Revenue Management

We have talked about Segment Pricing as well as Fenced Pricing in previous articles so now we will keep building on those concepts and discuss the next concept known as Revenue Management.  

Revenue Management is a termed used (and often misused) in many industries for many different functions, however the accurate definition of Revenue Management is:

The application of disciplined tactics that predict consumer behavior at the segment level and optimize product availability and price to maximize revenue growth.

As the definitions implies Revenue Management adds two new dimensions of pricing to what has already been discussed, namely Capacity Management and Forecasting.  By improving forecasting one can predict customers segments better.  When predicting customers segments better one can apply fenced pricing.  Then by adding in capacity management it is now possible to further maximize revenue and profit.

Revenue Management is mostly used in the service sector and incorporates all pricing concepts to sell the right product to the right customer at the right time for the right price.  Companies that implement revenue management can expect between 2 to 7% revenue improvement which often results in 50 to 100% profit improvement!  This is because price improvements do not increase cost therefore all incremental revenue goes straight to the profit line.

There are seven key characteristics of companies that mostly benefit from revenue management:

1. Fixed capacity
   Companies such as airlines, hotels, theaters, restaurants, bus companies, etc., have a fixed number of seats, rooms or tables and cannot expand their capacity if there is a surge in demand at a given time or given day.
   
   
2. Perishable products
   A seat or room cannot be re-sold once it goes empty.  For example, if you don’t sell an airline seat that departs today you will never get that seat back to sell again.  
   
   
3. High fixed costs and low variable costs  
   Hotels, airlines, theaters are perfect examples of high fixed cost companies.  Once a plane is scheduled to fly, the cost of occupying one more seat is almost nothing.  Hotels are similar.  The hotel is already built, and rooms are available so the cost of having one more guest is minimal.
   
   
4. Price differentiation. 
   The product can be priced differently to different customers segments and/or willingness to pay.  This also allows companies to utilize marginal costing to sell more capacity at reduced rates (but you must have Fences in place).
   
   
5. Time variable demand 
   Different demand day to day, weekends vs weekdays, holidays, seasons, etc. allows companies to price differently based on market conditions.
   
   
6. Advanced purchase 
   A company should have some sort of reservations system or manual processes to keep track of inventory and remaining capacity as sales occur.  This can also be done with a simple forecast for small businesses.
   
   
7. Product wastage (no-shows)
   Some customers make reservations but do not show up.  Companies that have this problem can forecast no-show occurrences intelligently and can overbook a certain percentage of capacity in order to maintain higher occupancy rates.
   

A company does not need to meet all seven criteria to benefit from revenue management. Even if only a few of these conditions are met then revenue management may be quite beneficial.  

The coming articles will discuss in more detail how forecasting and capacity management is conducted to optimize revenue and profit.