Fundamentals of Operations Mgmt Revenue Management with Capacity Controls December, 2012

1. Fundamentals of Operations MgmtRevenue Managementwith Capacity ControlsDecember, 2012

2. Matching Demand & Supply is at the Core of Operations Mgmt Supply (Transformation/ Conversion) Profitable Revenue Demand Feedback Feedback Feedback Control There is a RESPONSE to a DEMAND forsomething valuable to Customers (Internal & External) and / or Society

3. A twist on the Commutative property in Mathematics The Commutative Law: When adding or multiplying two or more numbers, the Order in which the numbers are added or multiplied does not change the answer. Examples: 5 X 4 = 20 and 4 X 5 = 20 8 + 17 = 25 and 17 + 8 = 25 Matching Supply with Demand can also mean Matching Demand with Supply

4. A Reminder on Fixed and Variable Costs • Fixed Costs do not vary with Volume • Indirect employees • Overhead • Depreciation • SG&A • Variable Costs “vary” with Volume • Labor • Material • “Truly” Variable Cost (TVC) • Labor may not be “truly variable” • Difficult to account for volume discounts and learning, so material not “truly” variable Contribution Margin => (Selling Price – Variable Cost)

5. Perishable Capacity Services, consumable services, and some time-sensitive products cannot be inventoried and sold at a later date. The potential revenue that the capacity offers will be lost forever if buyers cannot be found • Services • Doctor not treating a patient • Stylist not styling hair • Music teacher not giving a lesson • Consumable services • Restaurant not selling a meal at 4:00 PM • An empty hotel room or airplane seat cannot be sold twice on a later date • An unrented rental car seat cannot be rented twice on a later date • Time-sensitive Products • Fresh fish is not fresh for long • Bakery products not baked today • And so on

6. Incentives to increase Demand for Perishable Capacity • Pricing • Restaurant coupons for midweek meals • Carwash coupons for midweek service • Priceline.com • Ticket agencies • Alternative production • Seasonal production (snow blowers in winter, jet skis in summer) • Catered meals prepared before the Lunch rush arrives • Bicycles and weight lifting equipment (both use tube bending technology) • Time-sensitive Products • One dollar for a dozen day-old bagels • Extra-ripe bananas on sale • Umberto’s Pizza

7. Examples of fixed supply: Travel industries (fixed number of seats, rooms, cars, etc). Advertising time (limited number of time slots). Telecommunications bandwidth. Size of the MBA program. Doctor’s availability for appointments. Revenue management is a solution: If adjusting supply is impossible – adjust the demand! Segment customers into high willingness to pay and low willingness to pay. Limit the number of tickets sold at a low price, i.e., control the average price by changing the mix of customers. Raising Prices when Demand is High & Perishable * Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

8. There is an opportunity to segment customers: different prices can be charged and different segments are willing to pay different prices. The same unit of capacity (e.g., airline seat) can be used to deliver services to different customer segments (e.g., business and leisure customers) at different prices. There are high gross margins so that the variable cost of additional sales is low Perishable and limited capacity (all possible customers cannot always be served). Capacity is sold in advance of demand. It is not illegal or morally irresponsible to discriminate among customers. Environments suitable for revenue management * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

9. Risk & Reward of Pre-building perishable Capacity The higher the margins, the more justifiable the risk • Product A would break even after 16 units and could bring $2400 in maximum profit (Risked $1600 to possibly make $2400) • Product E would break even only after 38 units and could bring only $200 in maximum profit (Risked $3800 to possibly make $200)

10. How many high-fare travelers will be refused a reservation? How many high-fare travelers will be accommodated? How many rooms will remain empty? What is the expected revenue? Unique issues for tiered-priced travel services Supply Price Demand Quantity Understanding PRICE ELASTICITY is a critical factor when stratifying customers * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

11. Demand forecasting Much information from reservation systems but there is seasonality, special events, changing fares & truncated demand data. Dynamic decisions. Variable capacity Different aircrafts, ability to move rental cars around. Group reservations. Non-refundability One-way vs round-trip tickets. Non-stop vs. connecting flights. Saturday-night stay requirement. Multi-leg passengers/multi-day reservations for cars and hotels: Not all customers using a given piece of capacity (a seat on a flight leg, a room for one night) are equally valuable. Revenue management challenge * Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

12. Approximately 50%of reservations get cancelled at some point in time. In many cases (car rentals, hotels, full fare airline passengers) there is no penalty for cancellations (which almost invites “no-shows”). Problem the company may fail to fill its capacity (e.g., seat, room or car) if the passenger cancels at the very last minute or does not show up. Solution (“over-booking”) accept/sell more reservations than capacity Danger (“bumping” loyal customers) some customers may have to be denied service even though they have a confirmed reservation. Cancellations and no-shows “Overbooking” is a necessary action to reduce the risk of capacity becoming available (while demand exists for the capacity) but without time to make the sale * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

13. Other Getting out of DEBT & Managing Cash Flow