Revenue management
Encyclopedia
Revenue Management is the application of disciplined analytics
that predict consumer behavior at the micro-market level and optimize product availability and price to maximize revenue
growth. The primary aim of Revenue Management is selling the right product to the right customer at the right time for the right price. The essence of this discipline is in understanding customers' perception of product value and accurately aligning product prices, placement and availability with each customer segment.
to answer these questions in order to increase revenue. The discipline of revenue management combines data mining and operations research with strategy, understanding of customer behavior, and partnering with the sales force. Today, the revenue management practitioner must be analytical and detail oriented, yet capable of thinking strategically and managing the relationship with sales.
(now British Airways
) experimented with differentiated fare products by offering capacity
controlled “Earlybird” discounts to stimulate demand
for seats that would otherwise fly empty. Taking it a step further, Robert Crandall
, former Chairman and CEO of American Airlines
, pioneered a practice he called Yield Management
, which focused primarily maximizing revenue through analytics-based inventory control
. Under Crandall’s leadership, American continued to invest in Yield Management’s forecasting, inventory control and overbooking capabilities. By the early 1980s, the combination of a mild recession and new competition spawned by airline deregulation
posed an additional threat. Low-cost, low-fare airlines like PeoplExpress were growing rapidly because of their ability to charge even less than American’s Super Saver fares. After investing millions in the next generation capability which they would call DINAMO (Dynamic Inventory Optimization and Maintenance Optimizer), American announced Ultimate Super Saver Fares in 1985 that were priced lower than the PeoplExpress. These fares were non-refundable in addition to being advance-purchase restricted and capacity controlled. This Yield Management system targeted those discounts to only those situations where they had a surplus of empty seats. The system and analysts engaged in continual re-evaluation of the placement of the discounts to maximize their use. Over the next year, American’s revenue increased 14.5% and its profits were up 47.8%.
Other industries took note of American’s success and implemented similar systems. Robert Crandall discussed his success with Yield Management with Bill Marriott, CEO of Marriott International
. Marriott International had many of the same issues that airlines did: perishable inventory, customers booking in advance, lower cost competition and wide swings with regard to balancing supply and demand. Since “yield” was an airline term and did not necessarily pertain to hotels, Marriott International and others began calling the practice Revenue Management. The company created a Revenue Management organization and invested in automated Revenue Management systems that would provide daily forecasts of demand and make inventory recommendations for each of its 160,000 rooms at its Marriott, Courtyard Marriott and Residence Inn brands. They also created “fenced rate” logic similar to airlines, which would allow them to offer targeted discounts to price sensitive market segments based on demand. To address the additional complexity created by variable lengths-of-stay, Marriott’s Demand Forecast System (DFS) was built to forecast guest booking patterns and optimize room availability by price and length of stay. By the mid-1990s, Marriott’s successful execution of Revenue Management was adding between $150 million and $200 million in annual revenue.
A natural extension of hotel Revenue Management was to rental car firms, which experienced similar issues of discount availability and duration control. In 1994, Revenue Management saved National Car Rental
from bankruptcy
. Their revival from near collapse to making profits served as an indicator of Revenue Management’s potential.
Up to this point, Revenue Management had focused on driving revenue from Business to Consumer (B2C) relationships. In the early 1990s UPS developed Revenue Management further by revitalizing their Business to Business (B2B
) pricing strategy. Faced with the need for volume growth in a competitive market, UPS began building a pricing organization that focused on discounting. Prices began to erode rapidly, however, as they began offering greater discounts to win business. The executive team at UPS prioritized specific targeting of their discounts but could not strictly follow the example set by airlines and hotels. Rather than optimizing the revenue for a discrete event such as the purchase of an airline seat or a hotel room, UPS was negotiating annual rates for large-volume customers using a multitude of services over the course of a year. To alleviate the discounting issue, they formulated the problem as a customized bid-response model, which used historical data to predict the probability of winning at different price points. They called the system Target Pricing. With this system, they were able to forecast
the outcomes of any contractual bid at various net prices and identify where they could command a price premium over competitors and where deeper discounts were required to land deals. In the first year of thes Revenue Management system, UPS reported increased profits of over $100 million.
The concept of maximizing revenue on negotiated deals found its way back to the hospitality
industry. Marriott’s original application of Revenue Management was limited to individual bookings, not groups or other negotiated deals. In 2007, Marriott introduced a “Group Price Optimizer” that used a competitive bid-response model to predict the probability of winning at any price point, thus providing accurate price guidance to the sales force. The initial system generated an incremental $46 million in profit. This led to an Honorable Mention for the Franz Edelman Award for Achievement in Operations Research and the Management Sciences
in 2009.
By the early 1990s Revenue Management also began to influence television ad sales. Companies like Canadian Broadcast Corporation, ABC
, and NBC
developed systems that automated the placement of ads in proposals based on total forecasted demand and forecasted ratings by program. Today, many television networks around the globe have Revenue Management Systems.
Revenue Management to this point had been utilized in the pricing of perishable products. In the 1990s, however, the Ford Motor Company
began adopting Revenue Management to maximize profitability
of its vehicles by segmenting customers into micro-markets and creating a differentiated and targeted price structure. Pricing for vehicles and options packages had been set based upon annual volume estimates and profitability projections. The company found that certain products were overpriced and some were underpriced. Understanding the range of customer preferences across a product line and geographical market, Ford leadership created a Revenue Management organization to measure the price-responsiveness of different customer segments for each incentive
type and to develop an approach that would target the optimal incentive by product and region. By the end of the decade, Ford estimated that roughly $3 billion in additional profits came from Revenue Management initiatives.
The public success of Pricing and Revenue Management at Ford solidified the ability of the discipline to address the revenue generation issues of virtually any company. Many auto manufacturers have adopted the practice for both vehicle sales and the sale of parts. Retailers have leveraged the concepts pioneered at Ford to create more dynamic, targeted pricing in the form of discounts and promotions to more accurately match supply with demand. Promotions planning and optimization
assisted retailers with the timing and prediction of the incremental lift of a promotion for targeted products and customer sets. Companies have rapidly adopted markdown
optimization to maximize revenue from end-of-season or end-of-life items. Furthermore, strategies driving promotion roll-offs and discount expirations have allowed companies to increase revenue from newly acquired customers.
By 2000, virtually all major airlines, hotel
firms, cruise lines and rental car firms had implemented Revenue Management Systems to predict customer demand and optimize available price. These Revenue Management Systems had limited “optimize” to imply managing the availability of pre-defined prices in pre-established price categories. The objective function was to select the best blends of predicted demand given existing prices. The sophisticated technology and optimization algorithms had been focused on selling the right amount of inventory at a given price, not on the price itself. Realizing that controlling inventory was no longer sufficient, InterContinental Hotels Group
(IHG) launched an initiative to better understand the price sensitivity of customer demand. IHG determined that calculating price elasticity at very granular levels to a high degree of accuracy still was not enough. Rate transparency had elevated the importance of incorporating market positioning against substitutable alternatives. IHG recognized that when a competitor changes its rate, the consumer’s perception of IHG’s rate also changes. Working with third party competitive data, the IHG team was able to analyze historical price, volume and share data to accurately measure price elasticity in every local market for multiple lengths of stay. These elements were incorporated into a system that also measured differences in customer elasticity based upon how far in advance the booking is being made relative to the arrival date. The incremental revenue from the system was significant as this new Price Optimization capability increased Revenue per Available Room (RevPAR
) by 2.7%.
. On the other hand, in situations where demand is strong for a product but the threat of cancellations looms (e.g. hotel rooms or airline seats), firms often overbook in order to maximize revenue from full capacity. Overbooking’s focus is increasing the total volume of sales in the presence of cancellations rather than optimizing customer mix.
or telephone service, promotions help attract customers who will then commit to contracts and produce revenue over a long time horizon. When this occurs, companies must also strategize their promotion roll-off policies; they must decide when to begin increasing the contract fees and by what magnitude to raise the fees in order to avoid losing customers. Revenue Management optimization proves useful in balancing promotion roll-off variables in order to maximize revenue while minimizing churn
.
associated with those channels. When faced with multiple channels to retailers and distributors, Revenue Management techniques can calculate appropriate levels of discounts for companies to offer distributors through opaque channels to push more products without losing integrity with respect to public perception of quality.
. Relevant data are paramount to a Revenue Management System’s capability to provide accurate, actionable information. A system must collect and store historical data for inventory, prices, demand, and other causal factors. Any data that reflects the details of products offered, their prices, competition, and customer behavior must be collected, stored, and analyzed. Information about customer behavior is a valuable asset that can reveal consumer behavioral patterns, the impact of competitors’ actions, and other important market information. This information is crucial to starting the Revenue Management process.
, and total market
. Its performance depends critically on the quality of these forecasts. Forecasting is a critical task of Revenue Management and takes much time to develop, maintain, and implement. Quantity-based forecasts, which use time-series models, booking curves, cancellation curves, etc., project future quantities of demand, such as reservations or products bought. Price-based forecasts seek to forecast demand as a function of marketing variables, such as price or promotion. These involve building specialized forecasts such as market response models or cross-price elasticity estimates to predict customer behavior at certain price points. By combining these forecasts with calculated price sensitivities and price ratios, a Revenue Management System can then quantify these benefits and develop price optimization strategies to maximize revenue.
s, or even customer lifetime value
s. Secondly, the business must decide which optimization technique to utilize. For example, many firms utilize linear programming
, a complex technique for determining the best outcome from a set of linear relationships, to set prices in order to maximize revenue. Regression analysis
, another statistical tool, involves finding the ideal relationship between several variables through complex models and analysis. Discrete choice models can serve to predict customer behavior in order to target them with the right products for the right price. Tools such as these allow a firm to optimize its product offerings, inventory levels, and pricing points in order to achieve the highest revenue possible.
Supply Chain Management
and Revenue Management have many natural synergies. Supply chain management (SCM) is a vital process in many companies today and several are integrating this process with a Revenue Management System. On one hand, supply chain management often focuses on filling current and anticipated orders at the lowest cost, while assuming that demand is primarily exogenous. Conversely, Revenue Management generally assumes costs and sometimes capacity are fixed and instead looks to set prices and customer allocations that maximize revenue given these constraints. A company that has achieved excellence in Supply Chain Management and Revenue Management individually may have many opportunities to increase profitability by linking their respective operational focus and customer-facing focus together.
Business Intelligence
platforms have also become increasingly integrated with the Revenue Management process. These platforms, driven by data mining
processes, offer a centralized data and technology environment that delivers business intelligence by combining historical reporting and advanced analytics to explain and evaluate past events, deliver recommended actions and eventually optimize decision-making. Not synonymous with Customer Relationship Management
(CRM), Business intelligence generates proactive forecasts, whereas CRM strategies track and document a company’s current and past interactions with customers. Data mining this CRM information, however, can help drive a business intelligence platform and provide actionable information to aid decision-making.
Analytics
Analytics is the application of computer technology, operational research, and statistics to solve problems in business and industry. Analytics is carried out within an information system: while, in the past, statistics and mathematics could be studied without computers and software, analytics has...
that predict consumer behavior at the micro-market level and optimize product availability and price to maximize revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
growth. The primary aim of Revenue Management is selling the right product to the right customer at the right time for the right price. The essence of this discipline is in understanding customers' perception of product value and accurately aligning product prices, placement and availability with each customer segment.
Overview
Businesses face important decisions regarding what to sell, when to sell, to whom to sell, and for how much. Revenue Management uses data-driven tactics and strategyStrategy
Strategy, a word of military origin, refers to a plan of action designed to achieve a particular goal. In military usage strategy is distinct from tactics, which are concerned with the conduct of an engagement, while strategy is concerned with how different engagements are linked...
to answer these questions in order to increase revenue. The discipline of revenue management combines data mining and operations research with strategy, understanding of customer behavior, and partnering with the sales force. Today, the revenue management practitioner must be analytical and detail oriented, yet capable of thinking strategically and managing the relationship with sales.
History
Before the emergence of Revenue Management, BOACBoac
Boac may refer to:* Boac, Marinduque, a municipality in the Southern Philippines* Boac , an American rapper* British Overseas Airways Corporation, a former British state-owned airline...
(now British Airways
British Airways
British Airways is the flag carrier airline of the United Kingdom, based in Waterside, near its main hub at London Heathrow Airport. British Airways is the largest airline in the UK based on fleet size, international flights and international destinations...
) experimented with differentiated fare products by offering capacity
Capacity
Capacity is the ability to hold a fluid, very similar to volume.Capacity may also refer to:* Capacity utilization, in economics, the extent to which an enterprise or a nation actually uses its potential output...
controlled “Earlybird” discounts to stimulate demand
Demand
- Economics :*Demand , the desire to own something and the ability to pay for it*Demand curve, a graphic representation of a demand schedule*Demand deposit, the money in checking accounts...
for seats that would otherwise fly empty. Taking it a step further, Robert Crandall
Robert Crandall
Robert Lloyd "Bob" Crandall is the former president and chairman of American Airlines. Called an industry legend by airline industry observers, Crandall has been the subject of several books and is a member of the Hall of Honor of the Conrad Hilton college.-Life:Robert Crandall was raised in Rhode...
, former Chairman and CEO of American Airlines
American Airlines
American Airlines, Inc. is the world's fourth-largest airline in passenger miles transported and operating revenues. American Airlines is a subsidiary of the AMR Corporation and is headquartered in Fort Worth, Texas adjacent to its largest hub at Dallas/Fort Worth International Airport...
, pioneered a practice he called Yield Management
Yield management
Revenue management is the process of understanding, anticipating and influencing consumer behavior in order to maximize yield or profits from a fixed, perishable resource...
, which focused primarily maximizing revenue through analytics-based inventory control
Inventory control
Inventory control is the supervision of supply, storage and accessibility of items in order to ensure an adequate supply without excessive oversupply....
. Under Crandall’s leadership, American continued to invest in Yield Management’s forecasting, inventory control and overbooking capabilities. By the early 1980s, the combination of a mild recession and new competition spawned by airline deregulation
Airline deregulation
Airline deregulation is the process of removing entry and price restrictions on airlines affecting, in particular, the carriers permitted to serve specific routes. In the United States, the term usually applies to the Airline Deregulation Act of 1978...
posed an additional threat. Low-cost, low-fare airlines like PeoplExpress were growing rapidly because of their ability to charge even less than American’s Super Saver fares. After investing millions in the next generation capability which they would call DINAMO (Dynamic Inventory Optimization and Maintenance Optimizer), American announced Ultimate Super Saver Fares in 1985 that were priced lower than the PeoplExpress. These fares were non-refundable in addition to being advance-purchase restricted and capacity controlled. This Yield Management system targeted those discounts to only those situations where they had a surplus of empty seats. The system and analysts engaged in continual re-evaluation of the placement of the discounts to maximize their use. Over the next year, American’s revenue increased 14.5% and its profits were up 47.8%.
Other industries took note of American’s success and implemented similar systems. Robert Crandall discussed his success with Yield Management with Bill Marriott, CEO of Marriott International
Marriott International
Marriott International, Inc. is a worldwide operator and franchisor of a broad portfolio of hotels and related lodging facilities. Founded by J. Willard Marriott, the company is now led by son J.W. Marriott, Jr...
. Marriott International had many of the same issues that airlines did: perishable inventory, customers booking in advance, lower cost competition and wide swings with regard to balancing supply and demand. Since “yield” was an airline term and did not necessarily pertain to hotels, Marriott International and others began calling the practice Revenue Management. The company created a Revenue Management organization and invested in automated Revenue Management systems that would provide daily forecasts of demand and make inventory recommendations for each of its 160,000 rooms at its Marriott, Courtyard Marriott and Residence Inn brands. They also created “fenced rate” logic similar to airlines, which would allow them to offer targeted discounts to price sensitive market segments based on demand. To address the additional complexity created by variable lengths-of-stay, Marriott’s Demand Forecast System (DFS) was built to forecast guest booking patterns and optimize room availability by price and length of stay. By the mid-1990s, Marriott’s successful execution of Revenue Management was adding between $150 million and $200 million in annual revenue.
A natural extension of hotel Revenue Management was to rental car firms, which experienced similar issues of discount availability and duration control. In 1994, Revenue Management saved National Car Rental
National Car Rental
National Car Rental is a rental car company based in Clayton, Missouri. National was founded by 24 independent rental car agents on August 27, 1947...
from bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
. Their revival from near collapse to making profits served as an indicator of Revenue Management’s potential.
Up to this point, Revenue Management had focused on driving revenue from Business to Consumer (B2C) relationships. In the early 1990s UPS developed Revenue Management further by revitalizing their Business to Business (B2B
Business-to-business
Business-to-business describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer...
) pricing strategy. Faced with the need for volume growth in a competitive market, UPS began building a pricing organization that focused on discounting. Prices began to erode rapidly, however, as they began offering greater discounts to win business. The executive team at UPS prioritized specific targeting of their discounts but could not strictly follow the example set by airlines and hotels. Rather than optimizing the revenue for a discrete event such as the purchase of an airline seat or a hotel room, UPS was negotiating annual rates for large-volume customers using a multitude of services over the course of a year. To alleviate the discounting issue, they formulated the problem as a customized bid-response model, which used historical data to predict the probability of winning at different price points. They called the system Target Pricing. With this system, they were able to forecast
Forecasting
Forecasting is the process of making statements about events whose actual outcomes have not yet been observed. A commonplace example might be estimation for some variable of interest at some specified future date. Prediction is a similar, but more general term...
the outcomes of any contractual bid at various net prices and identify where they could command a price premium over competitors and where deeper discounts were required to land deals. In the first year of thes Revenue Management system, UPS reported increased profits of over $100 million.
The concept of maximizing revenue on negotiated deals found its way back to the hospitality
Hospitality
Hospitality is the relationship between guest and host, or the act or practice of being hospitable. Specifically, this includes the reception and entertainment of guests, visitors, or strangers, resorts, membership clubs, conventions, attractions, special events, and other services for travelers...
industry. Marriott’s original application of Revenue Management was limited to individual bookings, not groups or other negotiated deals. In 2007, Marriott introduced a “Group Price Optimizer” that used a competitive bid-response model to predict the probability of winning at any price point, thus providing accurate price guidance to the sales force. The initial system generated an incremental $46 million in profit. This led to an Honorable Mention for the Franz Edelman Award for Achievement in Operations Research and the Management Sciences
Franz Edelman Award for Achievement in Operations Research and the Management Sciences
The Franz Edelman Award for Achievement in Operations Research and the Management Sciences recognizes excellence in the execution of operations research on the organizational level...
in 2009.
By the early 1990s Revenue Management also began to influence television ad sales. Companies like Canadian Broadcast Corporation, ABC
American Broadcasting Company
The American Broadcasting Company is an American commercial broadcasting television network. Created in 1943 from the former NBC Blue radio network, ABC is owned by The Walt Disney Company and is part of Disney-ABC Television Group. Its first broadcast on television was in 1948...
, and NBC
NBC
The National Broadcasting Company is an American commercial broadcasting television network and former radio network headquartered in the GE Building in New York City's Rockefeller Center with additional major offices near Los Angeles and in Chicago...
developed systems that automated the placement of ads in proposals based on total forecasted demand and forecasted ratings by program. Today, many television networks around the globe have Revenue Management Systems.
Revenue Management to this point had been utilized in the pricing of perishable products. In the 1990s, however, the Ford Motor Company
Ford Motor Company
Ford Motor Company is an American multinational automaker based in Dearborn, Michigan, a suburb of Detroit. The automaker was founded by Henry Ford and incorporated on June 16, 1903. In addition to the Ford and Lincoln brands, Ford also owns a small stake in Mazda in Japan and Aston Martin in the UK...
began adopting Revenue Management to maximize profitability
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
of its vehicles by segmenting customers into micro-markets and creating a differentiated and targeted price structure. Pricing for vehicles and options packages had been set based upon annual volume estimates and profitability projections. The company found that certain products were overpriced and some were underpriced. Understanding the range of customer preferences across a product line and geographical market, Ford leadership created a Revenue Management organization to measure the price-responsiveness of different customer segments for each incentive
Incentive
In economics and sociology, an incentive is any factor that enables or motivates a particular course of action, or counts as a reason for preferring one choice to the alternatives. It is an expectation that encourages people to behave in a certain way...
type and to develop an approach that would target the optimal incentive by product and region. By the end of the decade, Ford estimated that roughly $3 billion in additional profits came from Revenue Management initiatives.
The public success of Pricing and Revenue Management at Ford solidified the ability of the discipline to address the revenue generation issues of virtually any company. Many auto manufacturers have adopted the practice for both vehicle sales and the sale of parts. Retailers have leveraged the concepts pioneered at Ford to create more dynamic, targeted pricing in the form of discounts and promotions to more accurately match supply with demand. Promotions planning and optimization
Optimization
Optimization or optimality may refer to:* Mathematical optimization, the theory and computation of extrema or stationary points of functionsEconomics and business* Optimality, in economics; see utility and economic efficiency...
assisted retailers with the timing and prediction of the incremental lift of a promotion for targeted products and customer sets. Companies have rapidly adopted markdown
Markdown
Markdown is a lightweight markup language, originally created by John Gruber and Aaron Swartz allowing people "to write using an easy-to-read, easy-to-write plain text format, then convert it to structurally valid XHTML "...
optimization to maximize revenue from end-of-season or end-of-life items. Furthermore, strategies driving promotion roll-offs and discount expirations have allowed companies to increase revenue from newly acquired customers.
By 2000, virtually all major airlines, hotel
Hotel
A hotel is an establishment that provides paid lodging on a short-term basis. The provision of basic accommodation, in times past, consisting only of a room with a bed, a cupboard, a small table and a washstand has largely been replaced by rooms with modern facilities, including en-suite bathrooms...
firms, cruise lines and rental car firms had implemented Revenue Management Systems to predict customer demand and optimize available price. These Revenue Management Systems had limited “optimize” to imply managing the availability of pre-defined prices in pre-established price categories. The objective function was to select the best blends of predicted demand given existing prices. The sophisticated technology and optimization algorithms had been focused on selling the right amount of inventory at a given price, not on the price itself. Realizing that controlling inventory was no longer sufficient, InterContinental Hotels Group
InterContinental Hotels Group
InterContinental Hotels Group plc is a global hotels company headquartered in Denham, United Kingdom. It is the largest hotels company in the world measured by rooms , and has over 4,500 hotels across over 100 countries...
(IHG) launched an initiative to better understand the price sensitivity of customer demand. IHG determined that calculating price elasticity at very granular levels to a high degree of accuracy still was not enough. Rate transparency had elevated the importance of incorporating market positioning against substitutable alternatives. IHG recognized that when a competitor changes its rate, the consumer’s perception of IHG’s rate also changes. Working with third party competitive data, the IHG team was able to analyze historical price, volume and share data to accurately measure price elasticity in every local market for multiple lengths of stay. These elements were incorporated into a system that also measured differences in customer elasticity based upon how far in advance the booking is being made relative to the arrival date. The incremental revenue from the system was significant as this new Price Optimization capability increased Revenue per Available Room (RevPAR
RevPAR
RevPAR, or revenue per available room, is a performance metric in the hotel industry, which is calculated by multiplying a hotel's average daily room rate by its occupancy rate...
) by 2.7%.
The Revenue Management Levers
Whereas yield management involves specific actions to generate yield through perishable inventory management, Revenue Management encompasses a wide range of opportunities to increase revenue. A company can utilize these different categories like a series of levers in the sense that all are usually available, but only one or two may drive revenue in a given situation. The primary levers are:Pricing
This category of Revenue Management involves redefining pricing strategy and developing disciplined pricing tactics. The key objective of a pricing strategy is anticipating the value created for customers and then setting specific prices to capture that value. A company may decide to price against their competitors or even their own products, but the most value comes from pricing strategies that closely follow market conditions and demand, especially at a segment level. Once a pricing strategy dictates what a company wants to do, pricing tactics determine how a company actually captures the value. Tactics involve creating pricing tools that change dynamically, in order to react to changes and continually capture value and gain revenue. Price Optimization, for example, involves constantly optimizing multiple variables such as price sensitivity, price ratios, and inventory to maximize revenues. A successful pricing strategy, supported by analytically-based pricing tactics, can drastically improve a firm’s profitability.Inventory
When focused on controlling inventory, Revenue Management is mainly concerned with how best to price or allocate capacity. First, a company can discount products in order to increase volume. By lowering prices on products, a company can overcome weak demand and gain market share, which ultimately increases revenue so long as each product sells for more than its marginal costMarginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
. On the other hand, in situations where demand is strong for a product but the threat of cancellations looms (e.g. hotel rooms or airline seats), firms often overbook in order to maximize revenue from full capacity. Overbooking’s focus is increasing the total volume of sales in the presence of cancellations rather than optimizing customer mix.
Marketing
Price promotion allow companies to sell higher volumes by temporarily decreasing the price of their products. Revenue Management techniques measure customer responsiveness to promotions in order to strike a balance between volume growth and profitability. An effective promotion helps maximize revenue when there is uncertainty about the distribution of customer willingness to pay. When a company’s products are sold in the form of long-term commitments, such as internetInternet
The Internet is a global system of interconnected computer networks that use the standard Internet protocol suite to serve billions of users worldwide...
or telephone service, promotions help attract customers who will then commit to contracts and produce revenue over a long time horizon. When this occurs, companies must also strategize their promotion roll-off policies; they must decide when to begin increasing the contract fees and by what magnitude to raise the fees in order to avoid losing customers. Revenue Management optimization proves useful in balancing promotion roll-off variables in order to maximize revenue while minimizing churn
Churn
Churn may refer to:* Butter churn, a device used for churning butter* Churning , the process of creating butter out of milk or cream* Churn drill, a large, older drilling machine that bores large diameter holes in the ground- People and places :...
.
Channels
Revenue Management through channels involves strategically driving revenue through different distribution channels. Different channels may represent customers with different price sensitivities. For example, customers who shop online are usually more price sensitive than customers who shop in a physical store. Different channels often have different costs and marginsGross margin
Gross margin is the difference between revenue and cost before accounting for certain other costs...
associated with those channels. When faced with multiple channels to retailers and distributors, Revenue Management techniques can calculate appropriate levels of discounts for companies to offer distributors through opaque channels to push more products without losing integrity with respect to public perception of quality.
Data Collection
The Revenue Management process begins with data collectionData collection
Data collection is a term used to describe a process of preparing and collecting data, for example, as part of a process improvement or similar project. The purpose of data collection is to obtain information to keep on record, to make decisions about important issues, to pass information on to...
. Relevant data are paramount to a Revenue Management System’s capability to provide accurate, actionable information. A system must collect and store historical data for inventory, prices, demand, and other causal factors. Any data that reflects the details of products offered, their prices, competition, and customer behavior must be collected, stored, and analyzed. Information about customer behavior is a valuable asset that can reveal consumer behavioral patterns, the impact of competitors’ actions, and other important market information. This information is crucial to starting the Revenue Management process.
Segmentation
After collecting the relevant data, market segmentation is the key to market-based pricing and revenue maximization. Success hinges on the ability to segment customers into similar groups based on a calculation of price responsiveness of customers to certain products based upon the circumstances of time and place. Revenue Management strives to determine the value of a product to a very narrow micro-market at a specific moment in time and then chart customer behavior at the margin to determine the maximum obtainable revenue from those micro-markets. Useful tools such as Cluster Analysis allow Revenue Managers to create a set of data-driven partitioning techniques gather interpretable groups of objects together for consideration. Market segmentation based upon customer behavior is essential to the next step, which is forecasting demand associated with the clustered segments.Forecasting
Revenue Management requires forecasting various elements such as demand, inventory availability, market shareMarket share
Market share is the percentage of a market accounted for by a specific entity. In a survey of nearly 200 senior marketing managers, 67 percent responded that they found the "dollar market share" metric very useful, while 61% found "unit market share" very useful.Marketers need to be able to...
, and total market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
. Its performance depends critically on the quality of these forecasts. Forecasting is a critical task of Revenue Management and takes much time to develop, maintain, and implement. Quantity-based forecasts, which use time-series models, booking curves, cancellation curves, etc., project future quantities of demand, such as reservations or products bought. Price-based forecasts seek to forecast demand as a function of marketing variables, such as price or promotion. These involve building specialized forecasts such as market response models or cross-price elasticity estimates to predict customer behavior at certain price points. By combining these forecasts with calculated price sensitivities and price ratios, a Revenue Management System can then quantify these benefits and develop price optimization strategies to maximize revenue.
Optimization
While forecasting suggests what customers are likely to do, optimization suggests how a firm should respond. Often considered the pinnacle of the Revenue Management process, optimization is about evaluating multiple options on how to sell your product and to whom to sell your product. Optimization involves solving two important problems in order to achieve the highest possible revenue. The first is determining which objective function to optimize. A business must decide between optimizing prices, total sales, contribution marginContribution margin
In cost-volume-profit analysis, a form of management accounting, contribution margin is the marginal profit per unit sale. It is a useful quantity in carrying out various calculations, and can be used as a measure of operating leverage...
s, or even customer lifetime value
Customer lifetime value
-Definition of Customer Lifetime Value:In marketing, customer lifetime value , lifetime customer value , or lifetime value is the net present value of the cash flows attributed to the relationship with a customer...
s. Secondly, the business must decide which optimization technique to utilize. For example, many firms utilize linear programming
Linear programming
Linear programming is a mathematical method for determining a way to achieve the best outcome in a given mathematical model for some list of requirements represented as linear relationships...
, a complex technique for determining the best outcome from a set of linear relationships, to set prices in order to maximize revenue. Regression analysis
Regression analysis
In statistics, regression analysis includes many techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables...
, another statistical tool, involves finding the ideal relationship between several variables through complex models and analysis. Discrete choice models can serve to predict customer behavior in order to target them with the right products for the right price. Tools such as these allow a firm to optimize its product offerings, inventory levels, and pricing points in order to achieve the highest revenue possible.
Dynamic Re-evaluation
Revenue Management requires that a firm must continually re-evaluate their prices, products, and processes in order to maximize revenue. In a dynamic market, an effective Revenue Management System constantly re-evaluates the variables involved in order to move dynamically with the market. As micro-markets evolve, so must the strategy and tactics of Revenue Management adjust.Revenue Management in an Organization
Revenue Management’s fit within the organizational structure depends on the type of industry and the company itself. Some companies place Revenue Management teams within Marketing because marketing initiatives typically focus on attracting and selling to customers. Other firms dedicate a section of Finance to handle Revenue Management responsibilities because of the tremendous bottom line implications. Some companies have elevated the position of Chief Revenue Officer, or CRO, to the senior management level. This position typically oversees functions like sales, pricing, new product development, and advertising and promotions. A CRO in this sense would be responsible for all activities that generate revenue and directing the company to become more “revenue-focused.”Supply Chain Management
Supply chain management
Supply chain management is the management of a network of interconnected businesses involved in the ultimate provision of product and service packages required by end customers...
and Revenue Management have many natural synergies. Supply chain management (SCM) is a vital process in many companies today and several are integrating this process with a Revenue Management System. On one hand, supply chain management often focuses on filling current and anticipated orders at the lowest cost, while assuming that demand is primarily exogenous. Conversely, Revenue Management generally assumes costs and sometimes capacity are fixed and instead looks to set prices and customer allocations that maximize revenue given these constraints. A company that has achieved excellence in Supply Chain Management and Revenue Management individually may have many opportunities to increase profitability by linking their respective operational focus and customer-facing focus together.
Business Intelligence
Business intelligence
Business intelligence mainly refers to computer-based techniques used in identifying, extracting, and analyzing business data, such as sales revenue by products and/or departments, or by associated costs and incomes....
platforms have also become increasingly integrated with the Revenue Management process. These platforms, driven by data mining
Data mining
Data mining , a relatively young and interdisciplinary field of computer science is the process of discovering new patterns from large data sets involving methods at the intersection of artificial intelligence, machine learning, statistics and database systems...
processes, offer a centralized data and technology environment that delivers business intelligence by combining historical reporting and advanced analytics to explain and evaluate past events, deliver recommended actions and eventually optimize decision-making. Not synonymous with Customer Relationship Management
Customer relationship management
Customer relationship management is a widely implemented strategy for managing a company’s interactions with customers, clients and sales prospects. It involves using technology to organize, automate, and synchronize business processes—principally sales activities, but also those for marketing,...
(CRM), Business intelligence generates proactive forecasts, whereas CRM strategies track and document a company’s current and past interactions with customers. Data mining this CRM information, however, can help drive a business intelligence platform and provide actionable information to aid decision-making.
Developing Industries
The ability for Revenue Management to optimize price based on forecasted demand, price elasticity and competitive rates has incredible benefits, and many companies are rushing to develop their own Revenue Management capabilities. Many industries are beginning to embrace Revenue Management and apply its principles to their business processes:- Financial ServicesFinancial servicesFinancial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...
– offer a wide range of products to a wide range of customers. Banks have applied segmented pricing tactics to loan holders, often utilizing heavy amounts of data and modeling to project interest rates based on how much a customer is willing to pay.
- MediaMass mediaMass media refers collectively to all media technologies which are intended to reach a large audience via mass communication. Broadcast media transmit their information electronically and comprise of television, film and radio, movies, CDs, DVDs and some other gadgets like cameras or video consoles...
/TelecomTelecomTelecom refers to:* An abbreviation of telecommunication.* Short for telecommunications company, in general.* A short name for any telecommunications company with "Telecom" specifically in the name, where context allows media or people to commonly exclude the rest of its name without confusion,...
– a promotion-driven industry often focused on attracting customers with discounted plans and then retaining them at higher price points. Businesses in this industry often face regulatory constraints, demand volatility, and sales through multiple channels to both business and consumer segments. Revenue Management can help these companies understand micro-markets and forecast demand in order to optimize advertising sales and long-term contracts.
- Distributors – face a complex environment that often includes thousands of individual SKUs with several different product lifecycles. Each distributor must account for factors such as channel conflict, cross-product cannibalization, and competitive actions. Revenue Management has proved useful to distributors in promotion analysis and negotiated contracts.
- Medical Products and Services – deal with large fluctuations in demand depending on time of day and day of week. Hospital surgeries are often overflowing on weekday mornings but sit empty and underutilized on the weekend. Hospitals may experiment with optimizing their inventory of services and products based on different demand points. Additionally, Revenue Management techniques allow hospitals to mitigate claim underpayments and denials, thus preventing significant revenue leakage.
See also
- ForecastingForecastingForecasting is the process of making statements about events whose actual outcomes have not yet been observed. A commonplace example might be estimation for some variable of interest at some specified future date. Prediction is a similar, but more general term...
- Inventory theoryInventory theoryInventory theory is the sub-specialty within operations research that is concerned with the design of production/inventory systems to minimize costs...
- Linear programmingLinear programmingLinear programming is a mathematical method for determining a way to achieve the best outcome in a given mathematical model for some list of requirements represented as linear relationships...
- Operations ResearchOperations researchOperations research is an interdisciplinary mathematical science that focuses on the effective use of technology by organizations...
- OptimizationOptimization (mathematics)In mathematics, computational science, or management science, mathematical optimization refers to the selection of a best element from some set of available alternatives....
- Regression AnalysisRegression analysisIn statistics, regression analysis includes many techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables...
- Yield ManagementYield managementRevenue management is the process of understanding, anticipating and influencing consumer behavior in order to maximize yield or profits from a fixed, perishable resource...