Dynamic pricing and yield management
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Dynamic Pricing and Yield Management. Yossi Sheffi Professor, MIT ESD.260J/1.260J/15.770J. What you are is clear – the only issue is price …. Outline. Airline revenue management The essence of price discrimination Revenue management in TL trucking.

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Dynamic Pricing and Yield Management

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Dynamic pricing and yield management

Dynamic Pricing and Yield Management

Yossi Sheffi

Professor, MIT

ESD.260J/1.260J/15.770J


Dynamic pricing and yield management

What you are is clear – the only issue is price…


Outline

Outline

  • Airline revenue management

  • The essence of price discrimination

  • Revenue management in TL trucking


Yield revenue management

Yield/Revenue Management

  • Objective:maximize revenue (minimize lost revenue / opportunity costs)

  • “Science of squeezing every possible dollar from customers”

Integrated management of capacity and pricing


Revenue management example airline

Revenue Management Example: Airline

# of Seats

100

$1,000

Price


Revenue management example airline1

Revenue Management Example: Airline


Revenue management example airline2

Revenue Management Example: Airline


Revenue management example airline3

Revenue Management Example: Airline


Revenue management example airline4

Revenue Management Example: Airline


Two challenges

Two Challenges:

  • How do we make sure that the people who are willing to pay $750 will not buy the $250 ticket?

  • How do we make sure that we have enough seats for those willing to pay $750?


Two answers

Two Answers:

  • Create artificial hurdles:

     Advance purchase: 21 days, 14 days, 7days

     Use limitations: Saturday night stay, non-refundable tickets

  • Restrict the number of seats sold at the low price

     This requires a forecast of future booking by higher-paying customers and the discipline to forgo a “bird-in-hand.”

  • Note 1: airlines do not change prices dynamically; they actually change capacity (classes) dynamically

  • Note 2: freight can also displace passengers when RM is really optimized


Why is this important

Why is This Important?

  • American Airlines saved over $1.4B between 1989-1992

  • “I believe that yield management is the single most important technical development in transportation management . . . “

     Robert Crandall, CEO AMR


Markdowns

Markdowns

Markdowns are one of the main levers that retailers have to influence results in-season. As such, it can be a very powerful driver of performance.

  • Markdown Opportunity:•Markdowns may represent more than 30% of total sales

  • • Short-cycle product can represent up to 80% of a retailer’s assortment

  • • In some segments, short-cyce products may represent a smaller percentage of the assortment but still have a significant impact on gross margin (up to 40%)

  • Goals / Trends:

  • • Movement to more Localized pricing decisions

  • •Growing realization of the true cost of left-over inventory

  • •Greater emphasis on inventory productivity as store base growth slows


Sales rate based discounting

Sales Rate-Based Discounting

  • After initial sales rate (r0= i0/t0)

  • Required sales rate: r1=i10-t1)

  • %r required: (r1/ r0)-1

  • Divide by ε

  • Get the % price change required


Price discrimination

Price Discrimination

  • First degree: willingness to pay (rare)

    • RR in late 1800-s, asking shippers for their income statement so they could determine their ability to pay

    • College financial aid

    • Taxes

  • Second degree: artificial hurdles but open

    • Buying process (coupons, advance purchase…)

    • Cost to serve (volume discounts, risk adjustments, "set up" costs in travel industry…)

    • Distribution channels (Internet, outlets, etc.)

    • Markdowns (timing of purchase, product age, selection, etc.)

    • Value of product (in many rail movements; regeltarifklassen)

    • Commodity type (part of tariffs; in many rail movements)

    • Use limitations (e.g., "final sale")

    • Bundling ("menu" vs. "a-la-cart")

    • Time of use (e.g., peak hour, congestion pricing)


Price discrimination1

Price Discrimination

  • First degree: willingness to pay (rare)

  • Second degree: artificial hurdles but open

  • Third degree: based on external factors

    • Geography (neighborhood, state)

    • Gender (women's clothing)

    • Age (senior/student discounts)

    • Profession/affiliation (small/large business business; educational,medical…)


3 rd degree discrimination

3rd Degree Discrimination

  • Online shopping: Dell Computer


Specific example

Specific Example

Dimension® 8200 Series, Pentium® 4 Processor at 1.7 GHz

128MB PC800 RDRAM

New Dell® Enhanced QuietKey Keyboard

Video Ready w/o Monitor

32MB NVIDIA GeForce2 MX 4X AGP Graphics Card with TV-Out

40GB Ultra ATA/100 Hard Drive

3.5 in Floppy Drive

MicrosoftR Windows® Millennium with WinXP Home Upgrade Coupon

MS IntelliMouse®

10/100 PCI Fast Ethernet NIC

56K Teephony Modem for Wndows-Sound Option

48X Max Variable CD-ROM

Integrated Audio with Soundblaster Pro/16 Compatibility

Harman Kardon HK-395 Speakers

Upgrade to Microsoft® Office Small Business w/EducateU

3 Year Ltd. Warranty, 3 Year At Home Service, Lifetime 24x7 Phone Support


Specific example1

Specific Example


When does ym work

When Does YM Work?

  • Economic conditions

  • Demand (LT with signaling; Governme conference

  • Segme

  • No arbitrage

  • Administration

  • A

  • A

  • Product

  • High fix

  • Perishability

  • Discipline !


Marketing

Marketing

  • Most schemes are based on 2nd degree discrimination – seems more fair (choice is available)

  • Positioning the message: discounts are more acceptable than price increases, even if the result is the same

  • Avoid gauging

  • "Profiteering" is not acceptable

  • Use open communications

  • Some forms of 3rd degree discrimination are illegal, but many are acceptable:

    • student/senior citizen discounts

    • profession/use (Dell)


Carrier portfolio of pricing

Carrier Portfolio of Pricing

Dynamic pricing with spot market shippers

Dynamic pricing with contracted shippers

Long-term fixed-rate contracts

LT fixed rate contracts with capacity commitments


Rev management in tl trucking

Rev. Management in TL Trucking

  • Little opportunity during bid response

    • No monopoly power

    • Exceptions: good service history coupled with client strategy geared towards service

    • Value-added services

  • Only opportunity in real-time (spot) market

    • There are limited opportunities for local/temporary monopolies:

      • Responses to shipper "dialing for diesels”

      • Requests along "power lanes"


Rev management in tl trucking1

Rev. Management in TL Trucking

  • Remember the twin challenges:

    • How do we make sure that the people who are willing to pay $750 will not buy the $250 ticket?

    • How do we make sure that we have enough seats for those willing to pay $750?

  • Comes down to one question:

    Should we take this load?

    • Should capacity be committed to a particular load/shipper/contract?, or should we wait for a better-paying load?

    • Depends on the forecast…


Strategic decisions set the limits for tactical decisions

Strategic Decisions Set the Limits for Tactical Decisions

  • Size of fleet

  • Market focus – regions, industries, equipment

  • Relationships with O/Os, 3PLs

  • Percent of business under long-term contract

  • Long-term contract rates

  • Bid-response strategies

  • Capacity commitments

  • Seasonal Pricing

  • Demand booking and solicitation

  • Dynamic pricing

  • Proactive empty repositioning

  • Driver assignment


System contribution of a load

System Contribution of a Load

  • Regional potential: the expected contribution of a truck in a region.

  • P(A) - Potential of region A

  • D(A-B) - Direct cost for moving a truck from A to B

  • R(A-B) - Revenue for the move from A to B


System contribution of a load1

System Contribution of a Load

  • S(A-B) = R(A-B) -D(A-B) + P(B) -P(A)

  • Direct contribution System impact

  • P(B) -the value of one more truck at region B

  • P(A) -the value of one less truck at region A

  • Order acceptance:

  • Take a load only if S(A-B) > 0

  • Take the load with the highest S(A-B)


Analysis of movements

Analysis of Movements

Head haul:

S(A-B) = R(A-B) -D(A-B) + P(B) -P(A)

Back haul:

S(A-B) = R(A-B) -D(A-B) + P(B) -P(A)


Ym in manufacturing

YM in Manufacturing

  • Reserve capacity to the highest paying customer

  • Tie the pricing to the capacity commitment

  • Use pricing to manage component supply (in BTO)


Final observations

Final Observations

  • RM involves the entire enterprise

    • Customer service

    • Sales

    • Reservations

    • Scheduling

  • RM can be used to increase profits and serve customers better

    • Bring in those who otherwise would not use the service

    • Provide higher LOS to those who pay a lot by giving them more frequent service, higher probability of service, etc.

    • Increase utilization by smoothing demand patterns

  • The essence of RM is the judicious management of capacity and pricing simultaneously

    • The trick: reserve capacity to the highest paying customers


Any questions

Any Questions?


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