Dynamic Pricing and
Yield Management
Yossi Sheffi
Professor, MIT
ESD.260J/1.260J/15.770J
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What you are is clear – the only issue is price…
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Outline
Airline revenue management
The essence of price
discrimination
Revenue management in TL
trucking
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Yield/Revenue Management
Integrated management
of capacity and pricing
 Objective:maximize revenue (minimize lost
revenue / opportunity costs)
 “Science of squeezing every possible dollar
from customers”
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Revenue Management Example:
Airline
# of Seats
100
$1,000 Price
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Revenue Management Example:
Airline
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Revenue Management Example:
Airline
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Revenue Management Example:
Airline
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Revenue Management Example:
Airline
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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?
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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
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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
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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
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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
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Price Discrimination
First degree: willingness to pay (rare)

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
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

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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)
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Price Discrimination
First degree: willingness to pay (rare)
Second degree: artificial hurdles but open
Third degree: based on external factors

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Geography (neighborhood, state)
Gender (women's clothing)
Age (senior/student discounts)
Profession/affiliation (small/large business business;
educational,medical…)
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3rd Degree Discrimination
Online shopping: Dell Computer
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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
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Specific Example
User
Base Price
Home
$1,378
Small business
$1,238
Large business
$1,338
Student
$1,327
University
$1,427
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When Does YM Work?
Economic conditions

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Demand (LT with signaling; Governme conference
Segme
No arbitrage
Administration
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A
A
Product
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High fix
 Perishability
Discipline !
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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)
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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
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Rev. Management in TL Trucking
Little opportunity during bid response

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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"
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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?

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Should capacity be committed to a particular
load/shipper/contract?, or should we wait for a
better-paying load?
Depends on the forecast…
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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
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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
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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)
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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)
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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)
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Final Observations
RM involves the entire enterprise
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Customer service
Sales
Reservations
Scheduling
RM can be used to increase profits and serve
customers better
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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
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The trick: reserve capacity to the highest paying customers
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Any Questions?
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