Supply Chain Management

1
Supply Chain Management

• Lecture 25

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Detailed Outline

• Tuesday December 1 Chapter 15
• Sections 15.1, 15.2
• Thursday December 3 Simulation Game briefing
• Tuesday December 8 Chapter 15, review
• Sections 15.1, 15.2
• Thursday December 10 Simulation Game
• In room 320
• Friday December 11 is the last day to turn in
  homework
• Saturday December 12 Final 730pm 1000pm

3
Drivers of Supply Chain Performance

• Facilities
• Inventory
• Transportation
• Sourcing
• Pricing
• Information

Impacts supply
Impacts demand
4
What is Revenue Management?

• Revenue management is the practice of
  differential pricing to increase supply chain
  profits
• A strategy that adjusts prices based on product
  availability, customer demand, and remaining
  duration of the sales season will result in
  higher supply chain profits

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Differential Pricing is Standard Practice
Relative Price
6
What is Revenue Management?

• Revenue management is the practice of
  differential pricing to increase supply chain
  profits
• A strategy that adjusts prices based on product
  availability, customer demand, and remaining
  duration of the sales season will result in
  higher supply chain profits
• Revenue management, also called yield management,
  is a technique to optimize revenue from a fixed,
  but perishable inventory

7
Revenue Management
Revenue ManagementMaps capacity into demand
Newsvendor problemMaps demand into capacity
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What is Revenue Management?

• Revenue management is the practice of
  differential pricing to increase supply chain
  profits
• A strategy that adjusts prices based on product
  availability, customer demand, and remaining
  duration of the sales season will result in
  higher supply chain profits
• Revenue management, also called yield management,
  is a technique to optimize revenue from a fixed,
  but perishable inventory

The challenge is to sell the right product to the
right customer at the right time for the right
price
9
What is Revenue Management?

• Is revenue management possible for
• Airline tickets
• Cruise travel
• Restaurants
• Hospitals
• TL-LTL trucking companies
• Apartment rental
• Incoming MBA class
• Vending machines

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Revenue Management and Vending Machines

• Coca-Cola announces that it is considering
  vending machines that will boost prices during
  hot weather.
• Coca-Cola is a product whose utility varies from
  moment to moment. In a final summer
  championship, when people meet in a stadium to
  enjoy themselves, the utility of a chilled
  Coca-Cola is very high. So it is fair it should
  be more expensive. The machine will simply make
  this process automatic.

Douglas Ivester, Chairman and CEO
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Conditions for Revenue Management

• The value of the product varies in different
  market segments
• Airline seats leisure versus business travel
• The product is highly perishable or product waste
  occurs
• Fashion and seasonal apparel
• High tech products
• Demand has seasonal and other peaks
• Products ordered at Amazon.com, peaking in
  December
• The product is sold both in bulk and on the spot
  market
• Owner of warehouse who can decide whether to
  lease the entire warehouse through long-term
  contracts or save a portion of the warehouse for
  use in the spot market

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Why Revenue Management?

• Success stories
• American Airlines increased annual revenue by
  over 1 billion through revenue management
• Marriott hotels increased annual revenue with
  100 million through revenue management
• National Car Rental was saved from liquidation
  through revenue management
• Canadian Broadcasting Corporation increased
  revenue with 1 million per week

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Airfare example
p
Choose the fare that maximizes the area (revenue)
of the rectangle
1000
800
600
400
200
q
1000
800
600
400
200
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Airfare example
p
Choose the fare that maximizes the area (revenue)
of the rectangle
Consumer surplus
1000
800
Maximum revenue 500500 250,000
600
400
Unaccommodated demand
200
q
1000
800
600
400
200
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Airfare example
p
Choose the fare that maximizes the SUM of areas
of the rectangles
1000
800
Business class
Maximum revenue 667333 333667 333,333
600
400
Economy class
200
q
1000
800
600
400
200
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Airfare example
p
Choose the fare that maximizes the SUM of areas
of the rectangles
1000
First class
800
Maximum revenue 200(800600400200)
400,000
Business class
600
Economy plus class
400
Economy class
200
q
1000
800
600
400
200
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Airfare example
p
Perfect price discrimination
1000
Charging a different price to a different buyer
for the same product without any true cost
differential to justify the different price
800
Maximum revenue 500,000
600
400
200
q
1000
800
600
400
200
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Is Revenue Management Price Discrimination?

• The same product sold at different times for
  different prices is not necessarily price
  discrimination, because at different times...
• The production or distribution costs may be
  different
• Inventory costs were incurred to keep the product
  in stock until a later time
• The product value may change over time, such as
  perishable or maturing or seasonal products,
  fashion goods, antiques.
• Interest is earned if product is sold at an
  earlier time
• Consumers value products differently at different
  points in time
• Locking sales in early reduces uncertainty

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Revenue Management for Multiple Customer Segments

• If a supplier serves multiple customer segments
  with a fixed asset, the supplier can improve
  revenues by setting different prices for each
  segment
• What price to charge each segment?
• How to allocate limited capacity among the
  segments?

Prices must be set with barriers such that the
segment willing to pay more is not able to pay
the lower price
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Revenue Management for Multiple Customer Segments

• To differentiate between various segments, one
  must create barriers by identifying product or
  service attributes that the segments value
  differently

The New York TimesJune 1, 2008
Its Back The Minimum StayAfter United revived
Saturday-night-stay rules on many routes, other
major airlines did, too
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Revenue Management

• Hotels, airlines, opera houses hope this tool
  will help them maximize sales and profits
• The real beneficiary of revenue management has
  been the consumer

Clearly, customers for which revenue management
has decreased the cost of air travel, have
benefited from revenue management. Could
customers for which revenue management has
increased the cost of air travel, also have
benefited from revenue management?
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What is Revenue Management?
p
p
1000
1000
800
800
600
600
400
400
200
200
1000
800
600
400
200
1000
800
600
400
200
q
q
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Revenue Management

• Hotels, airlines, opera houses hope this tool
  will help them maximize sales and profits
• Golf courses are studying how to use it to
  better reflect the value of a tee time on
  Saturday morning in summer versus a Wednesday
  afternoon in winter

Which factors can the opera houses let their
ticket prices depend on
Which factors can the internet service providers
and fiber optic networks let their prices depend
on
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Revenue Management

• Hotels, airlines, opera houses hope this tool
  will help them maximize sales and profits

Many opera houses and theatres offer tickets at a
discount just before the performance starts, if
there are still seats available. The airlines
used to offer tickets at a discount to standby
passengers, if there were still seats available
just before departure time. Why would they do
that?
What is the disadvantage of this pricing strategy?
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Example 15-1 Pricing to multiple segments

• A contract manufacturer has identified two
  customers segments for its production
  capacityone willing to place an order more than
  one week in advance and the other willing to pay
  a higher price as long as it can provide less
  than a weeks notice for production. The
  customers that are unwilling to commit in advance
  are less price sensitive and have a demand curve
  d1 5,000 20p1. Customers willing to commit in
  advance are more price sensitive and have a
  demand curve of d2 5,000 40p2. Production
  cost is c 10 per unit. What price should the
  contract manufacturer charge each segment if its
  goal is to maximize profits?

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Example 15-1 Pricing to multiple segments
d1 5,000 20p1
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Example 15-1 Pricing to multiple segments
d1 5,000 20p1
Profit
p - c
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Pricing Multiple Segments

• Assume that the demand curve for segment i is
  given by
• di Ai Bipi
• The goal of the supplier is to price so as to
  maximize profits
• Max (pi c)(Ai Bipi)

Profit
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Pricing Multiple Segments

• The optimal price for segment i is given by
• pi Ai/2Bi c/2

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Example 15-1 Pricing to multiple segments

• For segment 1
• pi Ai/2Bi c/2 pi 5,000/(220) 10/2
  130
• Profit (pi 10)(5,000 20pi) (130
  10)(5,000 20130) 288,000
• For segment 2
• pi Ai/2Bi c/2 pi 5,000/(240) 10/2
  67.50
• Profit (pi 10)(5,000 40pi) (67.5
  10)(5,000 4067.5) 127,650

Total profit 415,650
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Example 15-1 Pricing to multiple segments

• If the contract manufacturer were to charge a
  single price over both segments, what should it
  be?

d1 5,000 20p1
d2 5,000 40p2
d (5,000 20p) (5,000 40p) 10,000 60p
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Example 15-1 Pricing to multiple segments

• For segment 1 and 2
• p Ai/2Bi c/2 p 10,000/(260) 10/2
  83.33
• Max (p c)(A Bp) Max (p 10)(10,000 60p)
  (83.33 10)(10,000 6083.33)
  366,650

Differential pricing raises profit from 366,650
to 415,650
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Example 15-1 Pricing to multiple segments

• If total capacity is limited to 4,000 units, what
  should the contract manufacturer charge each
  segment?
• For segment 1 p1 130
• Demand d1 (5,000 20p1) 2,400
• For segment 2 p2 67.50
• Demand d2 (5,000 40p2) 2,300
• Total demand 2,400 2,300 4,700

Total demand exceeds production capacity of 4,000
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Pricing Multiple Segments

• The goal of the supplier is to price so as to
  maximize profits
• Max ?ki1 (pi c)(Ai Bipi)
• Subject to?ki1(Ai Bipi) ? Qpi ? 0

Maximize profits
Production capacity
Price
35
Revenue Management for Multiple Customer Segments

• If a supplier serves multiple customer segments
  with a fixed asset, the supplier can improve
  revenues by setting different prices for each
  segment
• What price to charge each segment?
• How to allocate limited capacity among the
  segments?

What if demand is uncertain?
36
The Park Hyatt Philadelphia

• 118 King/Queen rooms.
• Hyatt offers a pL 128 (low fare) targeting
  leisure travelers.
• Regular fare is pH 181 (high fare) targeting
  business travelers.
• Demand for low fare rooms is abundant.
• Let DH be uncertain demand for high fare rooms.
• Assume demand for the high fare (business) occurs
  only within a few days of the actual stay

How much capacity should Hyatt save for the
higher priced segment?