Pricing in Supply Chains: Airline R evenue Management

1. Pricing in Supply Chains:Airline Revenue Management Salih ÖZTOP 20202801 14.05.2003

2. 1. Introduction Aim of the paper To give definitions and insights about the pricing ofseasonal products and give some future research directions such as pricing decision with substitute or complementary products. Pricing in Supply Chains

3. Revenue Management • Selling a fixed stock of items over a finite horizon for maximizing profit (revenue) • Examples: • Hotels’ renting rooms • Seasonal goods of retailers (swimsuits) (your additional orders cannot reach you during the season:fixed stock) • Airlines’ seats (you cannot sell today’s flight ticket tomorrow:finite horizon) Pricing in Supply Chains

4. Airline Revenue Management Short term costs are mostly fixed ex.Fuel usage for one flight Variable costs per passenger are small ex.Beverage cost per passenger “Pricing policy (booking) is the most important tool for profit maximization.” Pricing in Supply Chains

5. First Airline Pricing Problem In 1970s British Airways offered bookings with discounted fares bought at least 21 days before the departure. Problem: Determine the number of seats (protected)reserved for late booking with full fare Low Protection: Full fare demand is not satisfied High Protection: Departing with empty seats Pricing in Supply Chains

6. Airline Revenue Management Two fare classes: Discounted fare and full fare Decide whether accept or reject the low fare booking request when you have left some amount of seat capacity. Littlewood’s Rule(1972): Two fare classes, Accept the discount fare customers as their revenue value exceeded the expected marginal revenue of future full fare sales Rdiscount>Rfull * P(Full fare demand > remaining seat #) Pricing in Supply Chains

7. Factors Effecting Booking Decisions • Relative fare prices Reservation price: Maximum price that a customer is willing to pay for a product • Itineraries(leg combinations,Origin-Destination) • Season • Day of the week,Time of the day • Cancellation Penalties and Restrictions (Ex.Saturday night stays) To prevent full fare passenger taking the advantage of promotional fare Pricing in Supply Chains

8. Network Effect First airline pricing studies considered single legs only Today's airline network structure is more complicated and multiple legs forms one itinerary and different combinations can be used for the same origin destination pair. Pricing in Supply Chains

9. Example Airline Network Leg 1+Leg2=Itinerary 1 Leg 3=Itinerary 1 London New York Istanbul Leg 2 Leg 1 Paris Ankara Leg 3 Destination Origin Pricing in Supply Chains

10. Demand Models used Random variable: Demand for different legs assumed as random variables Stochastic:(Depends on t) Demand of leg depends on • Price of leg • Price of other legs • Remaining time before departure Pricing in Supply Chains

11. Pricing Decision When making pricing decision seller knows only the probability distribution of the reservation prices. Therefore seller faces a trade off between: Losing sales due to high prices Losing consumer surplus due to low prices Consumer Surplus:Difference between reservation price and product price (Bitran & Mondschein 1997) Pricing in Supply Chains

12. Models • Dynamic Programming used (Gallego& Van Ryzin 1997) • Price Set (P1,P2..,Pn) • Null Price: For closing one fare class, price of that fare assigned to extremely large value say infinity. • Deterministic demand case was used to determine a bound • Heuristics were developed Pricing in Supply Chains

13. Models • Switch price: 1) Switch when a certain amount of time passed 2) Switch when certain amoun of seat left • Feng Gallego 1995 (DP) • They cannot be optimal since revenue depends both the time-to-go and the remaining seat number. • Result: Increase the price as soon as the remaining time-to-go is above a time threshold depends on number of unsold seats Pricing in Supply Chains

14. Substitutate/Complementary • Complementary Products: Ex. Razor and Blade, price of Razor determines the Blade (complementary) sales amount • Substitute Products: Different leg combinations gives same Origin-Destination pair and price of them effects the capacity usage of each leg. Pricing in Supply Chains

15. Effects on Demand • In general Price is a function of item’s demand. • Price of Substitute products • Price of Complementary products • Bundling: • Pure Bundling • Mixed Bundling Pricing in Supply Chains

16. Conclusion&Research Directions • Although the airline revenue management is as early as 1970s they mostly consider the problem under single legs and given prices. However determination of prices and increasing network effect makes this issue still hot. • Including Group Booking Pricing in Supply Chains

17. Conclusion&Research Directions • Effect of Substitutable/Complementary Products(Bundling) • Including other firms price decisions (Game theoretical approaches) Pricing in Supply Chains

18. References Belobaba 1987 “Airline Yield Management:An overview of seat inventory control” Weather, Bodily 1992 “Taxonomy and Research overview of Perishable-Asset Revenue Management : Yield management Overbooking and Pricing” McGill, Van Ryzin 1994, “Revenue Management: Research Overview and Prospects Bitran, Mondschein 1997“Periodic pricing of Seasonal Products in Retailing” Feng, Gallego 1995 “Optimal Starting Times for End-of-Season sales and Optimal Stopping Times for Promotional sales” Gallego, Van Ryzin 1997 “A Multiproduct Dynamic Pricing problem and its Applications to Network Yield Management ” Pricing in Supply Chains

19. 5. Questions & Answers Thank you Pricing in Supply Chains