How could I apply revenue management to my business ?

In his book, Revenue Management: Hard-Core Tactics for Market Domination, Robert G. Cross defines revenue management as “the application of disciplined tactics that predict consumer behavior at the micro-market level and optimize product availability and price to maximize growth”.

Most people associate RM with complicated pricing models, state of the art IT, and high-flying mathematicians. Needless to say, it helps. Revenue Management relies on a few basic principles. Everything is just a matter of implementation, in accordance with the sector, the organization and the size of the company: you don't need SAP to manage a hair salon; you don't need to be a Rube Goldberg machine to take the first steps towards the optimization of your revenue.

Indeed, Robert G. Cross summarizes revenue management with 7 core concepts:
•   Focus on price rather than costs when balancing supply and demand
•   Replace cost-based pricing with market-based pricing
•   Sell to segment micro-markets, not to mass markets
•   Save the products for the most valuable customers
•   Make decisions based on knowledge, not supposition
•   Exploit each product's value cycle
•   Continually re-evaluate your revenue opportunities

Principles
Three basic constraints shape the RM practice:
•   The ressources available for sale have to be in a fixed/limited amount
•   The ressources have to be "perishable": there should be a time limit after which the ressources loose their value
•   The different customers must be wiling to pay a different price for the same amount of ressource

If in your business, the costs are mainly made of fixed costs (ie, high % of fixed costs vs variable costs), then revenue management is a key factor to optimize your profit: as variable costs are rather low versus revenue, each increment in revenue will increase cost absorption, and impact directly the bottom line.

The goal is to maximize revenue for a given product, within a certain time horizon: the company should aim at providing each unit to the customer exctracting the highest price possible from the customer base. Ebay is a good illustration for this, and a simple way to encompass these principles for any product.

To trigger the purchase, Revenue Management uses two main leverages: price and inventory. In the price-based approach, the customer buys as soon as the price has decreased to her/his real or sensed expectations. As we will study in a later article, theaters could optimize their occupancy rates and then boost their sales by using this approach…

In opposition to this, Talluri and Van Ryzin, in their book The Theory and Practice of Revenue Management, highlighted the quantity based view, where the leverage used is the remaining inventory. As most applications of Revenue Management occurred in industries where the inventory is critical and highly perishable, the inventory approach is prevalent today.

Customer segmentation and pricing fences
It's obvious: know your customers.

What segments can you identify among your customers? On which criteria is this segmentation based? What price are the customers from distinct segments ready to pay for your product(s)? How are they sensitive to price fluctuations? What are their purchasing patterns over time?

You should be able to answer each of these questions, ideally with quantitative answers. The idea is to be able to segment customers on the basis of their willigness to pay, and to be able to charge different prices to different customer categories.

Therefore, customers should not be able to arbitrate between the different prices proposed for the same good. Indeed, the pricing has to be based on adequate and efficient fences, such as:
•   The time of purchase: as detailed in our previous article, the airline industry charge different fares, depending on the booking time.
•   The creation of a costless customer value: concert tickets are a good example. Certain tickets will give personal access to the perfomers before/after the concert, against a substantially higher price, and costing nearly nothing to the organizer.

Of course, this will depend largely on the product type, quantity and the opportunities for offer customization; but the focus has to be centered primarily on the customer.
 
Marketing management and ethics
Every move towards revenue optimization should be made in accordance with a company's marketing strategy.

As RM relies on price discrimination, it can stir up customer resistance, and harm the customer relationship. Long term customers can end up in the higher price range while expecting a well deserved discount/advantage. As the development of RM systems tended to weaken their customer base, the airline carriers answered by implementing the frequent flyer programs. Thus, RM practice has to be integrated within customer relationship management, has a tool to secure customer loyalty.

It also has to be consistant with the management of the company's image: in 2002, when Deutsche Bahn tried to implement RM on its "frequent loyalty card passengers" ( see article), it faced customer disaprovement and a declining number of passengers, and finally step back to fixed pricing.

In terms of princing, a common fear is that customer segmentation could be based upon unethical criteria. This has to be adressed through the practice in itself, and communicated consistantly.
 
Our blog
In the following articles, our goal is to illustrate these generic principles. For this purpose, we will study successful and unsuccessful RM practicies in various fields, discuss the potential application of RM principles within small and medium businesses, and try to develop simplified pricing and decision tools.

Revenue Management and its applications: Airlines

A brief context of the implementation

Revenue Management systems (also known as Yield Management) were first implemented at American Airlines and Delta Airlines about 30+ years ago. Robert Cross – now president at Revenue Analytics, and author of the famous Revenue Management, Hard-core tactics for market domination – implemented this system at Delta. Robert Crandall – retired CEO at AMR Corp. and founder of Sabre distribution system – implemented it at American Airlines.

At that time, airlines used to set prices per class of service and per season.

In the hospitality industry, the implementation of a Revenue Management system was an answer to the necessity to steer an entropic market, with unreachable and numerous customers: every flight and every route represented new markets, where revenue had to be maximized. Revenue Management systems enabled continuous growth of travelers, (who were booking tickets over the counter at that time) along with the development of global distribution systems (SABRE, and later Amadeus), and the very first strong information systems.

The first preoccupation of early adopters of Revenue Management systems was to face the growing competition and the crawling crisis. Long story short, marketing efforts to stop the fare war were not enough, and a backroad between supply chain management, marketing, and information systems was the creation of Revenue Management systems. Revenue Management systems aimed at controlling inventory and maximizing the price of each seat contingent on demand in a real time system. The primary goal was to repair the market. In addition to the fare war, the expansion of the low cost airline PeopleExpress forced the market to offer more competitive call fares, such as ”ultimate super savers” by American Airlines in 1985.

The way it works in the airline industry…

As you may understand, Revenue Management is a very sensitive topic within airlines, but some of the key features are common to most carriers (including both flag carriers and low cost carriers).

Basic principles: How a plane gets filled

The fares are mostly function of time and load factor of the aircraft. During the weekdays, the main goal is to separate business travelers from leisure ones. During weekends, it is the contrary, which affects significantly the perspective for revenue: the strategy aims at having less but more profitable customers during weekdays in order to reduce operational costs. Every flight / route combination (one origin and one destination) is managed as a new service, where profit – and consequently the load factor - must be maximized. The more filled-up a flight gets, the more expensive your ticket will be. Besides, airlines usually like to offer tickets with distinct characteristics: flexible, reimbursable and re-bookable with or without fee, or non-flexible (simply put, if you don’t use the ticket you lose it).

Assuming that bookings increase over time, as a linear function, here are two graphs representing the evolution of the fares function of number of bookings (and so function of advance booking):

From what we explained in the previous paragraph, fares should increase with time. However, praxis showed a real difference. The second graph is the relevant one: there you can assess the dynamic of Revenue Management and its interest for a corporation - adapting exactly the pricing to the market situation based on historical data.


Note that the charts presented above, represent an observed trend, and not precise data to be analyzed in details.

Fares and booking systems

To model pricing in their revenue management system, airlines use price brackets, called “booking classes”, which contain a reference fare, (i.e. the flexibility and availability during the weekdays). Each booking class can be opened or closed according to the aircraft load factor and the achievement of the profit objectives. Cheaper booking classes have limited inventory (at the bottom of the ladder), last seat availability classes are available as long as a seat is available in the aircraft (at the top of the ladder).

Every airline has its own coding system for the reference fare (booking class + fare basis). Airlines also like to set low fares with more flexible reference fares for their corporate customers. This is a way to bias the market. This is what a travel agent can get in its global distribution system.

If you would like to have a better understanding on how Revenue Management systems work in a real life case, the MIT proposed a simulation of an Airline Revenue Management.

…and in other businesses

We want this blog to be interactive, and our goal is to gather a community of beginners and insiders, trying to create inspirations for businesses. Therefore, any valuable input is much appreciated.

More specifically, we invite readers from any background to submit ideas of business sectors where Revenue Management principles could be applied.

Introduction - Companies should pay more attention to their top line

Dear Reader,

Thank you for passing by and visiting this blog! We would just like to share with you a quick introduction on our blog, its purpose and content.

We are two French students, Julien GUBIANI and Yoann PINET:

- Yoann is a MBA candidate at Pepperdine University (California): He has 2 years of experience in corporate finance and consulting, and is now focusing his career on consulting. 

- Julien just graduated from Rouen Business School's Master in Management (France): He his now consutling in the Revenue Management field with air management companies. He has 2 years of experience in business consulting. More particularly, Julien addressed yield management issues as intern at Carlson Wagonlit Travel for 7 months. 

Revenue Management is not a common topic in management science - at school or within corporations. It is widely associated with airlines companies and hotel chains. We have created this blog to cast Revenue Management in a different light.  

It seems that many corporations are primarily focused on optimizing costs. Obiously, the outcomes of the financial crisis give a good example: companies' first move was to cut costs. Even in regular economic conditions, they are clearly communicating shareholders and third parties about the successful results of cost-cutting measures, rather than actions to maximize revenue (sensitive subject or lack of tactic to drive revenue? Maybe both…). 

In corporate communication (internal and external), the reporting of actions on revenue is conducted through the P&L, as well as through the very “unique” mission statement: “We commit on delivering the best value to our customers” - which at first sight is a widespread PR or sales speech. Taking a closer look at that kind of mission statement, we could see another explanation: delivering the best value to customers can also mean achieving a price and service combination that matches expectations with regard to the limited ressources available for sale. The hospitality industry (airlines, hotels…) has been applying this principle for 25 years, with the results we know: top airlines & low cost carriers operating profits are in the top 30 list, see the 2010 IATA report. 

The optimization of supply and demand, matching constraints of profitability and available inventory on a given market, is Revenue Management.

In this blog, after a more detailed explanation of Revenue Management objectives and methods; we will try to demonstrate that this discipline is at an early stage in terms of implementation, and that it can still be implemented (partially or fully) in many sectors.