue Management for Bulk and Spot Contracts Problems constructing a portfolio of long-term bulk contracts and short-term spot market contracts Decide what fraction of the asset to sell in bulk and what fraction of the asset to save for the spot market The amount reserved for the spot market should be such that the expected marginal revenue from the spot market equals the current revenue from a bulk sale

Pricing and Revenue Management for Bulk and Spot Contracts

Long-Term Bulk Contracts versus the Spot Market Bulk contract cost, cB = $10,000 per million units Spot market cost, cS = $12,500 per million units

Using Pricing and Revenue Management in Practice Evaluate your market carefully Quantify the benefits of revenue management Implement a forecasting process Keep it simple Involve both sales and operations Understand and inform the customer Integrate supply planning with revenue management

Summary of Learning Objectives Understand the role of revenue management in a supply chain Identify conditions under which revenue management tactics can be effective Describe trade-offs that must be considered when making revenue management decisions

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