Dynamic Pricing andYield Mana ementg

Yossi Sheffi Professor, MIT

ESD.260J/1.260J/15.770J

What you are is clear – the only issue is price…

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Outline

Airline revenue management

discrimination Revenue management in TL trucking

© Yoss Sheffi, MIT

The essence of price

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Yield/Revenue Management

Objective:

Integrated management of capacity and pricing

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maximize revenue (minimize lost revenue / opportunity costs) “Science of squeezing every possible dollar from customers”

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Revenue Management Example: Airline

$1,000 Price

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# of Seats

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Price

Revenue Management Example : Airline

$1,000

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$500

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# of Seats

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Price

Revenue Management Example: Airline

$750 $1,000

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50

$500

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# of Seats

R=$31,250

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Price

Revenue Management Example: Airline

$750 $1,000

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50

$500

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$250

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# of Seats

R=$37,500

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ithe curve) =

Price$1,000

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Revenue Management Example: Airline

Note: ≠ happiness to pay…

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Max mum Revenue: (area under $50,000

# of Seats

willingness to pay

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Two Challenges:

who are willing to pay $750 will not buy the $250 ticket? How do we make sure that we have enough seats for those willing to pay $750?

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How do we make sure that the people

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Two Answers: Create artificial hurdles: �

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Note 1: airlines do not change prices

Note 2: freight can also displace passengers when RM is really optimized

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Advance purchase: 21 days, 14 days, 7days Use limitations: Saturday night stay, non-refundable tickets

Restrict the number of seats sold at the low price This requires a forecast of future booking by higher-paying customers and the discipline to forgo a “bird-in-hand.”

dynamically; they actually change capacity (classes) dynamically

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Why is This Important?

American Airlines saved over $1.4B between 1989-1992 “I believe that yield management is the single most important technical development in transportation management . . . “ � Robert

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Crandall, CEO AMR

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Markdown Opportunity: �

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Goals / Trends: � Movement to more Localized pricing decisions �

inventory � ity as store

Markdowns Markdowns are one of the main levers that retailers have to influence results in-season. As such, it can be a very powerful driver of performance.

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Markdowns may represent more than 30% of total sales Short-cycle product can represent up to 80% of a retailer’s assortment In some segments, short-cyc e products may represent a smaller percentage of the assortment but still have a significant impact on gross margin (up to 40%)

Growing realization of the true cost of left-over

Greater emphasis on inventory productivbase growth slows

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Sales Rate-Based Discounting After initial sales rate (r0= i0/t0) Required sales rate: r1=i1 0- t1) %r required: (r1/ r0)-1 Divide by ε Get the % price changerequired

Inve

nto

ry

t1 t2 t0

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i0

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/(t

Time

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Price Discrimination �

� College financial aid � Taxes

Second degree: artificial hurdles but open �

� store P/U,

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First degree: willingness to pay (rare) RR in late 1800-s, asking shippers for their income statement so they could determine their ability to pay

Buying process (coupons, advance purchase…) Cost to serve (volume discounts, risk adjustments,“set up” costs in travel industry…) Distribution channels (Internet, outlets, etc.) Markdowns (timing of purchase, product age, selection, etc.) Value of product (in many rail movements; regeltarifklassen) Commodity type (part of tariffs; in many rail movements) Use limitations (e.g., “final sale”) Bundling (“menu” vs. “a-la-cart”) Time of use (e.g., hour, congestion pricing)

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Price Discrimination

Second degree: artificial hurdles but open l factors

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� Profession/affiliatieducational, medical…)

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First degree: willingness to pay (rare)

Third degree: based on externaGeography (neighborhood, state) Gender (women’s clothing)

Age (senior/student discounts) on (small/large business business;

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3rd Degree Discrimination

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� Online shopping: Dell Computer

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l i ion

Specific Example

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Dimension® 8200 Series, Pentium® 4 Processor at 1.7 GHz

128MB PC800 RDRAM

New Dell® Enhanced QuietKey Keyboard

Video Ready w/o Monitor

32MB NVIDIA GeForce2 MX 4X AGP Graphics Card with TV-Out

40GB Ultra ATA/100 Hard Drive

3.5 in Floppy Drive

Microsoft® Windows® Millennium with WinXP Home Upgrade Coupon

MS IntelliMouse®

10/100 PCI Fast Ethernet NIC

56K Te ephony Modem for W ndows-Sound Opt

48X Max Variable CD-ROM

Integrated Audio with Soundblaster Pro/16 Compatibility

Harman Kardon HK-395 Speakers

Upgrade to Microsoft® Office Small Business w/EducateU

3 Year Ltd. Warranty, 3 Year At Home Service, Lifetime 24x7 Phone Support

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University

Home

Base Price

Specific Example

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$1,427

$1,327 Student

$1,338 Large business

$1,238 Small business

$1,378

User

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monopoly; ST monopoly situations; oligopoly nt-sanctioned oligopoly – ocean

s)ntation ability

Cost to manage multiple pricingAbility to change costs quickly

ed costs and low marginal costs

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When Does YM Work?

Economic conditions � Demand (LT

with signaling; Governme conference

� Segme � No arbitrage

Administration �

�

Product � High fix � Perishability

Discipline !

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Marketing nd

Avoid gauging

rd

student/senior citizen discounts ll)

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Most schemes are based on 2 degree discrimination – seems more fair (choice is available) Positioning the message: discounts are more acceptable than price increases, even if the result is the same

“Profiteering” is not acceptable

Use open communications

Some forms of 3 degree discrimination are illegal, but many are acceptable:

profession/use (De

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Carrier Portfolio of Pricing

Dynamic pricing with contracted

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LT fixed rate contracts with capacity commitments

Long-term fixed-rate contracts

shippers

Dynamic pricing with spot market shippers

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Rev. Management in TL Trucking

� No monopoly power � Exceptions: good service history coupled with

client strategy geared towards service � Value-added services

� There are limited opportunities for local/temporary monopolies: �

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Little opportunity during bid response

Only opportunity in real-time (spot) market

Responses to shipper “dialing for diesels” Requests along “power lanes”

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Rev. Management in TL Trucking

Remember the twin challenges: � How do we make sure that the people who are

willing to pay $750 will not buy the $250 ticket? � How do we make sure that we have enough seats

for those willing to pay $750? Comes down to one question:

Should we take this load? � Should capacity be committed to a particular

load/shipper/contract?, or should we wait for a better-paying load?

� Depends on the forecast…

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Strategic Decisions Set the Limits for Tactical Decisions

Structural • Size of fleet • Market focus – regions, industries, equipment • Relationships with O/Os, 3PLs

Strategic • Percent of business under long-term contract • Long-term contract rates • Bid-response strategies • Capacity commitments • Seasonal Pricing

• Demand booking and solicitation Tactical • Dynamic pricing • Proactive empty repositioning • Driver assignment

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System Contribution of a Load

Regional potential: the expected

P(A) A D(A-B) from A to B R(A-B) A to B

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contribution of a truck in a region. - Potential of region

- Direct cost for moving a truck

- Revenue for the move from

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System Contribution of a Load

Direct contribution

more truckless

Order acceptance: - l-

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S(A-B) = R(A-B) - D(A-B) + P(B) - P(A)

System impact

P(B) - the value of one at region B P(A) - the value of one truck at region A

Take a oad only if S(A-B) > 0 Take the load with the highest S(A-B)

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Analysis of Movements

Head haul:

Back haul:

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S(A-B) = R(A-B) - D(A-B) + P(B) - P(A)

S(A-B) = R(A-B) - D(A-B) + P(B) - P(A)

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YM in Manufacturing

Reserve capacity to the highest paying customer Tie the pricing to the capacity

Use pricing to manage component supply (in BTO)

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commitment

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Final Observations

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� Sales � Reservations � Scheduling

RM can be used tocustomers better �

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capacity and pricing simultaneously �

© Yoss Sheffi, MIT

RM involves the entire enterprise Customer service

increase profits and serve

Bring in those who otherwise would not use the service Provide higher LOS to those who pay a lot by giving them more frequent service, higher probability of service, etc. Increase utilization by smoothing demand patterns

The essence of RM is the judicious management of

The trick: reserve capacity to the highest paying customers

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Any Questions?

© Yoss Sheffi, MIT

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