Pricing and Revenue Management in

the Supply Chain

Outline
◆ The Role of RM (Revenue Management) in the
SCs
◆ RM for Multiple Customer Segments
◆ RM for Perishable Assets
◆ RM for Seasonable Demand
◆ RM for Bulk and Spot Customers
◆ Using RM in Practice
◆ Summary of Learning Objectives

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Revenue Management
 Revenue management is the use of pricing
to increase the profit generated from a
limited supply of supply chain assets
 Revenue management may also be defined
as the use of differential pricing based on
customer segment, time of use, and product
or capacity availability to increase supply
chain profits
 Most common example is in airline pricing
Supply assets
◦ Capacity: expiring

◦ Inventory: often preserved

Conditions for RM to Work
◆ The value of the product varies in different market segments
– Airline seats: Leisure vs. Business travel
◆ The product is highly perishable or product waste occurs
– Fashion and seasonal apparel
– High tech products
◆ Demand has seasonal and other peaks
– Products ordered at Amazon.com, peaking in December
– Supply Chain textbook orders peaking in August and January.
◆ The product is sold both in bulk and on the spot market
– Owner of warehouse who can decide whether to lease the entire warehouse
through long-term contracts or save a portion of the warehouse for use in the
spot market
– Truck capacities for a transportation company

5
RM for Multiple Customer
Segments
◆ If a supplier serves multiple customer segments with a fixed
asset, the supplier can improve revenues by setting different
prices for each segment
– Must figure out customer segments
◆ Prices must be set with barriers such that the segment willing
to pay more is not able to pay the lower price
– Barriers: Time, location, prestige, inconvenience, extra
service
◆ In the case of time barrier,
– The amount of the asset reserved for the higher price segment is such
that quantities below are equal
» the expected marginal revenue from the higher priced segment
» the price of the lower price segment 6
 Barrier: Extra service
Price What is the targeted
demand? What is the
Revenue?
Could we do better?
Money left on the table
P0=1200 =160,000

Revenue=480,00
0

P=2000-
2Q
C=400 No.
seats
Customer Segmentation by extra service
Example: Cruise ship
◆ A cruise ship with C=400 identical cabins
◆ What is the price to maximize revenue?

2000

Price P=2000-
2Q
Demand
Curve

1000
No. Seats 8
 Example: Cruise ship
Offer additional services to differentiate
Price products and pricing

Revenue=1600(200) + 1200(400-
P2=1600 200)=560,000
P1=1200 Increase revenue
more?

Q2=20 Q1 =400 No. seats 9

0
 Example
Price
P3=1800 Revenue=1800(100) + 1600(200-100)
+ 1200(400-200)=580,000
P2=1600

P1=1200 How to allocate

capacity for each
product/service
optimally?

Q3=100 Q1 =400 No. seats

Q2=200
Two questions:
◆ What happens to the capacity reserved for the high
paying segment, when the high paying segment
starts paying about the low paying segment?
– How much does the high paying segment value quick
service?
◆ We never consider the distribution of the demand for
low paying segment when computing the reserved
capacity for the high paying segment. Can this be
correct, why?

11
RM in the Service Industries

◆ Airline Industry uses RM the most.

◆ Evidence of airline revenue increases of 4 to 6 percent:
– With effectively no increase in flight operating costs
◆ RM allows for tactical matching of demand vs. supply:
– Booking limits can direct low-fare demand to empty flights
– Protect seats for highest fare passengers on forecast full
flights
◆ Hotel, Restaurant, Car rental, Overseas shipping, Cruise
travel, Transportation capacity providers, Computation
capacity providers (computer farms) and sometimes
Health care industries show similarities to airline
industry in using RM.
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What are the barriers among customer
segments in the airline industry?

Sensitivity to Duration
Sensitivity to Flexibility

Low
Leisure No
Travelers Demand

No Business
Offer Travelers
High

Sensitivity to Price
High Lo
w
RM for Perishable Assets
◆ Any asset that loses value over time is perishable
◆ Examples: high-tech products such as computers and cell
phones, high fashion apparel, underutilized capacity, fruits
and vegetables
◆ Two basic approaches:
– Dynamic Pricing: Vary price over time to maximize expected
revenue
– Overbooking: Overbook sales of the asset to account for
cancellations
» Airlines use the overbooking most
» Passengers are “offloaded” to other routes
» Offloaded passengers are given flight coupons
» This practice is legal
– Dynamic pricing belongs to RM while overbooking can be said to
more within the domain of Yield management. 14
» But concepts are more important than the names!
RM for Perishable Assets
◆ Overbooking or overselling of a supply chain asset is valuable
if order cancellations occur and the asset is perishable

◆ The level of overbooking is based on the trade-off between the

cost of wasting the asset if too many cancellations lead to unused
assets (spoilage) and the cost of arranging a backup (offload) if
too few cancellations lead to committed orders being larger than
the available capacity
◆ Spoilage and offload are actually terms used in the airline
industry

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RM for Seasonal Demand
◆ Seasonal peaks of demand are common in many SCs\
– Most retailers achieve a large portion of total annual demand
in December
» Amazon.com
◆ Off-peak discounting can shift demand from peak to
non- peak periods
◆ Charge higher price during peak periods and a lower
price during off-peak periods

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RM for Bulk and Spot Customers
◆ Most consumers of production, warehousing, and
transportation assets in a supply chain face the problem of
constructing a portfolio of long-term bulk contracts and
short-term spot market contracts
– Long-term contracts for low cost
– Short-term contracts for flexibility
◆ The basic decision is the size of the bulk contract
◆ The fundamental trade-off is between wasting a portion of the
low- cost bulk contract and paying more for the asset on the
spot market

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Using RM in Practice
◆ Evaluate your market carefully
– Understand customer requirements for services and
products
– Price, flexibility (time, specs), value-added services,
etc.
– Based on requirements identify customer segments
(groups)
– Differentiate products/services and their pricing
according to customer segments
» Dell:
» Same product is sold at a different price to different
consumers (private/small or large
business/government/academia/health care)
» Price of the same product for the same industry varies
Using RM in Practice
◆ Quantify the benefits of revenue management
◆ Implement a forecasting process
◆ Apply optimization to obtain the revenue
management decision
◆ Involve both sales and operations
◆ Understand and inform the customer
◆ Integrate supply planning with revenue
management

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RM for Bulk and Spot
Customers
For the simple case where the spot market price is known
but demand is uncertain, a formula can be used
cB = bulk rate
cS = spot market price
Q* = optimal amount of the asset to be purchased in bulk
p* = probability that the demand for the asset does not exceed
Q*

Marginal cost of purchasing another unit in bulk is cB.

The expected marginal cost of not purchasing another unit in

bulk and then purchasing it in the spot market is (1-p*)cS. 20