The status of contracts in the RM-based industries: A bias to spot market, and to an optimal Revenue Management?

The issue of contracts in Revenue Management has not been studied by many scholars or corporations. It is however pregnant in this field. A 2005 white paper from the software company Ideas, now a SAS institute company, included an insightful paragraph on the subject. This also was one of the key elements of interest to Julien, when he was working with Carlson Wagonlit Travel, negotiating airline fares for large corporate contracts (not agency fares).

To fill planes, carriers have decided to build corporate contracts with negotiated fares per booking class, or even with capped fares, untying from the spot market (what is a spot market?). This situation may seem surprising: Have companies using RM lost faith in the market? Certainly not : According to the expected marginal revenue curve, the marginal revenue per unit decreases when the number of units sold increases:

We can therefore easily understand that this is an alternative to make sure that the plane, or the hotel, will be full (let’s remember that a day of sales can be not profitable if the expected demand is not realized). Note that graph presented above, is an abstract from an article by the decision technology team at American Airlines.

This graph implies that by adding more classes into the class nesting, chances of getting a high revenue for the marginal seat are higher. A traditional marginal revenue curve would look like this:

Corporate contracts are also subject to performance: This way, carriers or hotels make sure that by making an effort on the price, they are rewarded by a minimum number of seats or rooms sold. Contract performance and tracking have become key aspects over the years.

We can bring one simple interpretation from this practice: Corporations are risk averse, especially in terms of revenue, and they are not ready to let their RM system work alone and automatically.

This practice can also raise some doubts among outsiders regarding the efficiency of Revenue Management: If there is a customer for every product, at the right time and at the right price, why are companies using contracts in order to make sure they sell enough, as demand should meet the offer? We believe that there are two elements of explanation:

• There might be an excess in capacity, which should be adjusted as much as possible. Industries implementing RM have high fixed costs: There has to be high volumes to dilute those costs. Therefore, sunk in capacities can jeopardize profit
• Even with reliable and strong forecasts, markets are not in a situation of perfect competition

The white paper adds a very interesting reason:

• The ability, for companies, to meet special customers’ expectations in terms of fares. Some sound strategies can be built around that…We can further investigate on the subject if requested 

Please share your thoughts on the subject!
Why are those corporations willing to secure sales at lower and non-market price? How do they arbitrate between settling contracts and letting the spot market mechanism work? How can they earn economic profits (revenues > opportunity costs) out of the contract implementation? Is it recurrent?