Maturity Mismatch (Revenue Mismatch)

Revenue Management consists of all that we have talked about in previous articles.  To recap it consists of Segment Pricing, Fenced Pricing, Capacity Management, Forecasting and Balanced Revenue Mix. 

Now, continuing with the theme of Balanced Revenue Mix I now want to go deeper into what can happen when a Maturity Mismatch occurs.  First, let me define Maturity Mismatch.  It originated as a financial term when the maturity dates (time horizon) of assets and liabilities are not aligned.  There are many different types of mismatch that can occur regarding interest rates, cash flows, currency conversions and maturity dates to name a few.  

There are also many different types of mismatch depending on the industry.  Insurance companies, brokerage companies, hedge funds, corporations, and investors can all have different reasons why they get into a mismatch.  Companies need to manage their mismatch closely because when assets and liabilities are not aligned over the time horizon then that can lead to losses or even bankruptcy. 

To give an example of maturity mismatch let’s say today short-term interest rates are lower than long-term interest rates.  A company wants to build a $50 million factory (asset) that will serve for 20 years and management decides to fund that development with short-term debt (liability) to save financing costs.  However, over the life of that factory the economy may change and short-term interest rates may become higher than long-term rates and that will result in a financial strain for the company.  In the finance industry it is always important to fund long-term assets with long-term liabilities (debt).  This way the funding is locked-in over the life of the asset creating a financially stable situation.

In the Pricing and Revenue Management industry we should apply this same concept to  Balanced Revenue Mix in order to avoid a term that I coined Revenue Mismatch.  Revenue Mismatch occurs when a company makes long-term investments based on revenue and profits earned from short-term or marginally profitable revenue.

In the 1990’s many airlines were perfecting their revenue management software as the power of new servers with new CPUs allowed them to make more computations in near real time.  By re-forecasting their available seats quickly (and using fenced pricing) they were able to sell their excess seats at marginal prices while maintaining their revenue from their primary business travellers.  One airline reported it made over $500 million in one year selling surplus seats at marginal prices.  Other airlines reported similar results.  That was good news and showed how offering different prices to different customers (segment pricing) can earn additional revenue and profit for these companies.

But then that is where the problems started.  These companies did not understand Maturity Mismatch, or as I said Revenue Mismatch.  With the additional marginal revenue and profits earned these airlines bought more airplanes, expanded routes and frequencies, hired more crews and made other long-term investments to grow their market share.  But then during the 2002 recession the passenger demand fell and many of these airlines filed for bankruptcy protection, and some even shut down completely.  Why?  Because they had long-term investments funded by marginally profitable revenue.  Those airlines used their marginal revenue to make long-term investments and when the economy went south those airlines found themselves in financial trouble.  Some have argued that Revenue Management caused these problems by selling seats at marginal prices.  I disagree.  It was not a revenue management problem, instead it was a management problem!  

Company management did not understand their customer segments and just saw revenue and profits growing without understanding their exposure, or mismatch, and decided to expand their company with long-term investments from marginal revenue.  

Instead, these companies should have understood their segments and made decisions based on their primary revenue, and should have treated their marginal revenue as extra profit to strengthen their balance sheets and/or pay dividends to their shareholders.  Maturity Mismatch (Revenue Mismatch) is critical to understand when managing a business.