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Supply Chain Management

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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Supply Chain Management

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  1. Supply Chain Management Lecture 25

  2. Semester Outline • Tuesday April 20 Chap 15 • Thursday April 22 Simulation Game briefing • Tuesday April 27 Review, buffer • Thursday April 29 Simulation Game

  3. 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

  4. 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

  5. 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

  6. Revenue Management Revenue Management:Maps capacity into demand Newsvendor problem:Maps demand into capacity

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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?

  19. 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

  20. 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?

  21. c = 10 Example 15-1: Pricing to multiple segments d1 = 5,000 – 20p1

  22. c = 10 Example 15-1: Pricing to multiple segments d1 = 5,000 – 20p1 Profit p - c

  23. 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

  24. Pricing Multiple Segments • The optimal price for segment i is given by • pi = Ai/2Bi + c/2

  25. 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

  26. 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

  27. 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

  28. 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

  29. 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

  30. 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?

  31. 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?

  32. 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

  33. 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

  34. 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

  35. 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

  36. 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

  37. 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

  38. 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?

  39. 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

  40. 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?

  41. 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

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