Discussion 5

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Pricing and Revenue Management in a Supply Chain

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Chopra and Meindl Supply Chain Management, 5e

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Learning Objectives

Understand the role of revenue management in a supply chain

Identify conditions under which revenue management tactics can be effective

Describe trade-offs that must be considered when making revenue management decisions

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Assets don’t vary but demand fluctuates.

How to better match demand and supply

The Role of Pricing and Revenue Management in the Supply Chain

Revenue management is the use of pricing to increase the profit generated from a limited supply of supply chain assets

Supply assets exist in two forms – capacity and inventory

Revenue management may also be defined as the use of differential pricing based on customer segment, time of use, and product or capacity availability to increase supply chain profits

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Assets take two forms: Capacity and Inventory

Capacity ( production) : machines, trucks, storage space is available

Inventory: Distributor, warehouse or in transit

Eg Amazon: Shipping cost is not constant- e.g. urgency of shipping : price

American Airlines: fare that is lower than those of low cost carrier. Strategy: started to offer lower prices on flights that are usually not full lower than competitor

The Role of Pricing and Revenue Management in the Supply Chain

Revenue management has a significant impact on supply chain profitability when one or more of the following four conditions exist

The value of the product varies in different market segments

The product is highly perishable or product waste occurs

Demand has seasonal and other peaks

The product is sold both in bulk and on the spot market

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1 . Eg ( ailine tickets)

Seasonal ( beginning vs end of season) e.g. Capacity is lost if machine is not being used. Transportation is not full and being used. The next day the truck is not available for a full load

Hotel rooms:

Long term purchase: e.g. cruises

Pricing and Revenue Management for Multiple Customer Segments

Differential pricing increases total profits for a firm

Two fundamental issues must be handled in practice

How can the firm differentiate between the two segments and structure its pricing to make one segment pay more than the other?

How can the firm control demand such that the lower-paying segment does not utilize the entire availability of the asset?

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E.g. Airlines Business and vacation travelers. Structure pricing. How to utilize demand so that the vacation travelers are not utilizing the entire capacity.

Business travelers usually purchase short term. Whereas vacation travelers purchase way in advance. Want to attract vacation travelers early we may not have seats available for business travelers.

Pricing and Revenue Management for Multiple Customer Segments

Figure 16-1

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Pricing and Revenue Management for Multiple Customer Segments

Figure 16-2

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6000 dx 2.00 = 12,000

3000 dx 3.5 = 10,500

At 2.00 x 3000 d =6,000 + ( 10,500) = 16.500

How far in advance the customer is willing to commit this pricing for discount. can give a better outcome.

Last minute purchase at 3.50 can get better profit.

How do you limit capacity for each segment buyer?

3000 for 2.00

300 for 3.50.

Allocating Capacity to a Segment Under Uncertainty

Basic trade-off is between committing to an order from a lower-price buyer or waiting for a higher-price buyer to arrive

Spoilage

Spill

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Risk: spoilage = wasted because higher price buyer is not coming to purchase

Spill: no availability for higher price buyer because you are full. (turn away consumers)

Allocating Capacity to a Segment Under Uncertainty

Effective use of revenue management increases firm profits and improves service for the more valuable customer segment

Create different versions of a product targeted at different segments

Tactics for multiple customer segments

Price based on the value assigned by each segment

Use different prices for each segment

Forecast at the segment level

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Pricing and Revenue Management for Perishable Assets

Any asset that loses value over time is perishable

Two basic approaches

Vary price dynamically over time to maximize expected revenue

Overbook sales of the asset to account for cancellations

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Perishables: losses value over time: Electronics, fashion, fruits,

Dynamic pricing: E.g. airline tickets- piece changes over time.

Overbook : selling more tickets for a flight to gain revenue.

Dynamic Pricing

Effective differential pricing increases the level of product availability for the consumer willing to pay full price and total profits for the retailer

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Overbooking

Basic trade-off is between having wasted capacity because of excessive cancellations or having a shortage of capacity because of few cancellations requiring expensive backup

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Pricing and Revenue Management for Seasonal Demand

Seasonal peaks of demand common in many supply chains

Off-peak discounting can shift demand from peak to non-peak periods

Charge higher price during peak periods and a lower price during off-peak periods

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e.g. Amazon during Christmas offering free shipping

E.g. Movie tickets : early bird or

Pricing and Revenue Management for Bulk and Spot Contracts

Problems constructing a portfolio of long-term bulk contracts and short-term spot market contracts

Decide what fraction of the asset to sell in bulk and what fraction of the asset to save for the spot market

The amount reserved for the spot market should be such that the expected marginal revenue from the spot market equals the current revenue from a bulk sale

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Decide how much to have projected for bulk market or spot market.

Purchase bulk at discount vs spot at full price.

What portion to sell in bulk and what portion to save for spot market.

Using Pricing and Revenue Management in Practice

Evaluate your market carefully

Quantify the benefits of revenue management

Implement a forecasting process

Keep it simple

Involve both sales and operations

Understand and inform the customer

Integrate supply planning with revenue management

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Summary of Learning Objectives

Understand the role of revenue management in a supply chain

Identify conditions under which revenue management tactics can be effective

Describe trade-offs that must be considered when making revenue management decisions

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