Yield management
Encyclopedia
Revenue management is the process of understanding, anticipating and influencing consumer
behavior
in order to maximize yield
or profits
from a fixed, perishable resource (such as airline seats or hotel room reservations). As a specific, inventory-focused branch of revenue management
, yield management involves strategic control of inventory to sell it to the right customer at the right time for the right price. This process can result in price discrimination
, where a firm charges customers consuming otherwise identical goods or services a different price for doing so. Yield management is a large revenue generator for several major industries; Robert Crandall
, former Chairman and CEO of American Airlines
, gave Yield Management its name and has called it "the single most important technical development in transportation management since we entered deregulation."
is generally regarded as the catalyst for yield management in the airline industry, but this tends to overlook the role of Global Distribution Systems (GDSs). It is arguable that the fixed pricing paradigm occurs as a result of decentralized consumption. With mass production
, pricing became a centralized management activity and customer contact staff focused on customer service
exclusively. Electronic commerce
, of which the GDSs were the first wave, created an environment where large volumes of sales could be managed without large numbers of customer service staff. They also gave management staff direct access
to price at time of consumption and rich data capture for future decision-making.
On January 17, 1985, American Airlines
launched Ultimate Super Saver fares in an effort to compete with low cost carrier PEOPLExpress. Donald Burr, the CEO of PeopleExpress, is quoted as saying "We were a vibrant, profitable company from 1981 to 1985, and then we tipped right over into losing $50 million a month...We had been profitable from the day we started until American came at us with Ultimate Super Savers." in the book "Revenue Management" by Robert G. Cross, Chairman and CEO of Revenue Analytics. The Yield management systems developed at American Airlines were recognized by the Edelman Prize committee of INFORMS for contributing $1.4 billion in a three year period at the airline.
Yield management spread to other travel and transportation companies in the early 1990s. Notable was implementation of Yield management at National Car Rental. In 1993, General Motors
Corporation was forced to take a $744 million charge against earnings related to its ownership of National Car Rental
Systems. In response, National's program expanded the definition of Yield management to include capacity management
, pricing and reservations control. As a result of this program, General Motors was able to sell National Car Rental Systems for an estimated $1.2 billion. Yield Management gave way to the more general practice of Revenue Management. Whereas Revenue Management involves predicting consumer behavior by segmenting markets, forecasting demand, and optimizing prices for several different types of products, Yield Management refers specifically to maximizing revenue through inventory control. Some notable Revenue Management implementations include the NBC
which credits its system with $200 million in improved ad sales from 1996 to 2000, the Target Pricing initiative at UPS
, and Revenue management at Texas Children's Hospital. Since 2000, much of the dynamic pricing, promotions management and dynamic packaging
that underlie ecommerce sites leverage Revenue management techniques. In 2002 GMAC launched an early implementation of web based revenue management in the financial services industry.
There have also been high profile failures and faux pas
. Amazon.com
was criticized for irrational price changes that resulted from a Revenue management software bug
. The Coca-Cola Company's plans for a dynamic pricing vending machine
were put on hold as a result of negative consumer reactions. Revenue management is also blamed for much of the financial difficulty currently experienced by legacy carriers. The reliance of the major carriers on high fares in captive markets arguably created the conditions for low cost carriers to thrive.
If the resources available are not fixed or not perishable, the problem is limited to logistics, i.e. inventory or production management
. If all customers would pay the same price for using the same amount of resources, the challenge would perhaps be limited to selling as quickly as possible, e.g. if there are costs for holding inventory.
Yield management is of especially high relevance in cases where the constant costs are relatively high compared to the variable cost
s. The less variable cost there is, the more the additional revenue earned will contribute to the overall profit. This is because it focuses on maximizing expected marginal revenue for a given operation and planning horizon
. It optimizes resource utilization by ensuring inventory availability to customers with the highest expected net revenue
contribution and extracting the greatest level of ‘willingness to pay’ from the entire customer base
. Yield management practitioners typically claim 3% to 7% incremental revenue gains. In many industries this can equate to over 100% increase in profits.
Yield management has significantly altered the travel and hospitality industry
since its inception in the mid 1980s. It requires analysts with detailed market knowledge and advanced computing systems who implement sophisticated mathematical techniques to analyze market behavior and capture revenue opportunities. It has evolved from the system airlines invented as a response to deregulation and quickly spread to hotels, car rental
firms, cruise line
s, media, telecommunications and energy to name a few. Its effectiveness in generating incremental revenues from an existing operation and customer base has made it particularly attractive to business leaders that prefer to generate return from revenue growth and enhanced capability rather than downsizing and cost cutting.
case, capacity is regarded as fixed because changing what aircraft flies a certain service based on the demand is the exception rather than the rule. When the aircraft departs, the unsold seats cannot generate any revenue and thus can be said to have perished. Airlines use special software to monitor how seats are being reserved and react accordingly, for example by offering discounts when it appears that seats will remain unsold.
Another way of capturing varying willingness to pay is to attempt market segmentation. A firm may repackage its basic inventory into different products to this end. In the passenger airline case this means implementing purchase restrictions, length of stay
requirements and requiring fees for changing or canceling tickets.
The airline needs to keep a specific number of seats in reserve to cater to the probable demand for high-fare seats. The price of each seat varies inversely with the number of seats reserved, that is, the fewer seats that are reserved for a particular category, the lower the price of each seat. This will continue till the price of seat in the premium class equals that of those in the concession class. Depending on this, a floor price (lower price) for the next seat to be sold is set.
, Megabus (North America), BoltBus
, and easyBus
, which run low-cost networks in the UK and parts of the US, and more recently, nakedbus.com
and Intercape, which have networks in New Zealand and South Africa. Now operating in Chile with Turbus, also known as Tu precio.
industry, yield optimization is focused on producing supply and demand
forecasts to determine rent recommendations for profit optimization. However, the use of the yield optimization systems is fairly new to the industry in the late 1990s, with Archstone Smith pioneering its use. The multifamily industry currently has two providers of yield management systems, the LRO (Lease Rent Options) Revenue Management System from Rainmaker, and the M/PF YieldStar Asset Optimization System from RealPage.
s utilize an average of just 35 to 40 percent of available network capacity. Recently, telecommunications software vendors such as Telcordia and Ericsson
have promoted yield management as a strategy for communications service providers to generate additional revenue and reduce capital expenditures by maximizing subscriber use of available network bandwidth. Approaches include basing a strategy on innovative services explicitly designed to use only spare capacity and borrowing proven methods from the airline industry. The approach can be more difficult to implement in the telecommunications industry than the airlines sector because of the difficulty to control and sometimes refuse network access to customers. Similarities that exist between the airline and telecom industries include a large sunk cost combined with low marginal cost, perishable inventory, reservations, pricing flexibility and the opportunity to upsell. Differences that present challenges for communications service providers include low-value transactions and overall network complexity. Suggested approaches to executing a successful yield management strategy include accurate network information collection, bandwidth capacity allocation that doesn’t impact service quality, the deployment of service management software such as Real time policy
and Real Time Charging
, and using new marketing channels to target consumers with innovative services.
center on detailed forecasting and mathematical optimization
of marginal revenue opportunities. The opportunities arise from segmentation of consumer willingness to pay. If the market for a particular good follows the simple straight line Price/Demand relationship illustrated below, a single fixed price
of $50 there is enough demand to sell 50 units of inventory. This results in $2500 in revenues. However the same Price/Demand relationship yields $4000 if consumers are presented with multiple prices.
In practice, the segmentation approach relies on adequate fences between consumers so that everyone doesn't buy at the lowest price offered. The airlines use time of purchase to create this segmentation, with later booking customers paying the higher fares. The fashion industry
uses time in the opposite direction, discounting later in the selling season once the item is out of fashion or inappropriate for the time of year. Other approaches to fences involve attributes that create substantial value to the consumer at little or no cost to the seller. A backstage pass
at a concert is a good example of this. Initially Yield Management avoided the complexity caused by the interaction of absolute price and price position by using surrogates for price such as booking class. By the mid-1990s, most implementation incorporated some measures of price elasticity
. The airlines were exceptional in this case, preferring to focus on more detailed segmentation by implementing O&D (Origin & Destination) systems.
At the heart of yield management decision-making process is the trade-off
of marginal yields from segments that are competing for the same inventory. In capacity-constrained cases, there is a bird-in-the-hand decision that forces the seller to reject lower revenue generating customers in the hopes that the inventory can be sold in a higher valued segment. The tradeoff is sometimes mistakenly identified as occurring at the intersection of the marginal revenue curves for the competing segments. While this is accurate when it supports marketing decisions where access to both segments is equivalent, it is wrong for inventory control
decisions. In these cases the intersection of the marginal revenue
curve of the higher valued segment with the actual value of the lower segment is the point of interest.
In the case illustrated here, a car rental company must set up protection levels for its higher valued segments. By estimating where the marginal revenue curve of the luxury segment crosses the actual rental value of the midsize car segment the company can decide how many luxury cars
to make available to midsize car renters. Where the vertical line
from this intersection point crosses the demand (horizontal) axis determines how many luxury cars should be protected for genuine luxury car renters. The need to calculate protection levels has led to a number of heuristic solutions, most notable EMSRa and EMSRb, which stands for Expected Marginal Seat Revenue
version a and b respectively. The balancing point of interest
is found using Littlewood's rule which states that demand for
should be accepted as long as
2 
1
1
where
is the value of the lower valued segment
is the value of the higher valued segment
is the demand for the higher valued segment and
is the capacity left
This equation is re-arranged to compute protection levels as follows:
1
−1
2
1
In words, you want to protect
1 units of inventory for the higher valued segment where 
1 is equal to the inverse probability
of demand of the revenue ratio of the lower valued segment to the higher valued segment. This equation defines the EMSRa algorithm which handles the two segment case. EMSRb is smarter and handles multiple segments by comparing the revenue of the lower segment to a demand weighted average
of the revenues of the higher segments. Neither of these heuristics produces the exact right answer and increasingly implementations make use of Monte Carlo simulation
to find optimal protection levels.
Since the mid 1990s increasingly sophisticated mathematical models have been developed such as the dynamic programming
formulation pioneered by Talluri and Van Ryzin which has led to more accurate estimates of bid prices. Bid prices represent the minimum price a seller should accept for a single piece of inventory and are popular control mechanisms
for Hotels and Car Rental firms. Models derived from developments in financial engineering are intriguing but have been unstable and difficult to place the parameters in practice. Yield management tends to focus on environments that are less rational than the financial markets.
that engage in yield management usually use computer
yield management systems to do so. The Internet
has greatly facilitated this process.
Enterprises that use yield management periodically review transactions for goods or services already supplied and for goods or services to be supplied in the future. They may also review information (including statistics) about events (known future events such as holidays, or unexpected past events such as terrorist attacks), competitive information (including prices), seasonal patterns, and other pertinent factors that affect sales. The models attempt to forecast total demand for all products/services they provide, by market segment and price point
. Since total demand normally exceeds what the particular firm can produce in that period, the models attempt to optimize the firm's outputs to maximize revenue.
The optimization attempts to answer the question: "Given our operating constraints, what is the best mix of products and/or services for us to produce and sell in the period, and at what prices, to generate the highest expected revenue?"
Optimization can help the firm adjust prices and to allocate capacity among market segments to maximize expected revenues. This can be done at different levels of detail:
Yield management is particularly suitable when selling perishable products, i.e. goods that become unsellable at a point in time (for example air tickets just after a flight takes off). Industries that use yield management include airlines, hotels, stadiums and other venues with a fixed number of seats, and advertising. With an advance forecast of demand and pricing flexibility, buyers will self-sort based on their price sensitivity (using more power in off-peak hours or going to the theater mid-week), their demand sensitivity (must have the higher cost early morning flight or must go to the Saturday night opera) or their time of purchase (usually paying a premium for the luxury of booking late).
In this way, yield management's overall aim is to provide an optimal mix of goods at a variety of price points at different points in time or for different baskets of features. The system will try to maintain a distribution
of purchases over time that is balanced as well as high.
Good yield management maximizes (or at least significantly increases) revenue production for the same number of units, by taking advantage of the forecast of high demand/low demand periods, effectively shifting demand from high demand periods to low demand periods and by charging a premium for late bookings. While yield management systems tend to generate higher revenues, the revenue streams tends to arrive later in the booking horizon as more capacity is held for late sale at premium prices.
Firms faced with lack of pricing power sometimes turn to yield management as a last resort. After a year or two using yield management, many of them are surprised to discover they have actually lowered prices for the majority of their opera seats or hotel rooms or other products. That is, they offer far higher discounts more frequently for off-peak times, while raising prices only marginally for peak times, resulting in higher revenue overall.
By doing this, they have actually increased quantity demanded by selectively introducing many more price points, as they learn about and react to the diversity of interests and purchase drivers of their customers.
s that determine airline ticket
prices could feasibly consider frequent flyer information, which includes a wealth of socio-economic
information such as age and home address. The airline then could charge higher prices to consumers who are between 30 and 65 or live in neighborhoods with higher average wealth, even if those neighborhoods also include poor households. Very few (if any) airlines using Yield Management are able to employ this level of price discrimination because prices are not set based on characteristics of the purchaser, which are in any case often not known at the time of purchase.
Some consumers also object that it is impossible for them to boycott yield management when buying some goods, such as airline tickets.
Yield Management also includes many noncontroversial and more prevalent practices, such as varying prices over time to reflect demand. This level of yield management makes up the majority of YM in the airline industry. For example airlines may make a ticket on the Sunday after Thanksgiving more expensive than the Sunday a week later. Alternatively, they may make tickets more expensive when bought at the last minute than when bought six months in advance. The goal of this level of yield management is essentially trying to get demand to equal supply.
When YM was introduced in the early 1990s, primarily in the airline industry, many suggested that despite the obvious immediate increase in revenues, it might harm customer satisfaction
and loyalty, interfere with relationship marketing
, and drive customers from firms that used YM to firms that did not. To frequent flier programs were developed as a response to regain customer loyalty
and reward frequent and high yield
passengers. Today, YM is nearly universal in many industries, including airlines.
Despite optimising revenue in theory, introduction of yield management can sometimes fail to achieve this in practice because of corporate image
problems. In 2002, Deutsche Bahn
, the German
national railway
company, experimented with yield management for frequent loyalty card
passengers. The fixed pricing model that had existed for decades was replaced with a more demand-responsive pricing model, but this reform proved highly unpopular with passengers, leading to widespread protests and a decline in passenger numbers.
have begun to study the yield management decisions of actual human decision makers. One question that this research addresses is how much might revenues increase if managers relied on yield management systems rather than their own judgment when making pricing decisions. Using methods from experimental economics
, this work has revealed that yield management systems are likely to increase revenues significantly http://behavioral-or.org/files/RMPaper1.pdf http://www.behavioral-or.org/papers/DynPrice.pdf. Further, this research reveals that "errors" in yield management decisions tend to be quite systematic. For instance, Bearden, Murphy, and Rapoport showed that with respect to expected revenue maximizing policies, people tend to price too high when they have high levels of inventory and too low when their inventory levels are low.
Consumer
Consumer is a broad label for any individuals or households that use goods generated within the economy. The concept of a consumer occurs in different contexts, so that the usage and significance of the term may vary.-Economics and marketing:...
behavior
Behavior
Behavior or behaviour refers to the actions and mannerisms made by organisms, systems, or artificial entities in conjunction with its environment, which includes the other systems or organisms around as well as the physical environment...
in order to maximize yield
Yield
-Physics/chemistry:* Yield , the amount of product obtained in a chemical reaction** The arrow symbol in a chemical equation* Fission product yield* Nuclear weapon yield-Earth science:* Crop yield** Yield...
or profits
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
from a fixed, perishable resource (such as airline seats or hotel room reservations). As a specific, inventory-focused branch of revenue management
Revenue management
Revenue Management is the application of disciplined analytics that predict consumer behavior at the micro-market level and optimize product availability and price to maximize revenue growth. The primary aim of Revenue Management is selling the right product to the right customer at the right time...
, yield management involves strategic control of inventory to sell it to the right customer at the right time for the right price. This process can result in price discrimination
Price discrimination
Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider...
, where a firm charges customers consuming otherwise identical goods or services a different price for doing so. Yield management is a large revenue generator for several major industries; Robert Crandall
Robert Crandall
Robert Lloyd "Bob" Crandall is the former president and chairman of American Airlines. Called an industry legend by airline industry observers, Crandall has been the subject of several books and is a member of the Hall of Honor of the Conrad Hilton college.-Life:Robert Crandall was raised in Rhode...
, former Chairman and CEO of American Airlines
American Airlines
American Airlines, Inc. is the world's fourth-largest airline in passenger miles transported and operating revenues. American Airlines is a subsidiary of the AMR Corporation and is headquartered in Fort Worth, Texas adjacent to its largest hub at Dallas/Fort Worth International Airport...
, gave Yield Management its name and has called it "the single most important technical development in transportation management since we entered deregulation."
Definition
Yield management has become part of mainstream business theory and practice over the last fifteen to twenty years. Whether an emerging discipline or a new management science (it has been called both), yield management is a set of yield maximization strategies and tactics meant to improve the profitability of certain businesses that focus on yield. It is complex because it involves several aspects of management control, including rate management, revenue streams management, and distribution channel management, just to name a few of them. Yield management is multidisciplinary because it blends elements of marketing, operations, and financial management into a highly successful new approach. Yield management strategists frequently must work with one or more other departments when designing and implementing yield management strategies.History
DeregulationDeregulation
Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...
is generally regarded as the catalyst for yield management in the airline industry, but this tends to overlook the role of Global Distribution Systems (GDSs). It is arguable that the fixed pricing paradigm occurs as a result of decentralized consumption. With mass production
Mass production
Mass production is the production of large amounts of standardized products, including and especially on assembly lines...
, pricing became a centralized management activity and customer contact staff focused on customer service
Customer service
Customer service is the provision of service to customers before, during and after a purchase.According to Turban et al. , “Customer service is a series of activities designed to enhance the level of customer satisfaction – that is, the feeling that a product or service has met the customer...
exclusively. Electronic commerce
Electronic commerce
Electronic commerce, commonly known as e-commerce, eCommerce or e-comm, refers to the buying and selling of products or services over electronic systems such as the Internet and other computer networks. However, the term may refer to more than just buying and selling products online...
, of which the GDSs were the first wave, created an environment where large volumes of sales could be managed without large numbers of customer service staff. They also gave management staff direct access
Direct access
Direct Access may refer to:*DirectAccess, a network technology in Windows 7 and Windows Server 2008 R2*Direct access, a concept in computer science*Direct Access Archive, a proprietary file format...
to price at time of consumption and rich data capture for future decision-making.
On January 17, 1985, American Airlines
American Airlines
American Airlines, Inc. is the world's fourth-largest airline in passenger miles transported and operating revenues. American Airlines is a subsidiary of the AMR Corporation and is headquartered in Fort Worth, Texas adjacent to its largest hub at Dallas/Fort Worth International Airport...
launched Ultimate Super Saver fares in an effort to compete with low cost carrier PEOPLExpress. Donald Burr, the CEO of PeopleExpress, is quoted as saying "We were a vibrant, profitable company from 1981 to 1985, and then we tipped right over into losing $50 million a month...We had been profitable from the day we started until American came at us with Ultimate Super Savers." in the book "Revenue Management" by Robert G. Cross, Chairman and CEO of Revenue Analytics. The Yield management systems developed at American Airlines were recognized by the Edelman Prize committee of INFORMS for contributing $1.4 billion in a three year period at the airline.
Yield management spread to other travel and transportation companies in the early 1990s. Notable was implementation of Yield management at National Car Rental. In 1993, General Motors
General Motors
General Motors Company , commonly known as GM, formerly incorporated as General Motors Corporation, is an American multinational automotive corporation headquartered in Detroit, Michigan and the world's second-largest automaker in 2010...
Corporation was forced to take a $744 million charge against earnings related to its ownership of National Car Rental
National Car Rental
National Car Rental is a rental car company based in Clayton, Missouri. National was founded by 24 independent rental car agents on August 27, 1947...
Systems. In response, National's program expanded the definition of Yield management to include capacity management
Capacity management
Capacity Management is a process used to manage information technology . Its primary goal is to ensure that IT capacity meets current and future business requirements in a cost-effective manner. One common interpretation of Capacity Management is described in the ITIL framework...
, pricing and reservations control. As a result of this program, General Motors was able to sell National Car Rental Systems for an estimated $1.2 billion. Yield Management gave way to the more general practice of Revenue Management. Whereas Revenue Management involves predicting consumer behavior by segmenting markets, forecasting demand, and optimizing prices for several different types of products, Yield Management refers specifically to maximizing revenue through inventory control. Some notable Revenue Management implementations include the NBC
NBC
The National Broadcasting Company is an American commercial broadcasting television network and former radio network headquartered in the GE Building in New York City's Rockefeller Center with additional major offices near Los Angeles and in Chicago...
which credits its system with $200 million in improved ad sales from 1996 to 2000, the Target Pricing initiative at UPS
United Parcel Service
United Parcel Service, Inc. , typically referred to by the acronym UPS, is a package delivery company. Headquartered in Sandy Springs, Georgia, United States, UPS delivers more than 15 million packages a day to 6.1 million customers in more than 220 countries and territories around the...
, and Revenue management at Texas Children's Hospital. Since 2000, much of the dynamic pricing, promotions management and dynamic packaging
Dynamic packaging
Dynamic packaging is a method that is becoming increasingly used in package holiday bookings that enables consumers to build their own package of flights, accommodation, and a hire car instead of a pre-defined package...
that underlie ecommerce sites leverage Revenue management techniques. In 2002 GMAC launched an early implementation of web based revenue management in the financial services industry.
There have also been high profile failures and faux pas
Faux pas
A faux pas is a violation of accepted social norms . Faux pas vary widely from culture to culture, and what is considered good manners in one culture can be considered a faux pas in another...
. Amazon.com
Amazon.com
Amazon.com, Inc. is a multinational electronic commerce company headquartered in Seattle, Washington, United States. It is the world's largest online retailer. Amazon has separate websites for the following countries: United States, Canada, United Kingdom, Germany, France, Italy, Spain, Japan, and...
was criticized for irrational price changes that resulted from a Revenue management software bug
Software bug
A software bug is the common term used to describe an error, flaw, mistake, failure, or fault in a computer program or system that produces an incorrect or unexpected result, or causes it to behave in unintended ways. Most bugs arise from mistakes and errors made by people in either a program's...
. The Coca-Cola Company's plans for a dynamic pricing vending machine
Vending machine
A vending machine is a machine which dispenses items such as snacks, beverages, alcohol, cigarettes, lottery tickets, consumer products and even gold and gems to customers automatically, after the customer inserts currency or credit into the machine....
were put on hold as a result of negative consumer reactions. Revenue management is also blamed for much of the financial difficulty currently experienced by legacy carriers. The reliance of the major carriers on high fares in captive markets arguably created the conditions for low cost carriers to thrive.
Use by industry
There are three essential conditions for yield management to be applicable:- That there is a fixed amount of resources available for sale.
- That the resources sold are perishable (there is a time limit to selling the resources, after which they cease to be of value).
- That different customers are willing to pay a different price for using the same amount of resources.
If the resources available are not fixed or not perishable, the problem is limited to logistics, i.e. inventory or production management
Production management
Theatrical production management is a sub-division of stagecraft. The production management team is responsible for realizing the visions of the producer and the director or choreographer within constraints of technical possibility...
. If all customers would pay the same price for using the same amount of resources, the challenge would perhaps be limited to selling as quickly as possible, e.g. if there are costs for holding inventory.
Yield management is of especially high relevance in cases where the constant costs are relatively high compared to the variable cost
Variable cost
Variable costs are expenses that change in proportion to the activity of a business. Variable cost is the sum of marginal costs over all units produced. It can also be considered normal costs. Fixed costs and variable costs make up the two components of total cost. Direct Costs, however,...
s. The less variable cost there is, the more the additional revenue earned will contribute to the overall profit. This is because it focuses on maximizing expected marginal revenue for a given operation and planning horizon
Planning horizon
The planning horizon is the amount of time an organization will look into the future when preparing a strategic plan. Many commercial companies use a five-year planning horizon, but other organizations such as the Forestry Commission in the UK have to use a much longer planning horizon to form...
. It optimizes resource utilization by ensuring inventory availability to customers with the highest expected net revenue
Net profit
Net profit or net revenue is a measure of the profitability of a venture after accounting for all costs. In a survey of nearly 200 senior marketing managers, 91 percent responded that they found the "net profit" metric very useful...
contribution and extracting the greatest level of ‘willingness to pay’ from the entire customer base
Customer base
The customer base is the group of customers and/or consumers that a business serves. In the most situations, a large part of this group is made up of repeat customers with a high ratio of purchase over time. These customers are the main source of consumer spending...
. Yield management practitioners typically claim 3% to 7% incremental revenue gains. In many industries this can equate to over 100% increase in profits.
Yield management has significantly altered the travel and hospitality industry
Hospitality industry
The hospitality industry consists of broad category of fields within the service industry that includes lodging, restaurants, event planning, theme parks, transportation, cruise line, and additional fields within the tourism industry. The hospitality industry is a several billion dollar industry...
since its inception in the mid 1980s. It requires analysts with detailed market knowledge and advanced computing systems who implement sophisticated mathematical techniques to analyze market behavior and capture revenue opportunities. It has evolved from the system airlines invented as a response to deregulation and quickly spread to hotels, car rental
Car rental
A car rental or car hire agency is a company that rents automobiles for short periods of time for a fee...
firms, cruise line
Cruise line
A cruise line is a company that operates cruise ships. Cruise lines have a dual character; they are partly in the transportation business, and partly in the leisure entertainment business, a duality that carries down into the ships themselves, which have both a crew headed by the ship's captain,...
s, media, telecommunications and energy to name a few. Its effectiveness in generating incremental revenues from an existing operation and customer base has made it particularly attractive to business leaders that prefer to generate return from revenue growth and enhanced capability rather than downsizing and cost cutting.
Airlines
In the passenger airlineAirline
An airline provides air transport services for traveling passengers and freight. Airlines lease or own their aircraft with which to supply these services and may form partnerships or alliances with other airlines for mutual benefit...
case, capacity is regarded as fixed because changing what aircraft flies a certain service based on the demand is the exception rather than the rule. When the aircraft departs, the unsold seats cannot generate any revenue and thus can be said to have perished. Airlines use special software to monitor how seats are being reserved and react accordingly, for example by offering discounts when it appears that seats will remain unsold.
Another way of capturing varying willingness to pay is to attempt market segmentation. A firm may repackage its basic inventory into different products to this end. In the passenger airline case this means implementing purchase restrictions, length of stay
Length of stay
Length of stay is a term commonly used to measure the duration of a single episode of hospitalization. Inpatient days are calculated by subtracting day of admission from day of discharge. However, persons entering and leaving a hospital on the same day have a length of stay of one...
requirements and requiring fees for changing or canceling tickets.
The airline needs to keep a specific number of seats in reserve to cater to the probable demand for high-fare seats. The price of each seat varies inversely with the number of seats reserved, that is, the fewer seats that are reserved for a particular category, the lower the price of each seat. This will continue till the price of seat in the premium class equals that of those in the concession class. Depending on this, a floor price (lower price) for the next seat to be sold is set.
Hotels
Hotels use this system in largely the same way, to calculate the rates, rooms and restrictions on sales in order to best maximize the return too. These systems measure constrained and unconstrained demand along with pace to gauge which restrictions e.g. length of stay, non refundable rate, or close to arrival. Yield management teams in the hotel industry have evolved tremendously over the last 10 years and in this global economy targeting the right distribution channels, controlling costs, and having the right market mix plays an important role in yield management. Yield management in hotels is selling rooms and services at the right price, at the right time, to the right people.Rental
In the rental car industry, yield management deals with the sale of optional insurance, damage waivers and vehicle upgrades. It accounts for a major portion of the rental company's profitability, and is monitored on a daily basis. In the equipment rental industry, yield management is a method to manage rental rates against capacity (available fleet) and demand.Inter city buses
Yield management has moved into the bus industry with companies such as Megabus (United Kingdom)Megabus (United Kingdom)
Megabus is a UK coach service operated by Stagecoach Group. It started in 2003 and as of February 2010 operated 19 UK coach routes serving 41 destinations in England, Scotland and Wales. Some services link with Megatrain services which are also operated by Stagecoach...
, Megabus (North America), BoltBus
BoltBus
BoltBus is a bus line operating in the northeastern United States. It is a 50/50 venture between Greyhound Lines and Peter Pan Bus Lines providing service between New York City and other cities in the northeastern United States, utilizing the existing operating authority of Greyhound Lines...
, and easyBus
EasyBus
EasyBus provides UK express coach services to and from London and its main airports. It was founded by entrepreneur Stelios Haji-Ioannou in 2003, and is part of the EasyGroup...
, which run low-cost networks in the UK and parts of the US, and more recently, nakedbus.com
Nakedbus.com
Nakedbus.com is a provider of low-cost intercity bus transport services around New Zealand. It uses concepts such as yield management and no-frills to provide low fares...
and Intercape, which have networks in New Zealand and South Africa. Now operating in Chile with Turbus, also known as Tu precio.
Multifamily Housing
In the Multifamily residentialMulti-family residential
Multi-family residential is a classification of housing where multiple separate housing units for residential inhabitants are contained within one building or several buildings within one complex. A common form is an apartment building...
industry, yield optimization is focused on producing supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
forecasts to determine rent recommendations for profit optimization. However, the use of the yield optimization systems is fairly new to the industry in the late 1990s, with Archstone Smith pioneering its use. The multifamily industry currently has two providers of yield management systems, the LRO (Lease Rent Options) Revenue Management System from Rainmaker, and the M/PF YieldStar Asset Optimization System from RealPage.
Insurance
Insurance companies use price (premium) optimization to improve profitability on policy sales. The method is widely used by property & casualty insurers and brokers in the UK, Spain and, to a lesser extent, in the US. Several vendors, such as Earnix, EMB, ODG, provide specialized pricing optimization software for the industry.Telecommunications
On average, Communications service providerCommunications Service Provider
A communications service provider or CSP is a service provider that transports information electronically. The term encompasses public and private companies in the telecom , Internet, cable, satellite, and managed services businesses.The market in which a communication service provider specializes...
s utilize an average of just 35 to 40 percent of available network capacity. Recently, telecommunications software vendors such as Telcordia and Ericsson
Ericsson
Ericsson , one of Sweden's largest companies, is a provider of telecommunication and data communication systems, and related services, covering a range of technologies, including especially mobile networks...
have promoted yield management as a strategy for communications service providers to generate additional revenue and reduce capital expenditures by maximizing subscriber use of available network bandwidth. Approaches include basing a strategy on innovative services explicitly designed to use only spare capacity and borrowing proven methods from the airline industry. The approach can be more difficult to implement in the telecommunications industry than the airlines sector because of the difficulty to control and sometimes refuse network access to customers. Similarities that exist between the airline and telecom industries include a large sunk cost combined with low marginal cost, perishable inventory, reservations, pricing flexibility and the opportunity to upsell. Differences that present challenges for communications service providers include low-value transactions and overall network complexity. Suggested approaches to executing a successful yield management strategy include accurate network information collection, bandwidth capacity allocation that doesn’t impact service quality, the deployment of service management software such as Real time policy
Real time policy
Real time policy, in telecommunications, is a technical capability used to implement a wide array of business rules and subscriber preferences. While the genesis of policy was in Quality of Service and congestion control, it has evolved as Communications Service Providers use it to create...
and Real Time Charging
Real Time Charging
Real-time charging is an extension of call accounting that enables communications service providers to apply customer-specific rules for rating, discounting, promotions and settlements to better personalize the telecom experience...
, and using new marketing channels to target consumers with innovative services.
Econometrics
Yield Management and econometricsEconometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...
center on detailed forecasting and mathematical optimization
Optimization (mathematics)
In mathematics, computational science, or management science, mathematical optimization refers to the selection of a best element from some set of available alternatives....
of marginal revenue opportunities. The opportunities arise from segmentation of consumer willingness to pay. If the market for a particular good follows the simple straight line Price/Demand relationship illustrated below, a single fixed price
Fixed price
The term "fixed price" is a phrase used in the English language to mean that no bargaining is allowed over the price of a good or, less commonly, a service...
of $50 there is enough demand to sell 50 units of inventory. This results in $2500 in revenues. However the same Price/Demand relationship yields $4000 if consumers are presented with multiple prices.
In practice, the segmentation approach relies on adequate fences between consumers so that everyone doesn't buy at the lowest price offered. The airlines use time of purchase to create this segmentation, with later booking customers paying the higher fares. The fashion industry
Fashion
Fashion, a general term for a currently popular style or practice, especially in clothing, foot wear, or accessories. Fashion references to anything that is the current trend in look and dress up of a person...
uses time in the opposite direction, discounting later in the selling season once the item is out of fashion or inappropriate for the time of year. Other approaches to fences involve attributes that create substantial value to the consumer at little or no cost to the seller. A backstage pass
Backstage pass
A backstage pass is an employee pass which allows its bearer access to employees-only areas at a performance venue. They are most commonly associated with rock music groups....
at a concert is a good example of this. Initially Yield Management avoided the complexity caused by the interaction of absolute price and price position by using surrogates for price such as booking class. By the mid-1990s, most implementation incorporated some measures of price elasticity
Elasticity (economics)
In economics, elasticity is the measurement of how changing one economic variable affects others. For example:* "If I lower the price of my product, how much more will I sell?"* "If I raise the price, how much less will I sell?"...
. The airlines were exceptional in this case, preferring to focus on more detailed segmentation by implementing O&D (Origin & Destination) systems.
At the heart of yield management decision-making process is the trade-off
Trade-off
A trade-off is a situation that involves losing one quality or aspect of something in return for gaining another quality or aspect...
of marginal yields from segments that are competing for the same inventory. In capacity-constrained cases, there is a bird-in-the-hand decision that forces the seller to reject lower revenue generating customers in the hopes that the inventory can be sold in a higher valued segment. The tradeoff is sometimes mistakenly identified as occurring at the intersection of the marginal revenue curves for the competing segments. While this is accurate when it supports marketing decisions where access to both segments is equivalent, it is wrong for inventory control
Inventory control
Inventory control is the supervision of supply, storage and accessibility of items in order to ensure an adequate supply without excessive oversupply....
decisions. In these cases the intersection of the marginal revenue
Marginal revenue
In microeconomics, marginal revenue is the extra revenue that an additional unit of product will bring. It is the additional income from selling one more unit of a good; sometimes equal to price...
curve of the higher valued segment with the actual value of the lower segment is the point of interest.
In the case illustrated here, a car rental company must set up protection levels for its higher valued segments. By estimating where the marginal revenue curve of the luxury segment crosses the actual rental value of the midsize car segment the company can decide how many luxury cars
Luxury vehicles
Luxury vehicle is a marketing term for a vehicle that provides luxury — pleasant or desirable features beyond strict necessity—at increased expense ....
to make available to midsize car renters. Where the vertical line
Vertical bar
The vertical bar is a character with various uses in mathematics, where it can be used to represent absolute value, among others; in computing and programming and in general typography, as a divider not unlike the interpunct...
from this intersection point crosses the demand (horizontal) axis determines how many luxury cars should be protected for genuine luxury car renters. The need to calculate protection levels has led to a number of heuristic solutions, most notable EMSRa and EMSRb, which stands for Expected Marginal Seat Revenue
Expected marginal seat revenue
EMSR stands for Expected Marginal Seat Revenue and is a very popular heuristic in Revenue Management. There are two versions: EMSRa and EMSRb, both of which were introduced by Belobaba. Both methods are for n-class, static, single-resource problems...
version a and b respectively. The balancing point of interest
Point of interest
A point of interest, or POI, is a specific point location that someone may find useful or interesting. An example is a point on the Earth representing the location of the Space Needle, or a point on Mars representing the location of the mountain, Olympus Mons.The term is widely used in...
is found using Littlewood's rule which states that demand for
should be accepted as long as2 11where
is the value of the lower valued segment is the value of the higher valued segment is the demand for the higher valued segment and is the capacity leftThis equation is re-arranged to compute protection levels as follows:
1−121In words, you want to protect
1 units of inventory for the higher valued segment where 1 is equal to the inverse probabilityInverse probability
In probability theory, inverse probability is an obsolete term for the probability distribution of an unobserved variable.Today, the problem of determining an unobserved variable is called inferential statistics, the method of inverse probability is called Bayesian probability, the "distribution"...
of demand of the revenue ratio of the lower valued segment to the higher valued segment. This equation defines the EMSRa algorithm which handles the two segment case. EMSRb is smarter and handles multiple segments by comparing the revenue of the lower segment to a demand weighted average
Weighted mean
The weighted mean is similar to an arithmetic mean , where instead of each of the data points contributing equally to the final average, some data points contribute more than others...
of the revenues of the higher segments. Neither of these heuristics produces the exact right answer and increasingly implementations make use of Monte Carlo simulation
Monte Carlo method
Monte Carlo methods are a class of computational algorithms that rely on repeated random sampling to compute their results. Monte Carlo methods are often used in computer simulations of physical and mathematical systems...
to find optimal protection levels.
Since the mid 1990s increasingly sophisticated mathematical models have been developed such as the dynamic programming
Dynamic programming
In mathematics and computer science, dynamic programming is a method for solving complex problems by breaking them down into simpler subproblems. It is applicable to problems exhibiting the properties of overlapping subproblems which are only slightly smaller and optimal substructure...
formulation pioneered by Talluri and Van Ryzin which has led to more accurate estimates of bid prices. Bid prices represent the minimum price a seller should accept for a single piece of inventory and are popular control mechanisms
Control system
A control system is a device, or set of devices to manage, command, direct or regulate the behavior of other devices or system.There are two common classes of control systems, with many variations and combinations: logic or sequential controls, and feedback or linear controls...
for Hotels and Car Rental firms. Models derived from developments in financial engineering are intriguing but have been unstable and difficult to place the parameters in practice. Yield management tends to focus on environments that are less rational than the financial markets.
Yield management system
FirmsCorporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
that engage in yield management usually use computer
Computer
A computer is a programmable machine designed to sequentially and automatically carry out a sequence of arithmetic or logical operations. The particular sequence of operations can be changed readily, allowing the computer to solve more than one kind of problem...
yield management systems to do so. The Internet
Internet
The Internet is a global system of interconnected computer networks that use the standard Internet protocol suite to serve billions of users worldwide...
has greatly facilitated this process.
Enterprises that use yield management periodically review transactions for goods or services already supplied and for goods or services to be supplied in the future. They may also review information (including statistics) about events (known future events such as holidays, or unexpected past events such as terrorist attacks), competitive information (including prices), seasonal patterns, and other pertinent factors that affect sales. The models attempt to forecast total demand for all products/services they provide, by market segment and price point
Price point
Price points are prices at which demand for a given product is supposed to stay relatively high.- Characteristics :Introductory microeconomics depicts a demand curve as downward-sloping to the right and either linear or gently convex to the origin...
. Since total demand normally exceeds what the particular firm can produce in that period, the models attempt to optimize the firm's outputs to maximize revenue.
The optimization attempts to answer the question: "Given our operating constraints, what is the best mix of products and/or services for us to produce and sell in the period, and at what prices, to generate the highest expected revenue?"
Optimization can help the firm adjust prices and to allocate capacity among market segments to maximize expected revenues. This can be done at different levels of detail:
- by goods (such as a seat on a flight or a seat at an opera production)
- by group of goods (such as the entire opera houseOpera houseAn opera house is a theatre building used for opera performances that consists of a stage, an orchestra pit, audience seating, and backstage facilities for costumes and set building...
or all the seats on a flight) - by market (such as sales from Seattle and Minneapolis for a flight going Seattle-Minneapolis-Boston)
- overall (on all the routes an airline flies, or all the seats during an opera production season)
Yield management is particularly suitable when selling perishable products, i.e. goods that become unsellable at a point in time (for example air tickets just after a flight takes off). Industries that use yield management include airlines, hotels, stadiums and other venues with a fixed number of seats, and advertising. With an advance forecast of demand and pricing flexibility, buyers will self-sort based on their price sensitivity (using more power in off-peak hours or going to the theater mid-week), their demand sensitivity (must have the higher cost early morning flight or must go to the Saturday night opera) or their time of purchase (usually paying a premium for the luxury of booking late).
In this way, yield management's overall aim is to provide an optimal mix of goods at a variety of price points at different points in time or for different baskets of features. The system will try to maintain a distribution
Distribution (business)
Product distribution is one of the four elements of the marketing mix. An organization or set of organizations involved in the process of making a product or service available for use or consumption by a consumer or business user.The other three parts of the marketing mix are product, pricing,...
of purchases over time that is balanced as well as high.
Good yield management maximizes (or at least significantly increases) revenue production for the same number of units, by taking advantage of the forecast of high demand/low demand periods, effectively shifting demand from high demand periods to low demand periods and by charging a premium for late bookings. While yield management systems tend to generate higher revenues, the revenue streams tends to arrive later in the booking horizon as more capacity is held for late sale at premium prices.
Firms faced with lack of pricing power sometimes turn to yield management as a last resort. After a year or two using yield management, many of them are surprised to discover they have actually lowered prices for the majority of their opera seats or hotel rooms or other products. That is, they offer far higher discounts more frequently for off-peak times, while raising prices only marginally for peak times, resulting in higher revenue overall.
By doing this, they have actually increased quantity demanded by selectively introducing many more price points, as they learn about and react to the diversity of interests and purchase drivers of their customers.
Ethical issues and questions of effectiveness
Some consumers are concerned that yield management could penalize them for conditions which cannot be helped and are unethical to penalize. For example, the formulas, algorithms, and neural networkNeural network
The term neural network was traditionally used to refer to a network or circuit of biological neurons. The modern usage of the term often refers to artificial neural networks, which are composed of artificial neurons or nodes...
s that determine airline ticket
Airline ticket
An airline ticket is a document, issued by an airline or a travel agency, to confirm that an individual has purchased a seat on a flight on an aircraft. This document is then used to obtain a boarding pass, at the airport...
prices could feasibly consider frequent flyer information, which includes a wealth of socio-economic
Socioeconomics
Socioeconomics or socio-economics or social economics is an umbrella term with different usages. 'Social economics' may refer broadly to the "use of economics in the study of society." More narrowly, contemporary practice considers behavioral interactions of individuals and groups through social...
information such as age and home address. The airline then could charge higher prices to consumers who are between 30 and 65 or live in neighborhoods with higher average wealth, even if those neighborhoods also include poor households. Very few (if any) airlines using Yield Management are able to employ this level of price discrimination because prices are not set based on characteristics of the purchaser, which are in any case often not known at the time of purchase.
Some consumers also object that it is impossible for them to boycott yield management when buying some goods, such as airline tickets.
Yield Management also includes many noncontroversial and more prevalent practices, such as varying prices over time to reflect demand. This level of yield management makes up the majority of YM in the airline industry. For example airlines may make a ticket on the Sunday after Thanksgiving more expensive than the Sunday a week later. Alternatively, they may make tickets more expensive when bought at the last minute than when bought six months in advance. The goal of this level of yield management is essentially trying to get demand to equal supply.
When YM was introduced in the early 1990s, primarily in the airline industry, many suggested that despite the obvious immediate increase in revenues, it might harm customer satisfaction
Customer satisfaction
Customer satisfaction, a term frequently used in marketing, is a measure of how products and services supplied by a company meet or surpass customer expectation...
and loyalty, interfere with relationship marketing
Relationship marketing
Relationship marketing was first defined as a form of marketing developed from direct response marketing campaigns which emphasizes customer retention and satisfaction, rather than a dominant focus on sales transactions....
, and drive customers from firms that used YM to firms that did not. To frequent flier programs were developed as a response to regain customer loyalty
Loyalty business model
The loyalty business model is a business model used in strategic management in which company resources are employed so as to increase the loyalty of customers and other stakeholders in the expectation that corporate objectives will be met or surpassed...
and reward frequent and high yield
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
passengers. Today, YM is nearly universal in many industries, including airlines.
Despite optimising revenue in theory, introduction of yield management can sometimes fail to achieve this in practice because of corporate image
Corporate image
A corporate image refers to how a corporation is perceived. It is a generally accepted image of what a company stands for. Marketing experts who use public relations and other forms of promotion to suggest a mental picture to the public...
problems. In 2002, Deutsche Bahn
Deutsche Bahn
Deutsche Bahn AG is the German national railway company, a private joint stock company . Headquartered in Berlin, it came into existence in 1994 as the successor to the former state railways of Germany, the Deutsche Bundesbahn of West Germany and the Deutsche Reichsbahn of East Germany...
, the German
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
national railway
National Railway
The National Railway or National Air Line Railroad was a planned railroad between New York City and Washington, D.C. in the United States around 1870...
company, experimented with yield management for frequent loyalty card
BahnCard
BahnCard is a loyalty card offered by Deutsche Bahn , the German national railway company. Unlike airline loyalty programs, but similarly to the UK Young Persons Railcard, the BahnCard entitles the passenger to a discount price and must be purchased prior to travel.Like most contracts in Germany,...
passengers. The fixed pricing model that had existed for decades was replaced with a more demand-responsive pricing model, but this reform proved highly unpopular with passengers, leading to widespread protests and a decline in passenger numbers.
Experimental studies of yield management decisions
Recently, people working in the area of Behavioral operations researchBehavioral Operations Research
Behavioral operations research examines the behavior of actual human agents in complex decision problems. BOR is the operations management analog of experimental economics and behavioral finance, and is part of the field known as management science....
have begun to study the yield management decisions of actual human decision makers. One question that this research addresses is how much might revenues increase if managers relied on yield management systems rather than their own judgment when making pricing decisions. Using methods from experimental economics
Experimental economics
Experimental economics is the application of experimental methods to study economic questions. Data collected in experiments are used to estimate effect size, test the validity of economic theories, and illuminate market mechanisms. Economic experiments usually use cash to motivate subjects, in...
, this work has revealed that yield management systems are likely to increase revenues significantly http://behavioral-or.org/files/RMPaper1.pdf http://www.behavioral-or.org/papers/DynPrice.pdf. Further, this research reveals that "errors" in yield management decisions tend to be quite systematic. For instance, Bearden, Murphy, and Rapoport showed that with respect to expected revenue maximizing policies, people tend to price too high when they have high levels of inventory and too low when their inventory levels are low.
See also
- Geo (marketing)Geo (marketing)As a general term, Geomarketing is the integration of Geographical intelligence into all marketing aspects including sales and distribution. Geomarketing Research is the use of geographic parameters in research methodology starting from sampling, data collection, analysis, and...
- Variable pricingVariable pricingMost firms use a fixed price policy. That is, they examine the situation, determine an appropriate price, and leave the price fixed at that amount until the situation changes, at which point they go through the process again...
- Price discriminationPrice discriminationPrice discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider...
- Last minute advertising
- INFORMS Institute for Operations ResearchOperations researchOperations research is an interdisciplinary mathematical science that focuses on the effective use of technology by organizations...
and the Management Sciences - Behavioral Operations ResearchBehavioral Operations ResearchBehavioral operations research examines the behavior of actual human agents in complex decision problems. BOR is the operations management analog of experimental economics and behavioral finance, and is part of the field known as management science....
- Revenue shortfall