Revenue management
• Revenue management (RM) – the allocation of
the capacity to different fare classes over time
• The goal being maximization of revenue
• It refers to both strategy and tactics of the
company
• The first industry, that introduced RM was
passenger airlines
When is it applicable….
• The seller is selling a fixed stock of perishable
capacity
• Customers book capacity prior to departure
• The seller manages a set of fare classes, each
of which has a fixed price (at least in the short
run)
• The seller can manage the availability of fare
classes over time
• Revenue management is a special case of
pricing with constrained supply
• But, it is not based on setting and updating
prices, but the availability of fare classes
• The objective of fare class management is a
legacy of RM from it’s early days as passenger
airlines built their reservation systems so as to
utilize the capability at hand*
• Later, RM has been adopted by a number of
industries, including hotels, rental cars, freight
transportation and cruise lines, many of whom
also use the reservation systems
• Thus the term revenue management industries*
The deregulation of the airline
industry
• Prior to 1978 both schedules and fares tightly
controlled by the Civil Aeronautics Board (CAB)
• The industry was to be deregulated by 1983
• The goal had been to guarantee reasonable ROI
• As we will see, RM has brought about a more
efficient airline operation
• All restrictions on domestic routes were removed
as well as fares were deregulated
A new entrant….
• was PeopleExpress
• It offered a bare-bones service
– Extra fees for baggage handling and onboard meals
– Had a significantly lower cost structure than the major
airlines
– Fares up to 70% less than competitors*
• Had discovered a previously untapped market
segment – price sensitive students and middle
class leisure travelers
PeopleExpress
• At first it entered underserved markets – and
competed with bus or car travel
• In 1984, after 4 years of phenomenal growth it
entered key markets of American Airlines
– Newark – Chicago
– New Orleans – Los Angeles
American Airlines
• If it matched the low prices, it would not cover
the costs
• Otherwise the customers would be siphoned
off
• In a deregulated market PeopleExpress could
move on to all AA’s core markets
• It only seemed have a choice between a slow
death and a rapid one
January 1985 – AA’s „Ultimate Super
Saver Fares“
• In order to qualify, a passenger would need to
book at least two weeks before departure and
stay at his destination over a Saturday night
• Others paid a higher fare
– PeopleExpress had no such restrictions
• AA restricted the number of seats sold at
discount
– PeopleExpress allowed every seat to be sold at a
low fare
AA’s two-pronged approach
• Vast majority of discount passengers were
leisure passengers, able to book early and
more price sensitive
• The later-booking passengers were primarily
business passengers; who were less price
sensitive, but needed a seat at the last
moment
• Both groups of passengers preferred AA’s
superior service to the bare-bones approach
• In effect, American Airlines had segmented the
market between leisure and business travelers
and used differentiated pricing to attack a
competitior
• In September, Texas Air bought PeopleExpress for
less than 10% of the market value it had enjoyed
a year before
– „We had great people, tremendous value, terrific
growth. We did a lot of things right. But we didn’t get
our hands around the yield management and
automation issues“ CEO Donald Burr
• American, United, Delta, Continental
– In 1980 and well into 1990s invested millions of
dollars in implementing computerized revenue
management systems and establishing revenue
management organizations
• Marriott was a pioneer in hotel revenue
management
• Hertz and National were pioneers in rental car
revenue management
• Vendors such as PROS and Talus Solutions
developed and sold commercial software
packages
• Cruise lines, passenger trains and various
modes of freight transportation followed
• Development and investment in revenue
management continues in many of these
industries today
Levels of revenue management
• Strategic
– Segment market and differentiate prices (quarterly,
annually)
• Tactical
– Calculate and update booking limits (daily, weekly)
– The „brains“ of the process – forecast future demand,
run optimization algorithms, set and update booking
limits
• Booking control
– Accept/reject bookings (real time)
Artificial restrictions to create an inferior
product@lower prices4price sensitive cust.
• Product versioning
• Airlines: products targeted to many segments - government,
senior citizens, groups, tour operators, cruise lines
• International airlines: regional pricing
• Airlines: channel pricing (the Internet cheaper than travel
agents)
• Hotels and car rentals: corporate, leisure and business
segments have different products; e.g. the kamaaina rates
for residents of Hawaii – available during slack periods
• Cruise lines – do not have early bookers in the traditional
sense, but sell to the incentive segment (early) – bulk
purchases as incentives to corporate employees; (e.g. a
medical company to reward the top 20 North American sales
managers)
• Cruises also charge different prices in different cities –
regional pricing.
RM in the context of Information
Systems (IS)
• AA used an IS – SABRE, from 1964, back when
it was a technological marvel – as the
products could be distributed and bookings
received globally*
– Computerized reservation system (CRS)
– Global distribution system (GDS)
Distribution channels for an airline*
Systems were developed first and RM
capabilities added later
•
•
•
•
•
Americal Airlines – SABRE
United Airlines – Galileo
Northwest Airlines – Worldspan
A consortia of airlines – ABACUS, AMADEUS
Following a federal ruling that eliminated the ability to give
preferential treatment to own flights on GDS, airlines largely
divested their GDSs
• In the past more than 80% of bookings went through the GDSs –
there are more than 180 000 terminals in the world – most are
placed with travel agents, but some in travel offices of large
companies
• Most airlines, hotels, car rental companies and cruise lines have
contracts with all the GDSs
• The systems were built on large mainframes using 1960s-vintage
software and modifications are expensive and time consuming
Booking control (decision is taken
within 200 milliseconds)
• Y-Class (business), M-Class (full fare), B-Class
(deep discount); as a consequence some
reservation systems limit the number of
booking classes per product to 26
• Booking limits
• Protection levels
• Allotments
• Dynamic nested booking control
• The booking limit for a class is the upper
bound on the total number of bookings (for
that class) that will be accepted
• NB! No-shows and cancellations
• The protection level for class i is the total
number of seats available to class i and all
higher classes
Tactical revenue management
• Calculates and periodically updates booking
limits
• Transmits the booking limits to the reservation
system
Resources, products and fare classes
• Resource – a unit of capacity; a flight departure, a hotel
room night; a rental car day; all resources are constrained
• Product – what customer seeks to purchase; may require
one or more resources; a seat on Flight 130 St.Louis to
Cleveland on Monday, June 30 – uses one resource; A twonight stay at the Sheraton Cleveland for a customer arriving
on March 19 and departing on March 21 uses two
resources
• With each product one or more fare classes are associated;
Fare class is a combination of a price and a set of
restrictions on who can purchase the product and when;
fare classes can be used to establish different virtual
products, for group pricing, for regional pricing, or for
combinations of all these
Resources and products in four
revenue management industries*
A supplier controls
• a set of resources with fixed and perishable capacity
• a portfolio of products consisting of combinations of
one or more of the resources
• a set of fare classes associated with each of the
products.
The tactical revenue management problem is to choose
which fare classes should be open and which closed for
sale at each moment in order to maximize expected
total net contribution.
The fact that fare classes are being opened and closed
does not make a big difference from the customer’s
point of view – they just see the lowest available fare
changing over time
• Most airlines believe the need to match the
advertised, or „head-line“, fares offered by
their competition in key markets in order to
drive demand
• As bookings arrive, revenue management
enables them to „shape“ demand to the
limited capacity of each flight
• Revenue management supplements rather
than replaces pricing
Components of tactical revenue
management
• Capacity allocation
• Network management
• Overbooking
• Capacity allocation is important if the same unit of
constrained capacity is sold at two or more different prices;
e.g. passenger airlines, rental cars and hotels; sporting teams
– how many to sell on discounts or promotions versus holding
to sell at full price; air freight carriers have agreements with
different customers specifying different rates
• However resort hotels, discount carriers such as Southwest,
and passenger trains maintain only a few prices for the same
inventory
• Network management is important for selling products
that consist of combinations of resources
• Passenger railways, rental cars, business hotels – more
important than rate class management; important for
airlines with hub-and-spoke systems, but not as
important as capacity allocation and overbooking
• Not important for those industries that sell a single
resource – cruise lines, point-to-point airlines, sporting
events and theater
• Overbooking is important whenever customers are
allowed to cancel or not show with little or no penalty
• Airline tickets, business hotels, rental cars – although it
has become somewhat less important as the fraction of
nonrefundable tickets has increased
• Not important for resort hotels, cruise lines, because of
the high perceived costs of denying service; generally
not used for sporting events and theater, where tickets
are nonrefundable and seats individually assigned
• Includes a database with fares for all product/fare
combinations, capacities on all flight legs,
passenger variable costs by product; This
information is extracted from the pricing system,
the scheduling system and various accounting
• The forecasting module generates and updates forecasts for
all product/fare class combinations for all future dates; The
first forecast will be given a year in advance, when the ticket
will at first be sold; monthly updates for the first six months;
daily updates for the last two weeks;
• Probabilistic forecasts – e.g. including mean and standard
deviation
• Delta Airlines employs a group of more than
30 „revenue management analysts“, who
continually monitor the forecasts and booking
limits generated
• For example, if Estonia hosts Eurovision on a
given year, this induces additional demand for
plane tickets for May
Updating booking limits
• Periodic updates, occuring with an increasing
frequency
• Event-driven updates are triggered when a
booking class closes, there is a change in
aircraft or unanticipated spike in demand
• Requested updates are launced by a flight
controller or revenue manager based on
competitive actions, changes in fares,
anticipated changes in future demand
Net contribution in revenue
management
• We are actually maximizing the expected net
contribution, which also takes into account incremental
costs
• The term revenue management originates from the era,
when airlines had their passenger variable costs well
below the fares and could be assumed to be zero
• In 1990s, however, discount fares began a steady
decline, to the point, where the difference between the
deepest discount fares and incremental costs was small
• Also, industries such as freight transportation and
cruise lines that now also implemented RM have a
significant incremental cost associated with customer
commitment
• Relatively high in cruise lines and container
shipping. For example, for cruise lines, food is a
major expense
• At the other end of the spectrum, relatively low in
theater and sporting events
• Somewhere in between are hotels, rental car
companies and passenger airlines
Variations by channel and market
segment
• For example, in 2004, still GDS accounted for 60% of
bookings for a typical airline and about 68% for a
typical hotel, leaving plenty of scope for future savings
• SABRE chages $3 to $4 per flight segment for airlines and
about $4 per room for a typical hotel booking
• Hotel’s web site variable costs are $1.50
• The figure represents a channel-pricing opportunity – which
fare classes are open for which channel
• Furthermore, there is a tremendous economic incentive to
steer demand through lower-cost channels
Activity-based costing model for a
rental car company*
• Airline passenger – a beer, duty-free goods or the
Internet
• Hotels – outgoing calls, minibar, room service
• Rental cars – insurance is highly profitable side
business
• Sporting events and theater – important
• Hotel/casinos – gambling is a dominant source of
revenue and profitability
Ancillary contribution
• RM company needs to estimate the ancillary
contribution for each booking request
• This must be estimated based on the
customer, product, channel
– Harrah’s Entertainment uses its CRM system to
track the gaming patterns of 28M customers, who
belong to its Total Rewards loyalty program. There
are 64 segments – for each the demand for rooms
is forecast, there is a gaming profit that Harrah’s
will realize on the average for that segment
Measuring revenue management
effectiveness
• Load factor shows the percentage of seats
that are full
• Before the deregulation of 1983, the prices
were set in a following way: if airline meets
the break-even load factor, 75%, they cover
their total costs; the rest is profits
• After deregulation the load factor was not the
only feasible indicator – otherwise just sell all
the seats to deep discount customers and you
fill up the planes
• Hence, another indicator – yield, which is essentially
revenue per passenger mile
• Sometimes the goal of managing bookings was to
increase yield, thus another term of yesteryear for our
topic – yield management
• Yield of course has another setback – just fill the plane
with only late-booking business customers, fly it almost
empty and you’ll have a high yield
• The solution is in „Revenue per Available Seat Mile“
(RASM) : a full 100 seat aircraft with 1800 mile flight
with a total revenue of $50000 has a RASM of
$50000/(100*1800) = $0.28
• The same flight with 50 passengers paying $1000 each
(still $50000 of revenue) and a corresponding load
factor of only 50% would still result in the same RASM
• This is the right focus from the revenue management
point of view – a policy that resulted in $51000 from a
flight is more successful than one that resulted in
$50000, notwithstanding a possibly lower load factor
• From PRO point of view net contribution per available
seat mile (NCASM) is an even better metric; assume
from the flight above, there is a per-passenger
operating cost of $50; Then 100 passengers paying
$500 each would result in an operating margin of
$50000 – 100*$50 = $45000 and NCASM $0.25, while
50 passengers paying $1000 apiece would result in an
operating margin of $50000 – 50*$50 = $47500 and an
NCASM of $0.26
• That is, we should once again move from revenue to
total contribution
Meanwhile in other industries
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Revenue per available room night (REVPAR)
Revenue per available rental day
Revenue per berth
It is possible to compare performace across markets
and within a single market over time
• Filghts that are achieving high RASM are generating a
higher return to the company’s assets than those with
low RASM; it is also a useful benchmark among
different airlines
• RASM does not guarantee high profitability (or any
profitability at all), since it is strictly a revenue-based
metric and ignores costs entirely
Revenue management in action
• Every major airline, hotel, rental car company, or cruise line
has a revenue management department
• At most major airlines it is considered to be a key
management function
• The practice of revenue management has spread to other
industries, including hotels, rental car companies, cruise lines,
railroads, tour operators, broadcasting and freight
transportation
• An important area of current research is on how to better
incorporate customer behavior, lifetime customer value,
competitive response into revenue management decisions
• The research continues in RM companies, at universities, and
at consulting companies and system vendors
• There are numerous efforts to adapt revenue approaches to
the needs of new industries, ranging from oil and gas
pipelines to health care to made-to-order manufacturing; as
in each of these industries constrained perishable capacity
plays a role and RM has the potential to supplement existing
pricing approaches, leading to improvements in profitability
• It would be nice to end here, but currently it is the carriers
with expensive and sophisticated RM systems (American,
Continental, Delta, Northwest, United Airlines and US
Airways) that are going bankrupt while their low-cost, low
fare rivals (Southwest, JetBlue, AirTran) thrive :(
• As is evident, average RASM is 25% than their lowcost competitors, which is an impressive
achievement as seats are rapidly becoming a
commodity and the Internet is enabling
unprecedented fare visibility
• However, the Big 6 are getting clobbered in the cost
game as their average cost per available seat mile is
50% higher than that of the low-cost carriers
• On the one hand the Internet has enabled the airlines to slash
their distribution costs by cutting out the middleman – especially
the travel agencies, who used to be the dominant distribution
channel for travel products
• Still, the Internet is providing unprecedented fare visibility and
eroding some traditional „product fences“ that used to keep
segments apart
• The Internet has lead to the rise of new online intermediaries,
such as Expedia, Travelocity, and Priceline, seeking to become the
dominant retailer of travel products on the Internet; thus, a
consortium of US airlines created Orbitz; for a foreseeable future a
variaty of online retailers, airlines’ own Web sites and the
traditional channels are here to stay
• The new „inferior“ products, like Priceline, which allows customers
to bid for travel without knowing the exact departure time or
airline they are purchasing; this has been explicitly marketed as an
„inferior“ product that airlines can safely sell at a high discount
without cannibalizing their mainstream products; other airlines
and hotels are experimenting with selling „distressed inventory“
(i.e., empty capacity close to departure) at deep discounts
• Revenue management companies will need to
manage a large portfolio of products and market
segments through many different channels
• As others outside the travel industry are adopting
revenue management approaches to managing
availability, the revenue management industries
might have to become experts in understanding
customer response and including that in the
combined models