Pricing & Revenue Management Decision Support

1. Pricing & Revenue Management Decision Support

2. Agenda Overview of pricing and revenue management Pricing & revenue management core concepts Traditional RM - availability optimization Market response model based P&RM Common framework for P&RM applications Talus Solutions. CONFIDENTIAL.

3. Revenue Management Defined “The application of disciplined tactics that predict consumer behavior at the micromarket level and optimize product availability and price to maximize revenue growth.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

4. What is Pricing and Revenue Management (PRM)? • It is a disciplined process for achieving profitable growth by assuring that the right products are sold: • To the right customer • Through the right channel • At the right time • At the right price • It is supported by technology deploying sophisticated management science methods • Demand modeling • Optimization Talus Solutions. CONFIDENTIAL.

5. Pricing & Revenue Management:Historical Synopsis • Developed in the early 1980’s as a result of airline deregulation • Initial successes lead to expansion into other industries • More impact than internally focused downsizing, re-engineering, etc. “Revenue Management ...The business strategy that is poised to explode” - Wall Street Journal, 1997 Talus Solutions. CONFIDENTIAL.

6. Business Business Processes Processes People People Information Information Systems Systems PRM requires more than technology PRM involves the interaction of technology, people and business processes toward a common goal, increased profitability Talus Solutions. CONFIDENTIAL.

7. Agenda Overview of pricing and revenue management Pricing & revenue management core concepts Traditional RM - availability optimization Market response model based P&RM Common framework for P&RM applications Talus Solutions. CONFIDENTIAL.

8. PRM Core Concepts 1. Sell to micro markets. 2. Exploit product value cycles. 3. Save products for the most valuable customers. 4. Focus on market-based pricing. 5. Focus on price rather than costs when balancing supply and demand. 6. Make decisions based on knowledge, not supposition. 7. Continually re-evaluate revenue opportunities. Talus Solutions. CONFIDENTIAL.

9. Sell to Micro Markets 1 “Market Segmentation is the key to market-based pricing and revenue maximization.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

10. Sell to Micro Markets 1 Micro Micro Mass Micro Versus Micro Micro Micro Market Attributes • Sell to Small Customer Groups • Creates Products for Each Customer Group Micro • Mass Market Attributes • Sell to Large Customer Groups • Creates and Sells a Single Product to Large Customer Group Talus Solutions. CONFIDENTIAL.

11. Market segments are groupings of customers who share: Purchase behavior Product needs Revenue management proposes you: Recognize selling a product vs. a commodity Develop products for each market segment Price each product according to customer purchase behavior and customer needs Sell to Micro Markets 1 Talus Solutions. CONFIDENTIAL.

12. $100 $100 $80 $60 PRICE $50 PRICE $40 $20 $1 $1 100 1 50 1 20 40 60 80 100 DEMAND DEMAND Sell to Micro Markets 1 DILUTED DEMAND UNACCOMMODATED DEMAND • one price • maximum achievable revenue of $2,500. • four prices • broader market segments can be addressed • produces $4,000 in revenue Talus Solutions. CONFIDENTIAL.

13. Exploit Product Value Cycles 2 “Generate maximum revenue by understanding the value cycle and optimally timing the availability and price of the product to each micro-market segment.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

14. Value Increases Over Time Value Decreases Over Time Price Price Time Time Exploit Product Value Cycles 2 Product value cycles represent the value of a product at any given time Different customers (market segments) value different things: Value may increase or decrease over time Knowing the product value cycle tells you what customers are willing to pay for your product at any given time. Talus Solutions. CONFIDENTIAL.

15. Product value cycles are also determined by market segment sensitivity to price changes (price elasticity) Demand is lesselastic when: Fewer acceptable options are available Product is perceived as inexpensive Limited time available to select a product Demand is more elastic when: More acceptable options are available Product is perceived as expensive Unlimited time available to select a product Pnew=$45 Pold=$30 Price D Quantity Qnew Qold Pnew=$45 Pold=$30 D Price Quantity Qnew Qold Exploit Product Value Cycles 2 Talus Solutions. CONFIDENTIAL.

16. Exploit Product Value Cycles 2 Revenue management proposes you: • Develop products to satisfy the needs and wants of each defined market segment Products are set of characteristics that meet a market segment’s wants and needs • Product characteristics may include: • Product features • Day of week/time of day • Advance purchase • Length of stay/rent • Flexibility …. Products are much more than just a rate! Talus Solutions. CONFIDENTIAL.

17. Save Products for Valuable Customers 3 “…you should find a way to predict which segments are willing to pay the most and save those products for them.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

18. Save Products for Valuable Customers 3 Accurate forecasts of unconstrained demand are essential to successful Revenue Management • Forecast accuracy depends upon the following • Quantity of data • Accuracy of data • Stability of data • Stability of the marketplace • Forecast methodology • How do forecasts enable you to save products for your most valuable customer? • Quantify the price inelastic late booking market segment • Identify over- and under-supply situations Talus Solutions. CONFIDENTIAL.

19. Miami Airport Location E-CAR Demand for Mondays in April 1998 1-Apr 8-Apr 15-Apr 22-Apr 200 29-Apr 150 100 Demand 50 0 0 4 8 12 16 20 24 Days Left 28 Save Products for Valuable Customers 3 Talus Solutions. CONFIDENTIAL.

20. Revenue management proposes you: Match demand forecasts with customer purchase behavior, in order to predict Who wants a given product When the request is made for the product Save products through: Inventory availability controls that save products for late booking price inelastic market segments Price breakpoints (discounts) to stimulate demand from price elastic market segments Save Products for Valuable Customers 3 Talus Solutions. CONFIDENTIAL.

21. Focus on Market Based Pricing 4 “The market (i.e., consumer) establishes the price, and your job is to find the market’s acceptable price point.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

22. Focus on Market Based Pricing 4 Cost-based pricing • Focuses on recovering costs • Sets product prices based on what corporations expect customers to pay for their goods and services • Does not consider customer price elasticity Market-based pricing: • Cost to create product is not primary driver • Sets products prices based on what customers are willing to pay • Requires information on price elasticity by market segment and product Talus Solutions. CONFIDENTIAL.

23. Focus on Market Based Pricing 4 Revenue Management proposes you: • Understand the demand for your products/services from each market segment • Recognize that customers do not consider the cost to produce a product/service when making their buying decision • Let the customer set the market price by buying or not buying the product/service Talus Solutions. CONFIDENTIAL.

24. Focus On Price When Balancing Supply and Demand 5 “The tendency for many companies encountering supply/demand imbalances is to remedy them by the use of capital assets. …Address short-term fluctuations first with price, then with capacity.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

25. D Demand S Supply Price Equilibrium Point PE=$30 QE=100 Quantity Focus On Price When Balancing Supply and Demand 5 Equilibrium points: • Exist for each market segment and product • Identify where supply and demand produce optimal returns Talus Solutions. CONFIDENTIAL.

26. Focus On Price When Balancing Supply and Demand 5 Revenue Management proposes you: • Practice rate optimization: • The function of using equilibrium points from multiple products and market segments to set rates that will maximize revenue • Set prices consumers will accept • Use prices to shift demand and utilize excess capacity: • When demand is high, prices should increase • When demand drops, offer discounts to sell products/service would otherwise go unsold. Talus Solutions. CONFIDENTIAL.

27. Make Decisions Based On Knowledge 6 “The RM tool that enables you to make decisions on knowledge, not supposition, is forecasting. It is essential to predict consumer behavior if you are going to exploit opportunities in the marketplace.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

28. Make Decisions Based On Knowledge 6 Human Forecasters • Intentional or unintentional biases • Hopeful • Focus on recent events • Use most accessible information Forecasting Systems • Based on customer transaction data • Use internal and external environmental factors • Predict customer behavior • Utilize sophisticated mathematical algorithms • Revenue Management proposes you: • Ensure quality data inputs • Use judgement and experience when using the data outputs Talus Solutions. CONFIDENTIAL.

29. Make Decisions Based on Knowledge Forecasting Parameters Historical Data Current Data Recent Trends Forecast Review, Adjust Prices Reports Optimize User Capacity Influences Recommend Accept, Reject or Modify Revenue Management System Distribution System Recommendation Review Measure Performance 6 Sample Revenue Management System Talus Solutions. CONFIDENTIAL.

30. Continually Re-evaluate Revenue Opportunities 7 “Give decision-support tools to the workers in the trenches to make dynamic decisions at the micromarket level.” - Robert G. Cross Revenue Management: Hardcore Tactics for Market Domination Talus Solutions. CONFIDENTIAL.

31. Continually Re-evaluate Revenue Opportunities 7 Markets are always changing; therefore, revenue opportunities are always changing Critical speed is replacing critical mass in capturing marketing opportunities • No time for “up-the-ladder” decision making Revenue Management proposes you: • Re-forecast as often as necessary • Empower and enable front-line workers to increase decision speed Talus Solutions. CONFIDENTIAL.

32. Continually Re-evaluate Revenue Opportunities 7 ? MarketSegmentation Customer Demand Data Forecasters Constraints ! Distribution $ Optimization Price and Availability Recommendations Talus Solutions. CONFIDENTIAL.

33. PRM Core Concepts 1. Sell to micro markets. 2. Exploit product value cycles. 3. Save products for the most valuable customers. 4. Focus on market-based pricing. 5. Focus on price rather than costs when balancing supply and demand. 6. Make decisions based on knowledge, not supposition. 7. Continually re-evaluate revenue opportunities. Talus Solutions. CONFIDENTIAL.

34. Agenda Overview of pricing and revenue management Revenue Management Core Concepts Traditional RM - availability optimization Market response model based P&RM Common framework for P&RM applications Talus Solutions. CONFIDENTIAL.

35. Traditional RM - Availability Optimization Allocation - Type Models • EMSRb • Math Programming - Stochastic Airline OD RMS - Delta Hotel RMS Talus Solutions. CONFIDENTIAL.

36. Expected Marginal (Seat) Revenue • Leg based airline systems • Room night based hotel systems • On-rent based rental car systems Talus Solutions. CONFIDENTIAL.

37. Math Programming Formulation • O&D base airline systems • Length of stay hotel systems • Length of rent car rental systems Talus Solutions. CONFIDENTIAL.

38. Agenda Overview of pricing and revenue management Revenue Management Core Concepts Traditional RM - availability optimization Market response model based P&RM Common framework for P&RM applications Talus Solutions. CONFIDENTIAL.

39. MRM-Based Pricing Market Response Models • Model win probability (Target Pricing), or market share (Promotions Pricing & Dynamic Pricing) as a function of • Product Characteristics • Customer Characteristics (segmentation) • Price ‘Pure’ MRM - based applications • Target Pricing - UPS • Promotions Pricing - Ford Talus Solutions. CONFIDENTIAL.

40. Objective of Target PricingContext: Ford Fleet Marketing Chose the target price that will maximize expected profit Given customer and bid characteristics , predict the probability of winning a bid as a function of Price Price can be relative to competitors’ prices, list price, or a business-as-usual (BAU) price, etc. Calculate Profit as a function of Price Choose Price that maximizes the Expected Profit Talus Solutions. CONFIDENTIAL.

41. Probability Curve from MRM 100% 90% 80% 70% Price Sensitivity = g 60% Brand Preference Probability of Winning Bid (%) 50% 40% 30% 20% 10% 0% 0.60 0.70 0.80 0.90 1.00 1.10 1.20 1.30 1.40 Offer Price BAU Price Talus Solutions. CONFIDENTIAL.

42. Calculating Profit • Here, candidate Target Prices are expressed as (List Price - Discount) • Note that in TP “Cost” is a pre-determined constant • for each product i . In fact, Cost could be a function of • customer or bid characteristics, or price. For example, • Shipping costs related to customer location • Production costs related to bid volume • Cost of a competitive price action related to price Profit Price Talus Solutions. CONFIDENTIAL.

43. Calculating Probability Target Pricinguses a Golden Section Search to find the maximum of the two-dimensional Expected Profit curve Maximize E(Profit) E(Profit) Net Price Talus Solutions. CONFIDENTIAL.

44. 30 30 30 20 10 20 10 10 20 0 0 0 How Is the Target Incentive Obtained? 25 20 Contribution ($1000) 15 Cost Information 10 5 0 X Discount (% off list) 100 80 Market Information and Strategic Goals Probability of Winning (%) 60 40 20 0 Discount (% off list) Target Price(22% Incentive) 10 8 Target Incentive Expected Contribution 6 4 2 0 Discount (% off list) Talus Solutions. CONFIDENTIAL.

45. Agenda Overview of pricing and revenue management Revenue Management Core Concepts Traditional RM - availability optimization Market response model based P&RM Common framework for P&RM applications Talus Solutions. CONFIDENTIAL.

46. Relationship Between Price and Availability Control: Are they the same thing? Yes and No. No: • MRM-based systems model customer response to changing prices - directly • Availability control paradigm, treats demand in different segments and at different price levels, as (sort of) independent. Yes: • both availability controls and price can/should be used to match supply and demand • Under some assumptions they can be shown to be the same • Many applications include both • Availability optimization systems often include aspects of market response (e.g. spill models). • MRM systems may incorporate availability constraints, or integrate with other systems that do Talus Solutions. CONFIDENTIAL.

47. Hybrid Solutions Dynamic Pricing - Fairchild Semiconductor • Uses sophisticated MRM modeling to predict market share • Incorporates supply constraints, at a high level Rental Car RMS - National Car Rental Systems • Technology mostly centered around availability optimization • Uses simple MRM models, and capacity constraints to generate rate recommendations • Second stage availability optimization produces LOR recommendations Broadcast RMS - The ABC Television Network • No forecasting algorithms - based on user specified sales forecasts • On the surface system recommends price (discount) • Behind the scenes is essentially an availability optimization, including opportunity costs associated with other (future) demand Talus Solutions. CONFIDENTIAL.

48. Integrated Systems:Promotions Pricing & Traditional Availability Optimization Bookings Res System Update forecast based on promotional lift HRMS Optimized Availability Room/LOS/rate allocations Predicted vacancies; opportunity cost by hotel/date Selected promotion: induced demand Rates Promotion usage Base Rates Rates DB Promotion Pricing Promotion rates & rules • Choose promo alternative • based on Hotel/LOS/Date range • Generate promo demand forecast Talus Solutions. CONFIDENTIAL.

49. Bonus: An Example RMS Architecture:Broadcast RMS Talus Solutions. CONFIDENTIAL.

50. Historical Seasonality Current Bookings Recent Trend Human Tweaking Factor Demand Forecast Rates Optimization Reports Overbooking Recommendations Human Tweaking Factor Reservations System Distribution Network Accept, Reject or Modify Performance Measurement Bonus: RMS Process Flow Talus Solutions. CONFIDENTIAL.