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Pricing & Revenue Management Decision Support. Agenda. Overview of pricing and revenue management Pricing & revenue management core concepts Traditional RM - availability optimization Market response model based P&RM Common framework for P&RM applications. Revenue Management Defined.

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Pricing revenue management decision support

Pricing & Revenue Management Decision Support


Agenda

Agenda

Overview of pricing and revenue management

Pricing & revenue management core concepts

Traditional RM - availability optimization

Market response model based P&RM

Common framework for P&RM applications

Talus Solutions. CONFIDENTIAL.


Revenue management defined

Revenue Management Defined

“The application of disciplined tactics that predict consumer behavior at the micromarket level and optimize product availability and price to maximize revenue growth.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


What is pricing and revenue management prm

What is Pricing and Revenue Management (PRM)?

  • It is a disciplined process for achieving profitable growth by assuring that the right products are sold:

    • To the right customer

    • Through the right channel

    • At the right time

    • At the right price

  • It is supported by technology deploying sophisticated management science methods

    • Demand modeling

    • Optimization

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Pricing revenue management historical synopsis

Pricing & Revenue Management:Historical Synopsis

  • Developed in the early 1980’s as a result of airline deregulation

  • Initial successes lead to expansion into other industries

  • More impact than internally focused downsizing, re-engineering, etc.

“Revenue Management ...The business strategy that is poised to explode”

- Wall Street Journal, 1997

Talus Solutions. CONFIDENTIAL.


Prm requires more than technology

Business

Business

Processes

Processes

People

People

Information

Information

Systems

Systems

PRM requires more than technology

PRM involves the interaction of technology, people and business processes toward a common goal, increased profitability

Talus Solutions. CONFIDENTIAL.


Agenda1

Agenda

Overview of pricing and revenue management

Pricing & revenue management core concepts

Traditional RM - availability optimization

Market response model based P&RM

Common framework for P&RM applications

Talus Solutions. CONFIDENTIAL.


Prm core concepts

PRM Core Concepts

1.Sell to micro markets.

2. Exploit product value cycles.

3. Save products for the most valuable customers.

4. Focus on market-based pricing.

5. Focus on price rather than costs when balancing supply and demand.

6. Make decisions based on knowledge, not supposition.

7. Continually re-evaluate revenue opportunities.

Talus Solutions. CONFIDENTIAL.


Sell to micro markets

Sell to Micro Markets

1

“Market Segmentation is the key to market-based pricing and revenue maximization.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Sell to micro markets1

Sell to Micro Markets

1

Micro

Micro

Mass

Micro

Versus

Micro

Micro

Micro Market Attributes

  • Sell to Small Customer Groups

  • Creates Products for Each Customer Group

Micro

  • Mass Market Attributes

    • Sell to Large Customer Groups

    • Creates and Sells a Single Product to Large Customer Group

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Sell to micro markets2

Market segments are groupings of customers who share:

Purchase behavior

Product needs

Revenue management proposes you:

Recognize selling a product vs. a commodity

Develop products for each market segment

Price each product according to customer purchase behavior and customer needs

Sell to Micro Markets

1

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Sell to micro markets3

$100

$100

$80

$60

PRICE

$50

PRICE

$40

$20

$1

$1

100

1

50

1

20

40

60

80

100

DEMAND

DEMAND

Sell to Micro Markets

1

DILUTED DEMAND

UNACCOMMODATED DEMAND

  • one price

  • maximum achievable revenue of $2,500.

  • four prices

  • broader market segments can be addressed

  • produces $4,000 in revenue

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Exploit product value cycles

Exploit Product Value Cycles

2

“Generate maximum revenue by understanding

the value cycle and optimally timing the availability

and price of the product to each micro-market segment.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Exploit product value cycles1

Value Increases Over Time

Value Decreases Over Time

Price

Price

Time

Time

Exploit Product Value Cycles

2

Product value cycles represent the value of a product at any given time

Different customers (market segments) value different things: Value may increase or decrease over time

Knowing the product value cycle tells you what customers are willing to pay for your product at any given time.

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Exploit product value cycles2

Product value cycles are also determined by market segment sensitivity to price changes (price elasticity)

Demand is lesselastic when:

Fewer acceptable options are available

Product is perceived as inexpensive

Limited time available to select a product

Demand is more elastic when:

More acceptable options are available

Product is perceived as expensive

Unlimited time available to select a product

Pnew=$45

Pold=$30

Price

D

Quantity

Qnew

Qold

Pnew=$45

Pold=$30

D

Price

Quantity

Qnew

Qold

Exploit Product Value Cycles

2

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Exploit product value cycles3

Exploit Product Value Cycles

2

Revenue management proposes you:

  • Develop products to satisfy the needs and wants of each defined market segment

    Products are set of characteristics that meet a market segment’s wants and needs

  • Product characteristics may include:

    • Product features

    • Day of week/time of day

    • Advance purchase

    • Length of stay/rent

    • Flexibility

…. Products are much more than just a rate!

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Save products for valuable customers

Save Products for Valuable Customers

3

“…you should find a way to predict which segments are willing to pay the most and save those products for them.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Save products for valuable customers1

Save Products for Valuable Customers

3

Accurate forecasts of unconstrained demand are essential to successful Revenue Management

  • Forecast accuracy depends upon the following

    • Quantity of data

    • Accuracy of data

    • Stability of data

    • Stability of the marketplace

    • Forecast methodology

  • How do forecasts enable you to save products for your most valuable customer?

    • Quantify the price inelastic late booking market segment

    • Identify over- and under-supply situations

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Pricing revenue management decision support

Miami Airport Location

E-CAR Demand

for Mondays

in April 1998

1-Apr

8-Apr

15-Apr

22-Apr

200

29-Apr

150

100

Demand

50

0

0

4

8

12

16

20

24

Days Left

28

Save Products for Valuable Customers

3

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Pricing revenue management decision support

Revenue management proposes you:

Match demand forecasts with customer purchase behavior, in order to predict

Who wants a given product

When the request is made for the product

Save products through:

Inventory availability controls that save products for late booking price inelastic market segments

Price breakpoints (discounts) to stimulate demand from price elastic market segments

Save Products for Valuable Customers

3

Talus Solutions. CONFIDENTIAL.


Focus on market based pricing

Focus on Market Based Pricing

4

“The market (i.e., consumer) establishes the price, and your job is to find the market’s acceptable price point.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Focus on market based pricing1

Focus on Market Based Pricing

4

Cost-based pricing

  • Focuses on recovering costs

  • Sets product prices based on what corporations expect customers to pay for their goods and services

  • Does not consider customer price elasticity

    Market-based pricing:

  • Cost to create product is not primary driver

  • Sets products prices based on what customers are willing to pay

  • Requires information on price elasticity by market segment and product

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Focus on market based pricing2

Focus on Market Based Pricing

4

Revenue Management proposes you:

  • Understand the demand for your products/services from each market segment

  • Recognize that customers do not consider the cost to produce a product/service when making their buying decision

  • Let the customer set the market price by buying or not buying the product/service

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Focus on price when balancing supply and demand

Focus On Price When Balancing Supply and Demand

5

“The tendency for many companies encountering supply/demand imbalances is to remedy them by the use of capital assets. …Address short-term fluctuations first with price, then with capacity.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Focus on price when balancing supply and demand1

D

Demand

S

Supply

Price

Equilibrium

Point

PE=$30

QE=100

Quantity

Focus On Price When Balancing Supply and Demand

5

Equilibrium points:

  • Exist for each market segment and product

  • Identify where supply and demand produce optimal returns

Talus Solutions. CONFIDENTIAL.


Focus on price when balancing supply and demand2

Focus On Price When Balancing Supply and Demand

5

Revenue Management proposes you:

  • Practice rate optimization:

    • The function of using equilibrium points from multiple products and market segments to set rates that will maximize revenue

    • Set prices consumers will accept

  • Use prices to shift demand and utilize excess capacity:

    • When demand is high, prices should increase

    • When demand drops, offer discounts to sell products/service would otherwise go unsold.

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Make decisions based on knowledge

Make Decisions Based On Knowledge

6

“The RM tool that enables you to make decisions on knowledge, not supposition, is forecasting. It is essential to predict consumer behavior if you are going to exploit opportunities in the marketplace.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Make decisions based on knowledge1

Make Decisions Based On Knowledge

6

Human Forecasters

  • Intentional or unintentional biases

  • Hopeful

  • Focus on recent events

  • Use most accessible information

Forecasting Systems

  • Based on customer transaction data

  • Use internal and external environmental factors

  • Predict customer behavior

  • Utilize sophisticated mathematical algorithms

  • Revenue Management proposes you:

    • Ensure quality data inputs

    • Use judgement and experience when using the data outputs

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Make decisions based on knowledge2

Make Decisions Based on Knowledge

Forecasting Parameters

Historical

Data

Current

Data

Recent

Trends

Forecast

Review, Adjust

Prices

Reports

Optimize

User

Capacity

Influences

Recommend

Accept, Reject

or Modify

Revenue

Management

System

Distribution System

Recommendation

Review

Measure

Performance

6

Sample Revenue Management System

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Continually re evaluate revenue opportunities

Continually Re-evaluate Revenue Opportunities

7

“Give decision-support tools to the workers in the trenches to make dynamic decisions at the micromarket level.”

- Robert G. Cross

Revenue Management:

Hardcore Tactics for Market Domination

Talus Solutions. CONFIDENTIAL.


Continually re evaluate revenue opportunities1

Continually Re-evaluate Revenue Opportunities

7

Markets are always changing; therefore, revenue opportunities are always changing

Critical speed is replacing critical mass in capturing marketing opportunities

  • No time for “up-the-ladder” decision making

    Revenue Management proposes you:

  • Re-forecast as often as necessary

  • Empower and enable front-line workers to increase decision speed

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Continually re evaluate revenue opportunities2

Continually Re-evaluate Revenue Opportunities

7

?

MarketSegmentation

Customer Demand Data

Forecasters

Constraints

!

Distribution

$

Optimization

Price and Availability Recommendations

Talus Solutions. CONFIDENTIAL.


Prm core concepts1

PRM Core Concepts

1.Sell to micro markets.

2. Exploit product value cycles.

3. Save products for the most valuable customers.

4. Focus on market-based pricing.

5. Focus on price rather than costs when balancing supply and demand.

6. Make decisions based on knowledge, not supposition.

7. Continually re-evaluate revenue opportunities.

Talus Solutions. CONFIDENTIAL.


Agenda2

Agenda

Overview of pricing and revenue management

Revenue Management Core Concepts

Traditional RM - availability optimization

Market response model based P&RM

Common framework for P&RM applications

Talus Solutions. CONFIDENTIAL.


Traditional rm availability optimization

Traditional RM - Availability Optimization

Allocation - Type Models

  • EMSRb

  • Math Programming - Stochastic

    Airline OD RMS - Delta

    Hotel RMS

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Expected marginal seat revenue

Expected Marginal (Seat) Revenue

  • Leg based airline systems

  • Room night based hotel systems

  • On-rent based rental car systems

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Math programming formulation

Math Programming Formulation

  • O&D base airline systems

  • Length of stay hotel systems

  • Length of rent car rental systems

Talus Solutions. CONFIDENTIAL.


Agenda3

Agenda

Overview of pricing and revenue management

Revenue Management Core Concepts

Traditional RM - availability optimization

Market response model based P&RM

Common framework for P&RM applications

Talus Solutions. CONFIDENTIAL.


Mrm based pricing

MRM-Based Pricing

Market Response Models

  • Model win probability (Target Pricing), or market share (Promotions Pricing & Dynamic Pricing) as a function of

    • Product Characteristics

    • Customer Characteristics (segmentation)

    • Price

      ‘Pure’ MRM - based applications

  • Target Pricing - UPS

  • Promotions Pricing - Ford

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Objective of target pricing context ford fleet marketing

Objective of Target PricingContext: Ford Fleet Marketing

Chose the target price that will maximize expected profit

Given customer and bid characteristics , predict the

probability of winning a bid as a function of Price

Price can be relative to competitors’ prices, list price,

or a business-as-usual (BAU) price, etc.

Calculate Profit as a function of Price

Choose Price that maximizes the Expected Profit

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Pricing revenue management decision support

Probability Curve from MRM

100%

90%

80%

70%

Price Sensitivity = g

60%

Brand Preference

Probability of Winning Bid (%)

50%

40%

30%

20%

10%

0%

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

Offer Price

BAU Price

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Calculating profit

Calculating Profit

  • Here, candidate Target Prices are expressed as (List Price - Discount)

  • Note that in TP “Cost” is a pre-determined constant

  • for each product i . In fact, Cost could be a function of

  • customer or bid characteristics, or price. For example,

    • Shipping costs related to customer location

    • Production costs related to bid volume

    • Cost of a competitive price action related to price

Profit

Price

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Calculating probability

Calculating Probability

Target Pricinguses a Golden Section Search to

find the maximum of the two-dimensional Expected Profit curve

Maximize E(Profit)

E(Profit)

Net Price

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How is the target incentive obtained

30

30

30

20

10

20

10

10

20

0

0

0

How Is the Target Incentive Obtained?

25

20

Contribution ($1000)

15

Cost Information

10

5

0

X

Discount (% off list)

100

80

Market Information and Strategic Goals

Probability of Winning (%)

60

40

20

0

Discount (% off list)

Target Price(22% Incentive)

10

8

Target Incentive

Expected Contribution

6

4

2

0

Discount (% off list)

Talus Solutions. CONFIDENTIAL.


Agenda4

Agenda

Overview of pricing and revenue management

Revenue Management Core Concepts

Traditional RM - availability optimization

Market response model based P&RM

Common framework for P&RM applications

Talus Solutions. CONFIDENTIAL.


Relationship between price and availability control are they the same thing yes and no

Relationship Between Price and Availability Control: Are they the same thing? Yes and No.

No:

  • MRM-based systems model customer response to changing prices - directly

  • Availability control paradigm, treats demand in different segments and at different price levels, as (sort of) independent.

    Yes:

  • both availability controls and price can/should be used to match supply and demand

  • Under some assumptions they can be shown to be the same

  • Many applications include both

    • Availability optimization systems often include aspects of market response (e.g. spill models).

    • MRM systems may incorporate availability constraints, or integrate with other systems that do

Talus Solutions. CONFIDENTIAL.


Hybrid solutions

Hybrid Solutions

Dynamic Pricing - Fairchild Semiconductor

  • Uses sophisticated MRM modeling to predict market share

  • Incorporates supply constraints, at a high level

    Rental Car RMS - National Car Rental Systems

  • Technology mostly centered around availability optimization

  • Uses simple MRM models, and capacity constraints to generate rate recommendations

  • Second stage availability optimization produces LOR recommendations

    Broadcast RMS - The ABC Television Network

  • No forecasting algorithms - based on user specified sales forecasts

  • On the surface system recommends price (discount)

  • Behind the scenes is essentially an availability optimization, including opportunity costs associated with other (future) demand

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Pricing revenue management decision support

Integrated Systems:Promotions Pricing & Traditional Availability Optimization

Bookings

Res

System

Update forecast

based on promotional

lift

HRMS

Optimized

Availability

Room/LOS/rate allocations

Predicted vacancies;

opportunity cost

by hotel/date

Selected promotion:

induced demand

Rates

Promotion

usage

Base

Rates

Rates

DB

Promotion

Pricing

Promotion

rates & rules

  • Choose promo alternative

  • based on Hotel/LOS/Date range

  • Generate promo demand forecast

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Bonus an example rms architecture broadcast rms

Bonus: An Example RMS Architecture:Broadcast RMS

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Bonus rms process flow

Historical

Seasonality

Current

Bookings

Recent Trend

Human

Tweaking

Factor

Demand

Forecast

Rates

Optimization

Reports

Overbooking

Recommendations

Human

Tweaking

Factor

Reservations

System

Distribution

Network

Accept, Reject

or Modify

Performance

Measurement

Bonus: RMS Process Flow

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