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Supply Chain Management. Lecture 25. Semester Outline. Tuesday April 20 Chap 15 Thursday April 22 Simulation Game briefing Tuesday April 27 Review, buffer Thursday April 29 Simulation Game. Outline. Today Chapter 15 Sections 1, 2 Homework 7 Online today

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semester outline
Semester Outline
  • Tuesday April 20 Chap 15
  • Thursday April 22 Simulation Game briefing
  • Tuesday April 27 Review, buffer
  • Thursday April 29 Simulation Game
outline
Outline
  • Today
    • Chapter 15
      • Sections 1, 2
  • Homework 7
    • Online today
    • Due Thursday April 29 before class
      • Homework submitted before April 29 will be graded and returned on April 29
  • Thursday
    • Simulation game briefing
what is revenue management
What is Revenue Management?
  • Revenue management is the practice of differential pricing to increase supply chain profits
    • A strategy that adjusts prices based on product availability, customer demand, and remaining duration of the sales season will result in higher supply chain profits
what is revenue management1
What is Revenue Management?
  • Revenue management is the practice of differential pricing to increase supply chain profits
    • A strategy that adjusts prices based on product availability, customer demand, and remaining duration of the sales season will result in higher supply chain profits
  • Revenue management, also called yield management, and sometimes smart pricing, is a technique to optimize revenue from a fixed, but perishable inventory
revenue management
Revenue Management

Revenue Management:Maps capacity into demand

Newsvendor problem:Maps demand into capacity

what is revenue management2
What is Revenue Management?
  • Revenue management, also called yield management, and sometimes smart pricing, is a technique to optimize revenue from a fixed, but perishable inventory
  • Is revenue management possible for…
    • Airline tickets
    • Cruise travel
    • Restaurants
    • Hospitals
    • LTL trucking companies
    • Apartment rental
    • Incoming MBA class
    • Vending machines
revenue management and vending machines
Revenue Management and Vending Machines
  • Coca-Cola announces that it is considering vending machines that will boost prices during hot weather.
    • “Coca-Cola is a product whose utility varies from moment to moment. In a final summer championship, when people meet in a stadium to enjoy themselves, the utility of a chilled Coca-Cola is very high. So it is fair it should be more expensive. The machine will simply make this process automatic.”

Douglas Ivester, Chairman and CEO

conditions for revenue management
Conditions for Revenue Management
  • The value of the product varies in different market segments
    • Airline seats: leisure versus business travel
  • The product is highly perishable or product waste occurs
    • Fashion and seasonal apparel
    • High tech products
  • Demand has seasonal and other peaks
    • Cruise travel
  • 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
why revenue management
Why Revenue Management?
  • Success stories
    • American Airlines increased annual revenue by over $1 billion through revenue management
    • Marriott hotels increased annual revenue with $100 million through revenue management
    • National Car Rental was saved from liquidation through revenue management
    • Canadian Broadcasting Corporation increased revenue with $1 million per week
airfare example
Airfare example

q

Choose the fare that maximizes the area (revenue) of the rectangle

1000

800

600

400

200

200

400

800

p

600

1000

airfare example1
Airfare example

q

Choose the fare that maximizes the area (revenue) of the rectangle

Unaccommodated demand

1000

800

Maximum revenue = 500*500= $250,000

600

400

Consumer surplus

200

200

400

800

p

600

1000

airfare example2
Airfare example

q

Choose the fare that maximizes the SUM of areas of the rectangles

1000

800

Economy class

Maximum revenue = 333*(333 + 667) = $333,000

600

400

Business class

200

200

400

800

p

600

1000

airfare example3
Airfare example

q

Choose the fare that maximizes the SUM of areas of the rectangles

1000

Economy class

800

Maximum revenue = 200*(800+600+400+200)= $400,000

Economy plus class

600

Business class

400

First class

200

200

400

800

p

600

1000

airfare example4
Airfare example

q

Perfect price discrimination

1000

Charging a different price to a different buyer for the same product without any true cost differential to justify the different price

800

Maximum revenue = $500,000

600

400

200

200

400

800

p

600

1000

is revenue management price discrimination
Is Revenue Management Price Discrimination?
  • The same product sold at different times for different prices is not necessarily price discrimination, because at different times...
    • The production or distribution costs may be different
    • Inventory costs were incurred to keep the product in stock until a later time
    • Consumers value products differently at different points in time
    • The product value may change over time, such as perishable or maturing or seasonal products, fashion goods, antiques.
    • Interest is earned if product is sold at an earlier time
    • Locking sales in early reduces uncertainty
revenue management for multiple customer segments
Revenue Management 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
    • What price to charge each segment?
    • How to allocate limited capacity among the segments?

Prices must be set with barriers such that the segment willing to pay more is not able to pay the lower price

revenue management1
Revenue Management
  • Hotels, airlines, opera houses hope this tool will help them maximize sales and profits
    • “The real beneficiary of revenue management has been the consumer”

Clearly, customers for which revenue management has decreased the cost of air travel, have benefited from revenue management. Could customers for which revenue management has increased the cost of air travel, also have benefited from revenue management?

what is revenue management3
What is Revenue Management?

q

q

1000

1000

800

800

600

600

400

400

200

200

200

800

200

800

400

600

1000

400

600

1000

p

p

example 15 1 pricing to multiple segments
Example 15-1: Pricing to multiple segments
  • A contract manufacturer has identified two customers segments for its production capacity—one willing to place an order more than one week in advance and the other willing to pay a higher price as long as it can provide less than a week’s notice for production. The customers that are unwilling to commit in advance are less price sensitive and have a demand curve d1 = 5,000 – 20p1. Customers willing to commit in advance are more price sensitive and have a demand curve of d2 = 5,000 – 40p2. Production cost is c = $10 per unit. What price should the contract manufacturer charge each segment if its goal is to maximize profits?
pricing multiple segments
Pricing Multiple Segments
  • Assume that the demand curve for segment i is given by
    • di = Ai – Bipi
  • The goal of the supplier is to price so as to maximize profits
    • Max (pi – c)(Ai – Bipi)

Profit

pricing multiple segments1
Pricing Multiple Segments
  • The optimal price for segment i is given by
    • pi = Ai/2Bi + c/2
example 15 1 pricing to multiple segments3
Example 15-1: Pricing to multiple segments
  • For segment 1:
    • pi = Ai/2Bi + c/2 pi = 5,000/(2*20) + 10/2 = $130
    • Profit (pi – 10)(5,000 – 20pi) = (130 – 10)(5,000 – 20*130) = $288,000
  • For segment 2:
    • pi = Ai/2Bi + c/2 pi = 5,000/(2*40) + 10/2 = $67.50
    • Profit (pi – 10)(5,000 – 40pi)= (67.5 – 10)(5,000 – 40*67.5) = $127,650

Total profit $415,650

example 15 1 pricing to multiple segments4
Example 15-1: Pricing to multiple segments
  • If total capacity is limited to 4,000 units, what should the contract manufacturer charge each segment?
    • For segment 1: p1 = $130
      • Demand d1 = (5,000 – 20p1) = 2,400
    • For segment 2: p2 = $67.50
      • Demand d2 = (5,000 – 40p2) = 2,300
    • Total demand = 2,400 + 2,300 = 4,700

Total demand exceeds production capacity of 4,000

pricing multiple segments2
Pricing Multiple Segments
  • The goal of the supplier is to price so as to maximize profits
    • Max ∑ki=1 (pi – c)(Ai – Bipi)
    • Subject to:∑ki=1(Ai – Bipi)  Qpi  0

Maximize profits

Production capacity

Price

example 15 1 pricing to multiple segments5
Example 15-1: Pricing to multiple segments
  • If the contract manufacturer were to charge a single price over both segments, what should it be?

d1 = 5,000 – 20p1

d2 = 5,000 – 40p2

d = (5,000 – 20p) + (5,000 – 40p) = 10,000 – 60p

example 15 1 pricing to multiple segments6
Example 15-1: Pricing to multiple segments
  • For segment 1 and 2:
    • p = Ai/2Bi + c/2 p = 10,000/(2*60) + 10/2 = $83.33
    • Max (p – c)(A – Bp) Max (p – 10)(10,000 – 60p) = (83.33 – 10)(10,000 – 60*83.33) = $366,650

Differential pricing raises profit from $366,650 to $415,650

revenue management for multiple customer segments1
Revenue Management 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
    • What price to charge each segment?
    • How to allocate limited capacity among the segments?

What if demand is uncertain?

the park hyatt philadelphia
The Park Hyatt Philadelphia
  • 118 King/Queen rooms.
  • Hyatt offers a pL= $128 (low fare) targeting leisure travelers.
  • Regular fare is pH= $181 (high fare) targeting business travelers.
  • Demand for low fare rooms is abundant.
  • Let DH be uncertain demand for high fare rooms.
  • Assume demand for the high fare (business) occurs only within a few days of the actual stay

How much capacity should Hyatt save for the higher priced segment?

allocating capacity to a segment under uncertainty
Allocating Capacity to a Segment Under Uncertainty
  • Basic tradeoff between committing to an order from a lower-price buyer or waiting for a high-price buyer to arrive later on
    • Spoilage occurs when the capacity reserved for higher-price buyers is wasted because demand from the higher-price segment does not materialize
    • Spill occurs if higher-price buyers have to be turned away because the capacity has already been committed to lower-price buyers
allocating capacity to a segment under uncertainty1
Allocating Capacity to a Segment Under Uncertainty
  • Expected revenue = sales probability xsales price

Never sell a unit of capacity for less than the expected revenue

$128  $181.00 = 1.0 x 181

$128  $162.90 = 0.9 x 181

$128  $144.80 = 0.8 x 181

$128 $126.70 = 0.7 x 181

allocating capacity to a segment under uncertainty2
Allocating Capacity to a Segment Under Uncertainty

$126.70 = 0.7 x 181

Expected revenue = sales probability x sales price

RH(CH) = Prob(demand from higher-price segment > CH) x pH

Never sell a unit of capacity for less than the expected revenue

allocating capacity to a segment under uncertainty3

pL = Prob(demand from higher-price segment > CH) x pH

Prob(demand from higher-price segment > CH) = pL/pH

Allocating Capacity to a Segment Under Uncertainty

$128 $126.70 = 0.7 x 181

Expected revenue = sales probability x sales price

RH(CH) = Prob(demand from higher-price segment > CH) x pH

Never sell a unit of capacity for less than the expected revenue

allocating capacity to a segment under uncertainty4

Prob

Prob(demand from higher-price segment > CH) = pL/pH

Allocating Capacity to a Segment Under Uncertainty

Prob(demand from higher-price segment  CH) = 1 – pL/pH

CH = F-1(1 – pL/pH, DH, H)

CH

1 – pL/pH

pL/pH

example allocating capacity to a segment under uncertainty
Example: Allocating Capacity to a Segment Under Uncertainty
  • Assume that demand for rooms at the high rate is normally distributed with mean 102 and standard deviation 20.8. Also assume that the high rate is 181 dollars and low rate (discount rate) is 128 dollars
    • Determine probability that expected marginal revenue of higher rate class will exceed marginal revenue of lower rate class
      • pL = 128
      • pH = 181
      • 1 – pL/pH = 1 – 128/181 = 0.2928
    • Convert that probability into the number of rooms
      • NORMINV(1 – pL/pH, DH, H) = NORMINV(0.2928, 102, 20.8) = 91

Hence, 91 rooms should be reserved for the high rate class

example 15 2 allocating capacity to multiple segments
Example 15-2 Allocating Capacity to Multiple Segments
  • ToFrom Trucking serves two customer segments. One segment (A) is willing to pay $3.50 per cubic feet but wants to commit with only 24 hours notice. The other segment (B) is willing to pay only $2.00, but is willing to commit to a shipment with up to one week notice. With two weeks to go, demand for segment A is forecast to be normally distributed, with a mean of 3,000 cubic feet and a standard deviation of 1,000. How much of the available capacity should be reserved for segment A?
example 15 2 allocating capacity to multiple segments1
Example 15-2 Allocating Capacity to Multiple Segments

$3.50

$2.00

3,000

1,000

F-1(1 – pB/pA, DH, H) =F-1(0.4286,3000,1000) =2,820

example 15 2 allocating capacity to multiple segments2
Example 15-2 Allocating Capacity to Multiple Segments
  • ToFrom Trucking serves two customer segments. One segment (A) is willing to pay $3.50 per cubic feet but wants to commit with only 24 hours notice. The other segment (B) is willing to pay only $2.00, but is willing to commit to a shipment with up to one week notice. With two weeks to go, demand for segment A is forecast to be normally distributed, with a mean of 3,000 cubic feet and a standard deviation of 1,000. How much of the available capacity should be reserved for segment A?

How should ToFrom change it decision if segment A is willing to pay $5 per cubic foot?

example 15 2 allocating capacity to multiple segments3
Example 15-2 Allocating Capacity to Multiple Segments

$5.00

$2.00

3,000

1,000

F-1(1 – pB/pA, DH, H) =F-1(0.6, 3000, 1000) =3,253