SERVICE OPERATIONS

MANAGEMENT
ISD 457
BBA IV

Author: James Fitzsimmons

Lecturer: Emmanuel Quansah

([email protected])
KNUST School of Business
Managing Capacity and Demand
 Learning Objectives

 Describe the strategies for matching capacity

and demand for services.
 Determine an overbooking strategy for a service
that minimizes expected loss.
 Explain what yield management is, when it’s
use is appropriate, and how it can be
accomplished using the critical fractile criterion.
 Introduction

 Whenever demand for a service falls

short of the capacity to serve, the results
are idle servers and facilities.
 The variability in service demand is quite
pronounced and heightened by the
varying customer habits and
preferences.
Four Scenarios
 Level Capacity and Chase Demand

 Level Capacity Strategy:

 Use of marketing-oriented strategies such as price
incentives that can smooth customer demand to
enable the service organization better utilize fixed
capacity.
 Chase Demand Strategy:
 Use of operations-oriented strategies such as
workshift scheduling to vary capacity to match the
changing levels of customer demand.
 Strategies for Managing Demand

1. Manage customer-induced variability

2. Segmenting of Demand
3. Offering Price Incentives
4. Promoting Off-Peak Demand
5. Developing Complimentary Services
6. Reservation Systems and Overbooking
 Strategies for Managing Demand
…cont’d 1

1. Manage customer-induced variability

Occurs in the forms of;
1. Arrival variability
2. Capability variability
3. Request variability
4. Effort variability
5. Subjective preference variability
Managed by using accommodation and/or reduction:
 Accommodation Strategy – favors customer experience over
operational efficiency(accommodate different customer choices).
 Reduction Strategy - favors operational simplicity over service
experience.(reduce customer choices)
 Strategies for Managing
Demand …cont’d 2
2. Segmenting of Demand
Segment demand into random arrivals and planned
arrivals by using appointments.

3. Offering Price Incentives

Use differential pricing for services at different
times/seasons.eg. weekend and night rates for telephone
calls, and off-season hotel rates.
 Strategies for Managing
Demand …cont’d 3
4. Promoting Off-Peak Demand
Utilize off-peak capacity by seeking different sources
of demand.eg. Renting hostel rooms to conference
attendees during the semester breaks, encouraging
customers to shop early to avoid Christmas rush.
5. Developing Complimentary Services.
Introduce complimentary services to occupy waiting
customers. This strategy can be used to expand a
service organizations service/product offering. e.g.
Gas stations introducing convenience stores.
 Strategies for Managing
Demand …cont’d 4
6. Reservation Systems and Overbooking
 Reservations can be used to pre-sell a service. As
reservations are made, additional demand is deflected to
other time slots.
 Reservations reduce customer waiting time and guarantees
service availability.
 Problems can arise when customers fail to honor their
reservations(no-shows).In some cases non refundable
tickets can be used to control no-shows.
 When no-shows cannot be controlled the strategy of
overbooking is adopted.
 Overbooking
 A strategy adopted by service organizations to hedge
against the possibility of no-shows.
 Aim is to strike a balance between the opportunity cost
of a vacant service capacity(hotel room, seat on a
bus/plane etc.) and the cost of a customer not honoring
a reservation
 First introduced in the airline industry.
 Duplicated in the hotel industry.
 Risk of turning away customers with reservations if
you overbook too much.
 Need to reimburse overbooked passengers and find
them space on the next available service.
 Overbooking…cont’d 1

 A good overbooking strategy should minimize the

expected opportunity cost of idle service capacity
as well as the expected cost of turning away
customers with reservations.
 minimize the expected cost in the long run.
 Cost of overbooking
 Loss of customer goodwill and the impact on future
business.
 Added cost of alternative service(if more expensive)
 Example 1
 In a given hotel, a vacant room as a result of a no-
show leads to an opportunity cost of $40.Given
that the data below represents the history of no-
shows for the current peak period;
1. Calculate the expected number of no-shows
2. Calculate the expected opportunity loss.
3. Given that the cost of overbooking per guest is
$100 create an overbooking loss table for the
given scenario.
4. Identify the best overbooking strategy?
5. What is the gain obtained from using this strategy?
 Example 1…cont’d

No- Shows Probability P(d) Reservations Cumulative

Overbooked (x) Probability P(d < x)
0 .07 0 0
1 .19 1 0.07
2 .22 2 0.26
3 .16 3 0.48
4 .12 4 0.64
5 .10 5 0.76
6 .07 6 0.86
7 .04 7 0.93
8 .02 8 0.97
9 .01 9 0.99
 Hotel Overbooking Loss Table

Number of Reservations Overbooked

No- Prob-
shows ability 0 1 2 3 4 5 6 7 8 9
0 .07 0 100 200 300 400 500 600 700 800 900
1 .19 40 0 100 200 300 400 500 600 700 800
2 .22 80 40 0 100 200 300 400 500 600 700
3 .16 120 80 40 0 100 200 300 400 500 600
4 .12 160 120 80 40 0 100 200 300 400 500
5 .10 200 160 120 80 40 0 100 200 300 400
6 .07 240 200 160 120 80 40 0 100 200 300
7 .04 280 240 200 160 120 80 40 0 100 200
8 .02 320 280 240 200 160 120 80 40 0 100
9 .01 360 320 280 240 200 160 120 80 40 0
Expected loss, $ 121.60 91.40 87.80 115.00 164.60 231.00 311.40 401.60 497.40 560.00

11-16
 Finding best overbooking strategy
using the Critical Fractile Model

Cu
P( d  x)  Cumulative probability that demand
Cu  Co will be less than the stock level which
guarantees that marginal revenue just
exceed the marginal costs

Where;
Cu – Cost of no-shows (no. of no-shows is underestimated)
Co – Cost of overbooking (no. of no-shows is overestimated)
d – no. of no-shows based on past experience
x – the number of rooms overbooked
 Some Parameters

 Total No. of No shows = Sum of (No Shows x

respective probability)
 Cost of No Shows = Cost of Room × No. of no
shows
 Expected loss of overbooking = Sum of (prob. Of
occurrence × loss)
 Best overbooking strategy = the one with minimum
expected loss of overbooking
 Gain = Cost of No shows – Cost of overbooking
 Example 2
 In a family inn, an empty room represents an
opportunity cost of $69, which is the average
room rate. In the case of overbooking, guests
are accommodated at the nearby resort which
charges $119 per night. What will be the best
overbooking policy and what will be the
expected gain from overbooking. The
frequency of no shows is given below
No shows 0 1 2 3
Frequency 4 3 2 1
 Example 3 (Ex 11.3 from textbk)
 A commuter airline overbooks all it’s flights by one
passenger. The no-show experience for the past 20
days is shown below:
No shows 0 1 2 3 4
Frequency 6 5 4 3 2

 Using the critical fractile model find the maximum

implied overbooking opportunity loss Co if the
revenue Cu from a passenger is $20.
 Example 4 (Ex 11.4 from textbk)

 Try solving this example yourself (Refer

to the textbook)
 Strategies for Managing Capacity

1. Schedule Workshifts
2. Increase Customer Participation
3. Create adjustable capacity
4. Share Capacity(facilities and equipment)
5. Cross-train employees
6. Use of part-time employees
7. Outsource
 Strategies for Managing Capacity

1. Schedule Workshifts:
Schedule the limited workers you have to match
your demand patterns by placing more workers on
the shifts/time periods with the highest demand
2. Increase Customer Participation:
- Allow customers to serve themselves. In this
situation the capacity to serve will vary directly
with demand rather than being fixed
- This is being adopted by the fast food restaurants
and the banks(ATM Service)
 Strategies for Managing Capacity

3. Create adjustable capacity:

- Through design, a portion of capacity can be made
variable
- For example, airlines move the partition between first
class and economy class to meet the changing mix of
passengers
4. Share Capacity:
- During periods of underutilization, it may be
possible to find other uses for your capacity
- Sometimes it makes business sense to rent out
facilities and equipment
 Strategies for Managing Capacity
5. Cross-train employees:
- Most service systems are made up of several operations and
when one operation is busy another may be idle
- Cross training employees to perform tasks in several
operations creates flexible capacity to meet peaks in demand
6. Use of part-time employees:
- Part time help can be used to supplement regular employees
when peaks of activity are persistent and predictable
7. Outsource: -
Contract another company to help serve peak demand
 Strategies for Matching Capacity
and Demand for Services
MANAGING MANAGING
DEMAND CAPACITY

Partitioning Increasing
demand customer
Developing participation
Sharing
complementary
capacity
services
Establishing
Scheduling
price
Developing Cross- work shifts
incentives
reservation training
systems employees
Promoting Creating
off-peak adjustable
Using
demand capacity
part-time
employees

Yield
management 11-26
 Yield Management

 A revenue maximization strategy

 A strategy that incorporates the concepts of
overbooking and segmenting demand
 Attempts to allocate fixed capacity of a service to
match the potential demand in various market
segments in the most profitable manner
 Airlines were the first to adopt yield management but
other capacity-constrained service industries have
also adopted this practice.(hotels, cuise lines, etc.)
 Yield Management…A definition

 An approach to allocating the right type

of capacity to the right kind of customer
at the right price so as to maximize
revenue or yield (Kimes, 1984)
 Yield Management

 Implementation:
Yield = actual revenue/potential revenue

Where;
Actual revenue = actual capacity used X average
actual price.
Potential revenue = total capacity X maximum price

 Requirements:
 Different Market segments.
 Price Sensitivity.
Traditional Fixed Price:
Airline Pricing for a Coach Seat
Price
Demand Curve

Consumer Surplus

Seats Available

Quantity

Total Revenue = PQ 11-30

 Multiple Pricing:
Airline Pricing for a Coach Seat
Using Yield Management
Price

Demand Curve

Consumer Surplus

P1

P2 Seats Available

P3

Quantity

Q1 Q2 Q3

Full Advanced Internet Total Revenue = P1Q1 + (Q2-Q1)P2 + (Q3-Q2)P3

Coach Purchase Special
 Yield Management Using the
Critical Fractile Model
Cu ( F  D)
P(d  x)  
Cu  Co pF

Where;

x = seats reserved for full-fare passengers

d = demand for full-fare tickets
F = Price of full fare
D = Price of discount fare
p = probability that a customer is seeking a discount (or proportion
of economizing (discount) passengers)
 Reading from Standard Normal
Distribution Tables
 Reserved Units at Full Cost = µ + zσ

 Read for the value of z based on the

critical fractile value.;
 Example 1

 Given that the demand for an airline’s full

fare rate has an average of 75 with a
standard deviation of 15, calculate how
many full-fare seats should be reserved if
the percentage of discount-seeking
passengers is 80 percent and the full-rate
and discount rates are $79 and 59$
respectively.
 Example 2
 (b) KNUST Rent-A-Bike Ltd has been experiencing
increasing demand since its introduction. The company
rents bicycles to staff and students who prefer to bike
their way around campus. At the recent board meeting,
management decided to re-examine the company’s
reservation policy. The table below contains data on the
rental experience of the company? Using yield
management, determine the optimal number of bicycles to
be held for customers paying the full rate.
Rental Discount Discount Avg. daily Standard
Rate Rate Seeker, % Demand Deviation
Rental GHȼ 30 GHȼ 20 80 50 15
Bicycle
 Example 3

A ski resort offers a weekend special for $ 159 per

person per night whiles the high season rates for the
same room is $299.Average weekend demand has a
normal distribution with a mean of 50 and a standard
deviation of 10.Given that the proportion of customers
willing to pay full rate is approximately 20 percent, how
many rooms should management set aside for full
paying customers?
 Ideal Characteristics for Yield
Management

 Relatively Fixed Capacity

 Ability to Segment Markets
 Perishable Inventory
 Product Sold in Advance
 Fluctuating Demand
 Low Marginal Sales Cost against a High
Capacity Change Cost
11-37
 THANK YOU

END OF SESSION

In Him was life and the Life was the light of Men
(John 1:4)