Revenue Management

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Revenue Management

• Dr. Cevat Ertuna

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What is Revenue Management?

• Revenue Management is concerned with
• maximization of revenue
• by allocating fixed capacity (room- nights)
• to different customer segments (classes)
• with different rates (prices).

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Revenue Management Aspects

• Priced based RM.
• Dynamic pricing
• Auctions
• Quantity based RM.
• Single Resource Capacity Control
• Overbooking
• Network Management

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Price Based Revenue Management

• Priced based Revenue Management deals with the
  question
• How to price various customer groups?
• The answer to this question could be in
• Dynamic pricing
• Auctions

5
Quantity Based Revenue Management

• Quantity based Revenue Management deals with the
  demand management decisions (accept reject
  decision for service/product)
• How to ration service/product?
• How to control availability?
• How much to sell and Whom to sell?
• The answer to this question could be in
• Single Capacity Control
• Network Capacity Control
• Overbooking

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Tools for Quantity based Rev. Mang.

• Capacity Control
• Overbooking
• Network Management

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The Basic Capacity Control Question
A customer is calling the reservation desk of a
hotel (or any service supplier) and requesting a
room (inventory of fixed capacity) at particular
rate for a particular date.

• Should the desk say yes and sell him the room
  at the requested rate or should the desk say
  no?
• Why would the reservation desk say yes
• To get his revenue
• Why would the reservation desk say no
• Because they don't have sufficient capacity to
  accommodate him
• Because they can sell the room at a higher rate
  to him or someone else.

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The Basic Overbooking Question
Hotel industry allows customers to cancel or
no-show without penalty. A hotel estimates that
number of customers who will book a room for 105
but fail to show up is normally distributed with
mean 20 and standard deviation 10. Hotel manager
wants book more guests than the capacity against
no-shows. If more customers show up than the
capacity they will be of course denied to stay at
the hotel. However they will be compensated which
will cost the hotel 300.

• How many overbooking should the manager allow?

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The Basic Network Question
A hotel, serving business travelers is down to
last two rooms for comming Monday and Tuesday,
but there are planty rooms available for the rest
of the week. Four customers want booking at the
reservation desk. Customer-A wants Monday night
at full rate (100). Customer-B Tuesday night at
full rate. Customer-C wants both Monday and
Tuesday at two-day package rate (150 in total).
Customer-D wants to stay all week at the weekly
rate (350 in total).

• Which combination whould be accepted to produce
  the highest revenue?

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Where can RM be useful?

• RM can be used if there are
• Fixed Capacity
• Perishable Inventory (hence, opportunity cost)
• Low Marginal Servicing Cost
• Segmented Market (hence, rate classes)
• Advanced Booking (or sales)
• Uncertainty in demand and customer behavior
  (no-show, cancellation)
• exist.

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Fixed Capacity

• In hotel business the number of rooms are fixed.

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Perishable Inventory

• In hotel business room-nights can be considered
  as perishable inventory.
• That is because, once a night has passed, the
  unsold room-night inventory for that night has no
  value.

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Low Marginal Cost

• The marginal cost of additional guest is
  relatively low (processing cost of check-in/out,
  cost of room cleaning).

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Segmented Market

• In Hotel business demand can be segmented into
  market sections corporate, transient, group,
  etc.
• That in tern can help with marketing mix. For
  example relatively price insensitive business
  guests are charged higher rates (prices) than
  more price sensitive leisure guests.

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Advance Booking

• Booking requests can be submitted in advance and
  be evaluated via computer programs.
• Rates can be changed on short notice.

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Uncertain Demand Customer Behavior

• Room demand varies by season and day-of-week and
  can be forecasted by night/day and rate category.
• Forecasts are not precise, however. For example
  the most we can say is that
• we are 95 confident that the demand for
  double-room on a particular day will be 272
  plus or minus 12, or
• There is a 79 percent probability that demand
  for double room will be at least 140.

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Steps for Revenue Management

• Design a Market Segment Pricing Strategy
• Define the market segments (based on common
  characteristics, like corporate, trancient,
  government, group, etc.),
• Define the pricing strategy (for different market
  segments, peak/off-peak periods, etc.).
• Use facts for your design. For example in the
  hotel industry, the business segment of the
  market is less sensitive to price levels than the
  leisure segment.

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Steps for Revenue Management

• Design a Market Segment Pricing Strategy
• Forecast Demand
• Using time series or other appropriate
  forecasting models
• For different segments, rates, time periods, etc.
  and combination of them.

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Steps for Revenue Management

• Design a Market Segment Pricing Strategy
• Forecast Demand
• Create Rules for Inventory Allocation
• Never sell a unite capacity for less than
  expected revenue

ExpectedRevenue SalesProbaility SalesPrice
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Steps for Revenue Management

• Design a Market Segment Pricing Strategy
• Forecast Demand
• Create Rules for Inventory Allocation
• Estimate Expected Revenue
• Expected revenue is equal to Probability of Sales
  at certain price times Sales Price
• Never sell a unite capacity for less than
  expected revenue

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Capacity Control Example

• Let assume that demand for rooms at higher rate
  is normally distributed with mean 102 and
  standard deviation 20.8. Let also assume that the
  high rate (or full rate) is 181 Euros and low
  rate (discount rate) is 128 Euros.
• How many rooms should be reserved (Protection
  Level) for high rate customers?

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Capacity Control Example - Computation

• Determine probability that expected marginal
  revenue of higher rate class will exceed marginal
  revenue of lower rate class.
• That probability is called Revenue Ratio and can
  be computed as
• Revenue Ratio 1 (Rate_L / Rate_H)
• Revenue Ratio 1 (128 / 181) 0.2928
• Convert that probability into number of rooms
• Norminv(revenue_ratio, mean, std_Dev)
• Norminv(0.2928,102,20.8) 90.6594 91
• 91 rooms should be reserved for full rate sales
  and (Capacity - 91) can be sold to lower rate
  guests.

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Capacity Control - Notes

• In two class model, only relevant distribution to
  compute Protection Level or Booking Limit is
  the distribution of Full Rate demand.
• In two class model capacity does not affect
  decision on Protection Level or Booking Limit.

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Overbooking Example

• A hotel estimates that number of customers who
  will book a room for 105 but fail to show up is
  normally distributed with mean 20 and standard
  deviation 10. Hotel manager wants book more
  guests than the capacity against no-shows. If
  more customers show up than the capacity they
  will be of course denied to stay at the hotel.
  However they will be compensated which will cost
  the hotel 300.

• How many overbooking should the manager allow?

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Overbooking Example - Computation

• Determine the Probability that Marginal Cost of
  Overbooking will exceed Marginal Revenue of
  Overbooking.
• That probability is called Critical Ratio and can
  be computed as
• Critical Ratio Rate / (Penalty Rate)
• Critical Ratio 105 / (300 105) 0.2593
• Convert that probability into number of rooms
• Norminv(critical_ratio, mean, std_Dev)
• Norminv(0.2593,20,10) 13.55 14
• 14 rooms over the capacity could be booked.

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Network Example
Four customers want booking at the reservation
desk. Customer-A wants Monday night at full rate
(100). Customer-B Tuesday night at full rate.
Customer-C wants both Monday and Tuesday at
two-day package rate (150 in total). Customer-D
wants to stay all week at the weekly rate (350
in total).

• Which combination whould be accepted to produce
  the highest revenue?

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Network Example - Computation

• Rule If you can sell an equal number of single,
  full rate units on all parts of your network,
  you should generally do so.

A 100
B 100
D 350

• Customers A, B, and D will generate highest
  revenue (550)