Using Pricing and Revenue Management in a Supply Chain in Practice

  1. Evaluate your market carefully. The first step in revenue management is to identify the customer segments being served and their needs. The goal is to understand what the customer is buying, as opposed to what you are selling. If an airline thinks of itself as only selling seats, it cannot use revenue management. It has to think of itself as selling seats, the ability to book at the last minute, the ability to alter flight plans, and the ability to pick a convenient flight schedule. Only then do revenue management opportunities present themselves.

Having identified the market needs, it is crucial to gather accurate and complete data relat­ing to products offered; prices; competition; and, most important, customer behavior. Informa­tion about customer behavior is a valuable asset that helps identify consumer preferences. Ultimately, a proper understanding of customer preferences and a quantification of the impact of various tactics on consumer behavior are at the core of successful revenue management.

  1. Quantify the benefits of revenue management. It is critical to quantify the expected benefits from revenue management before starting the project. Ideally, historical data and a good model of customer preferences should be used to estimate the benefits through a simulation. The outcome of this step should be explicit revenue targets that are to be achieved as a result of rev­enue management. The revenue targets should be such that all people involved believe in them. The revenue management effort should then be compared to the expected benefit.
  2. Implement a forecasting process. The foundation of any revenue management sys­tem is the forecasting function. By forecasting, we do not mean obtaining an estimate that is always accurate. Forecasting involves estimating demand and also attributing an expected error to the forecast itself. It is difficult to forecast at a micro level, at which all behavior is essentially idiosyncratic. For example, an airline with 100 fare classes will find it difficult to forecast demand for each class and also forecast the behavior of customers when they find a fare class full. It is thus important to ensure that revenue management tactics are planned over a level that is aggregate enough so effective forecasting is possible.
  1. Keep it simple. Most of the benefits of revenue management are realized through a few dimensions for differential pricing. Additional complexity adds to the effort required without necessarily adding much value. An airline, for example, can achieve most of the benefits from revenue management using a few fare classes. Further complexity will only make forecasting more difficult without necessarily enhancing revenue.
  2. Involve both sales and operations. Salespeople must understand the revenue man­agement tactics in place so they can align their sales pitches accordingly. It makes no sense for a firm to offer an off-peak discount if the sales force continues to push people toward the period with highest prices. The sales force must differentiate between customers that truly need the sup­ply chain asset during the peak period and those who will benefit from moving their orders to the off-peak period. Such an approach will increase profits for the firm while also satisfying custom­ers. Operations must understand the potential outcomes of the revenue management tactics in place and be informed of actual outcomes taking place. For example, operations in an airline using overbooking must be ready to book passengers who are unable to depart on the full flight onto other feasible flights.
  3. Understand and inform the customer. Customers will have a negative perception of revenue management tactics if they are simply presented as a mechanism for extracting maxi­mum revenue. Such a perception is likely to diminish customer loyalty in the long term and encourage the customer to try to game the process. Thus, it is important for the firm to structure its revenue management program in a way that it increases revenue while improving service along some dimension that is important to customers that pay the highest price. As discussed earlier in the chapter, a proper implementation of revenue management tactics should achieve both outcomes. It is important for the firm to convey this information to its most valuable cus­tomers. Remember, a change in behavior by this set of customers can destroy any potential ben­efit of a revenue management program.
  4. Integrate supply planning with revenue management. Although the supply planning and revenue management ideas we discuss in this book are valuable in their own right, combin­ing them can create significantly more value. The point here is not to use revenue management in isolation, but rather to combine it with decisions on the supply side. For instance, if, after apply­ing revenue management, a manufacturer finds that the production of a short-lead-time facility provides the majority of its profit, it should look into adding more short-lead-time capacity. Understanding and acting on the interactions among supply, demand, and pricing can bring about powerful results.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.

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