Dynamic Pricing andYield Mana ementg
Yossi Sheffi Professor, MIT
ESD.260J/1.260J/15.770J
What you are is clear – the only issue is price…
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Outline
Airline revenue management
discrimination Revenue management in TL trucking
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The essence of price
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Yield/Revenue Management
Objective:
Integrated management of capacity and pricing
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maximize revenue (minimize lost revenue / opportunity costs) “Science of squeezing every possible dollar from customers”
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Revenue Management Example: Airline
$1,000 Price
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# of Seats
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Price
Revenue Management Example : Airline
$1,000
100
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$500
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# of Seats
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Price
Revenue Management Example: Airline
$750 $1,000
100
50
$500
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# of Seats
R=$31,250
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Price
Revenue Management Example: Airline
$750 $1,000
100
50
$500
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$250
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© Yoss Sheffi, MIT
# of Seats
R=$37,500
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ithe curve) =
Price$1,000
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Revenue Management Example: Airline
Note: ≠ happiness to pay…
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Max mum Revenue: (area under $50,000
# of Seats
willingness to pay
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Two Challenges:
who are willing to pay $750 will not buy the $250 ticket? How do we make sure that we have enough seats for those willing to pay $750?
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How do we make sure that the people
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Two Answers: Create artificial hurdles: �
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Note 1: airlines do not change prices
Note 2: freight can also displace passengers when RM is really optimized
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Advance purchase: 21 days, 14 days, 7days Use limitations: Saturday night stay, non-refundable tickets
Restrict the number of seats sold at the low price This requires a forecast of future booking by higher-paying customers and the discipline to forgo a “bird-in-hand.”
dynamically; they actually change capacity (classes) dynamically
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Why is This Important?
American Airlines saved over $1.4B between 1989-1992 “I believe that yield management is the single most important technical development in transportation management . . . “ � Robert
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Crandall, CEO AMR
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Markdown Opportunity: �
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Goals / Trends: � Movement to more Localized pricing decisions �
inventory � ity as store
Markdowns Markdowns are one of the main levers that retailers have to influence results in-season. As such, it can be a very powerful driver of performance.
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Markdowns may represent more than 30% of total sales Short-cycle product can represent up to 80% of a retailer’s assortment In some segments, short-cyc e products may represent a smaller percentage of the assortment but still have a significant impact on gross margin (up to 40%)
Growing realization of the true cost of left-over
Greater emphasis on inventory productivbase growth slows
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Sales Rate-Based Discounting After initial sales rate (r0= i0/t0) Required sales rate: r1=i1 0- t1) %r required: (r1/ r0)-1 Divide by ε Get the % price changerequired
Inve
nto
ry
t1 t2 t0
i1
i0
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/(t
Time
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Price Discrimination �
� College financial aid � Taxes
Second degree: artificial hurdles but open �
� store P/U,
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First degree: willingness to pay (rare) RR in late 1800-s, asking shippers for their income statement so they could determine their ability to pay
Buying process (coupons, advance purchase…) Cost to serve (volume discounts, risk adjustments,“set up” costs in travel industry…) Distribution channels (Internet, outlets, etc.) Markdowns (timing of purchase, product age, selection, etc.) Value of product (in many rail movements; regeltarifklassen) Commodity type (part of tariffs; in many rail movements) Use limitations (e.g., “final sale”) Bundling (“menu” vs. “a-la-cart”) Time of use (e.g., hour, congestion pricing)
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Price Discrimination
Second degree: artificial hurdles but open l factors
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� Profession/affiliatieducational, medical…)
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First degree: willingness to pay (rare)
Third degree: based on externaGeography (neighborhood, state) Gender (women’s clothing)
Age (senior/student discounts) on (small/large business business;
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3rd Degree Discrimination
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� Online shopping: Dell Computer
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l i ion
Specific Example
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Dimension® 8200 Series, Pentium® 4 Processor at 1.7 GHz
128MB PC800 RDRAM
New Dell® Enhanced QuietKey Keyboard
Video Ready w/o Monitor
32MB NVIDIA GeForce2 MX 4X AGP Graphics Card with TV-Out
40GB Ultra ATA/100 Hard Drive
3.5 in Floppy Drive
Microsoft® Windows® Millennium with WinXP Home Upgrade Coupon
MS IntelliMouse®
10/100 PCI Fast Ethernet NIC
56K Te ephony Modem for W ndows-Sound Opt
48X Max Variable CD-ROM
Integrated Audio with Soundblaster Pro/16 Compatibility
Harman Kardon HK-395 Speakers
Upgrade to Microsoft® Office Small Business w/EducateU
3 Year Ltd. Warranty, 3 Year At Home Service, Lifetime 24x7 Phone Support
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University
Home
Base Price
Specific Example
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$1,427
$1,327 Student
$1,338 Large business
$1,238 Small business
$1,378
User
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monopoly; ST monopoly situations; oligopoly nt-sanctioned oligopoly – ocean
s)ntation ability
Cost to manage multiple pricingAbility to change costs quickly
ed costs and low marginal costs
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When Does YM Work?
Economic conditions � Demand (LT
with signaling; Governme conference
� Segme � No arbitrage
Administration �
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Product � High fix � Perishability
Discipline !
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Marketing nd
Avoid gauging
rd
student/senior citizen discounts ll)
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Most schemes are based on 2 degree discrimination – seems more fair (choice is available) Positioning the message: discounts are more acceptable than price increases, even if the result is the same
“Profiteering” is not acceptable
Use open communications
Some forms of 3 degree discrimination are illegal, but many are acceptable:
profession/use (De
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Carrier Portfolio of Pricing
Dynamic pricing with contracted
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LT fixed rate contracts with capacity commitments
Long-term fixed-rate contracts
shippers
Dynamic pricing with spot market shippers
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Rev. Management in TL Trucking
� No monopoly power � Exceptions: good service history coupled with
client strategy geared towards service � Value-added services
� There are limited opportunities for local/temporary monopolies: �
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Little opportunity during bid response
Only opportunity in real-time (spot) market
Responses to shipper “dialing for diesels” Requests along “power lanes”
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Rev. Management in TL Trucking
Remember the twin challenges: � How do we make sure that the people who are
willing to pay $750 will not buy the $250 ticket? � How do we make sure that we have enough seats
for those willing to pay $750? Comes down to one question:
Should we take this load? � Should capacity be committed to a particular
load/shipper/contract?, or should we wait for a better-paying load?
� Depends on the forecast…
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Strategic Decisions Set the Limits for Tactical Decisions
Structural • Size of fleet • Market focus – regions, industries, equipment • Relationships with O/Os, 3PLs
Strategic • Percent of business under long-term contract • Long-term contract rates • Bid-response strategies • Capacity commitments • Seasonal Pricing
• Demand booking and solicitation Tactical • Dynamic pricing • Proactive empty repositioning • Driver assignment
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System Contribution of a Load
Regional potential: the expected
P(A) A D(A-B) from A to B R(A-B) A to B
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contribution of a truck in a region. - Potential of region
- Direct cost for moving a truck
- Revenue for the move from
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System Contribution of a Load
Direct contribution
more truckless
Order acceptance: - l-
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S(A-B) = R(A-B) - D(A-B) + P(B) - P(A)
System impact
P(B) - the value of one at region B P(A) - the value of one truck at region A
Take a oad only if S(A-B) > 0 Take the load with the highest S(A-B)
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Analysis of Movements
Head haul:
Back haul:
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S(A-B) = R(A-B) - D(A-B) + P(B) - P(A)
S(A-B) = R(A-B) - D(A-B) + P(B) - P(A)
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YM in Manufacturing
Reserve capacity to the highest paying customer Tie the pricing to the capacity
Use pricing to manage component supply (in BTO)
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commitment
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Final Observations
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� Sales � Reservations � Scheduling
RM can be used tocustomers better �
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capacity and pricing simultaneously �
© Yoss Sheffi, MIT
RM involves the entire enterprise Customer service
increase profits and serve
Bring in those who otherwise would not use the service Provide higher LOS to those who pay a lot by giving them more frequent service, higher probability of service, etc. Increase utilization by smoothing demand patterns
The essence of RM is the judicious management of
The trick: reserve capacity to the highest paying customers
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Any Questions?
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