pricing and revenue management - logistics · concentration: supply chain management &...

Pelin Pekgün, Ph.D.

H. Milton Stewart School of Industrial and Systems Engineering

Georgia Institute of Technology

10 April 2012

Panama Marriott Hotel

Breakfast & Learn Series

Pricing and Revenue Management

Background

� Ph.D. (2007), Industrial and Systems Engineering, Georgia Inst. of Technology

� Concentration: Supply Chain Management & Logistics

� 2008 INFORMS George B. Dantzig Dissertation Award -Honorable Mention

� 2005-2011, Manager, Analytical Services, JDA Software Group

� Pricing and Revenue Management in Retail, Hospitality, Passenger Travel, Leisure Industries

� 2012 INFORMS Franz Edelman Award Finalist (w/ JDA and Carlson Rezidor Hotel Group)

� 2011-2012, Visiting Professor, Industrial and Systems Engineering, Georgia Inst. of Technology

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1. Revenue Management (RM) Core Concepts

2. Price Sensitive Demand Forecasting

3. Price Optimization

4. Any Questions?

Table of Contents

3

What is Revenue Management?

The process of maximizing revenue using data and analytics to predict customer behavior and optimize

price and availability of products

Selling the right product

to the right customer

at the right time

for the right price

through the right channel

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Perishable Products or Services

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The birth of Revenue Management

� The Champion – American Airlines

� The Challenger – People Express• Product - Low cost, no-frills

• Fare Structure -Rock-bottom

• Average Cost - 5¢ per Available Seat Mile

• Average Yield - 7.2¢ per Revenue Passenger Mile

• Product- Full-service network carrier

• Fare Structure - Regulated oligopoly

• Average Cost - 8.9¢ per Available Seat Mile

• Average Yield - 12.3¢ per Revenue Passenger Mile

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The birth of Revenue Management

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• one price sells 102 economy seats• $6,300 revenue

• six prices sell 126 economy seats• $9,420 revenue

People Express

Fare $60

American Airlines

Fare $40

Fare $50

Fare $60

Fare $80

Fare $100

Fare $120

$0

$20

$40$60

AA Extra Revenue

30 SpoiledSeats } passengers

unwilling to pay even $60

1986: RM Kills People Express

Don Burr, CEO, People Express, 15 Sep 1986 bankruptcy announcement

“[T]he day…American came at us with Ultimate Super Savers…was the end of our run � because they were able to underprice us at will…

� all they needed to take away from us was that marginal traffic above breakeven…

� All you have to do is take away a few seats on every flight and the guy's dead.”

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a. Sell to micro markets.

b. Exploit product value cycles.

c. Save products for the most valuable customers.

d. Focus on market-based pricing.

e. Focus on price rather than costs when balancing supply and demand.

f. Make decisions based on knowledge, not supposition.

g. Continually re-evaluate revenue opportunities.

Revenue Management Core Concepts

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10

MicroMicro

Micro

MicroMicro

Micro

vs.Mass

Mass Market Attributes:

� Sell to Large Customer Groups

� Creates and Sells a Single Product

a. Sell to Micro Markets

Micro Market Attributes:

� Sell to Small Customer Groups

� Creates Products for each Customer Group

100P

RIC

E

$100

$80

$60

$40

$20

$11 20 40 60 80

DEMAND

� one price� maximum achievable

revenue of $2,500.

� four prices� produces $4,000 in revenue

100

PR

ICE

DEMAND

$100

$50

$11 50

DILUTED DEMAND

UNACCOMMODATED DEMAND

a. Sell to Micro Markets

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� Product value cycles represent the value of a product at any given time

� Different customers (market segments) value different things

� Value may increase or decrease over time

ex: food, technology ex: antiques, last room availability

� Knowing the product value cycle tells you what customers are willing to pay for your product at any given time.

Time

Value Increases Over Time

Time

Value Decreases Over Time

b. Exploit Product Value Cycles

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Revenue Management proposes you:

� Match demand forecasts with customer purchase behavior, in order to predict

� Who wants a given product

� When the request is made for the product

� Save products through:

� Inventory availability controls that save products for price inelastic market segments

� Price breakpoints (discounts) to stimulate demand from price elastic market segments

c. Save Products for Valuable Customers

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d. Focus on Market Based Pricing

� Cost-based pricing� Focuses on recovering costs

� Sets product prices based on what companies expect customers to pay for their goods and services

� Does not consider customer price elasticity

� Market-based pricing:

� Cost to create product is not primary driver

� Sets products prices based on what customers are willing to pay

� Requires information on price elasticity by market segment and product

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Demand is less elastic when:� Fewer acceptable options are available

� Product is perceived as inexpensive

� Limited time available to select a product

Demand is more elastic when:� More acceptable options are available

� Product is perceived as expensive

� Unlimited time available to select a product

Price elasticity can also be represented as a win/lose probability

Pold=$30

Quantity

Pnew=$45

Qnew

D

Qold

Pold=$30

Quantity

Pnew=$45

Qnew

D

Qold

d. Focus on Market Based Pricing

Price Elasticity = % change in demand / % change in price

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“American offered cheaper fares to stimulate demand in a controlled manner on low demand flights while maintaining higher profits on

popular flights by limiting the number of super-saver fares offered.”Barry C. Smith, American Airlines Decision Technologies, 1990

SUPPLY

DEMAND

e. Focus On Price When Balancing Supply and Demand

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� Practice price optimization:

� Use equilibrium points from multiple products and market segments to set prices that will maximize revenue

� Set prices that consumers will accept

� Use prices to shift demand and utilize excess capacity:

� When demand is high, increase prices

� When demand drops, offer discounts to sell products/services that would otherwise go unsold.

e. Focus On Price When Balancing Supply and Demand

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Human Forecasters

� Intentional or unintentional biases

� Hopeful

� Focus on recent events

� Use most accessible information

Forecasting Systems

� Based on customer transaction data

� Use internal and external environmental factors

� Predict customer behavior

� Utilize sophisticated mathematical algorithms

f. Make Decisions Based On Knowledge


� Ensure quality data inputs

� Use judgment and experience when using the data outputs

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f. Make Decisions Based on Knowledge

MeasurePerformance

DRMSystem

Accept, Rejector Modify

Distribution System

Calibrate and/or Forecast

Reports

Prices

HistoricalData

Review, Adjust

CapacityUserInfluences

RecommendationReview

ParametersRecentTrends

CurrentData

Sample Revenue Management System

Optimize

Recommend

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� Markets are always changing; therefore, revenue opportunities are always changing

� Critical speed is replacing critical mass in capturing marketing opportunities

� No time for “up-the-ladder” decision making

� Revenue Management proposes you:

� Re-calibrate and/or re-forecast as often as necessary based on new data

� Establish “auto-pilot” guidelines for recommendations that fall within acceptable bounds, focus on exception management

� Empower front-line workers to increase decision speed

g. Continually Re-evaluate Revenue Opportunities

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a. Sell to micro markets.

b. Exploit product value cycles.

c. Save products for the most valuable customers.

d. Focus on market-based pricing.

e. Focus on price rather than costs when balancing supply and demand.

f. Make decisions based on knowledge, not supposition.

g. Continually re-evaluate revenue opportunities.

Revenue Management Core Concepts

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4. Any Questions?

Table of Contents

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Understanding what shaped the past gives better visibility of future demand

Promotions

SeasonalLift

-8%

20%

SpringPeak

SummerPeak Christmas

25%

Pricing

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Constructing Baseline Demand

0

50

100

150

200

250

300

Nov-01 Feb-02 May-02 Sep-02 Dec-02 Mar-03 Jun-03 Oct-03 Jan-04

0

50

100

150

200

250

300


10

20

30

40

50

60

70


Total History

Promotional HistoryBaseline History

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Retail (Seasonal Apparel) Example

Price elasticity: -1.31

0

50

100

150

200

250

300

350

1/15

/200

6

1/29

/200

6

2/12

/200

6

2/26

/200

6

3/12

/200

6

3/26

/200

6

4/9/

2006

4/23

/200

6

5/7/

2006

5/21

/200

6

6/4/

2006

6/18

/200

6

7/2/

2006

7/16

/200

6

7/30

/200

6

8/13

/200

6

8/27

/200

6

9/10

/200

6

9/24

/200

6

Price Impact

Total Sales

Baseline Sales

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Unconstraining Demand

� Identify periods when sales history was constrained� User controls in place

� Insufficient capacity

� Use statistical methods to “repair” history� Estimates lost sales due to capacity shortages

Observed Demand

Capacity

Purchase Requests

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time

dem

and

Baseline Forecast (Demand Planning)

Price-Sensitive Demand Forecast (Price Optimization)

Price Influenced Forecast

Baseline Forecast

Integrated Demand Planning

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4. Any Questions?

Table of Contents

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Price Optimization Concept

Price Sensitive Unconstrained Demand

Revenue CapacityLegend:

Price Sensitive Demand Model

Price

Dem

and

Reven

ue

CapacityAt what price will we make the most money?

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Base Price (before tax & shipping): $149.99

On the average, the customer expects to pay $135.91 rather than $149.99.

Price Transparency via the Internet

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* http://fastfood.freedomblogging.com/mcdonalds-vs-starbucks-espresso-prices/ (Prices taken in Anaheim, CA)

Price Competition is Everywhere…

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How do you respond?

� Which competitors are your true competitors?

� At what price do they become more competitive?

� What price do you charge?

Market / Competition

$100

$120

$140

$160

$180

Sun

Mon Tu

e

Wed Th

u Fri

Sat

Day of Week

PriceMarket / Competition

$100

$120

$140

$160

$180

Sun

Mon Tu

e

Wed Th

u Fri

Sat

Day of Week

Price

Understanding dynamic nature of competitor prices over time, and choosing the optimal price w.r.t. to customers’ reference price is critical…

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Bid Response Curves for B2B Settings

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4. Any Questions?

Table of Contents

34

Any Questions?Contact Information:

Pelin Pekgün

Visiting Professor

H. Milton Stewart School of

Industrial and Systems Engineering

765 Ferst Drive, Atlanta, GA, 30332

[email protected]

Office Phone: 404-894-3037

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pricing and revenue management - logistics · concentration: supply chain management &...

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