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Supply Chain Management Lecture 25. Semester Outline Tuesday April 20Chap 15 Thursday April 22Simulation Game briefing Tuesday April 27Review, buffer.

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Presentation on theme: "Supply Chain Management Lecture 25. Semester Outline Tuesday April 20Chap 15 Thursday April 22Simulation Game briefing Tuesday April 27Review, buffer."— Presentation transcript:

1 Supply Chain Management Lecture 25

2 Semester Outline Tuesday April 20Chap 15 Thursday April 22Simulation Game briefing Tuesday April 27Review, buffer Thursday April 29Simulation Game

3 Outline Today –Chapter 15 Sections 1, 2 Homework 7 –Online today –Due Thursday April 29 before class Homework submitted before April 29 will be graded and returned on April 29 Thursday –Simulation game briefing

4 What is Revenue Management? Revenue management is the practice of differential pricing to increase supply chain profits –A strategy that adjusts prices based on product availability, customer demand, and remaining duration of the sales season will result in higher supply chain profits

5 What is Revenue Management? Revenue management is the practice of differential pricing to increase supply chain profits –A strategy that adjusts prices based on product availability, customer demand, and remaining duration of the sales season will result in higher supply chain profits Revenue management, also called yield management, and sometimes smart pricing, is a technique to optimize revenue from a fixed, but perishable inventory

6 Revenue Management Newsvendor problem: Maps demand into capacity Revenue Management: Maps capacity into demand

7 What is Revenue Management? Revenue management, also called yield management, and sometimes smart pricing, is a technique to optimize revenue from a fixed, but perishable inventory Is revenue management possible for… –Airline tickets –Cruise travel –Restaurants –Hospitals –LTL trucking companies –Apartment rental –Incoming MBA class –Vending machines

8 Revenue Management and Vending Machines Coca-Cola announces that it is considering vending machines that will boost prices during hot weather. –Coca-Cola is a product whose utility varies from moment to moment. In a final summer championship, when people meet in a stadium to enjoy themselves, the utility of a chilled Coca-Cola is very high. So it is fair it should be more expensive. The machine will simply make this process automatic. Douglas Ivester, Chairman and CEO

9 Conditions for Revenue Management The value of the product varies in different market segments –Airline seats: leisure versus business travel The product is highly perishable or product waste occurs –Fashion and seasonal apparel –High tech products Demand has seasonal and other peaks –Cruise travel The product is sold both in bulk and on the spot market –Owner of warehouse who can decide whether to lease the entire warehouse through long-term contracts or save a portion of the warehouse for use in the spot market

10 Why Revenue Management? Success stories –American Airlines increased annual revenue by over $1 billion through revenue management –Marriott hotels increased annual revenue with $100 million through revenue management –National Car Rental was saved from liquidation through revenue management –Canadian Broadcasting Corporation increased revenue with $1 million per week

11 Airfare example p q Choose the fare that maximizes the area (revenue) of the rectangle

12 Airfare example Choose the fare that maximizes the area (revenue) of the rectangle Maximum revenue = 500*500 = $250,000 Consumer surplus Unaccommodated demand p q

13 Airfare example Choose the fare that maximizes the SUM of areas of the rectangles Economy class Business class Maximum revenue = 333*( ) = $333,000 p q

14 Airfare example Choose the fare that maximizes the SUM of areas of the rectangles Economy class Economy plus class First class Maximum revenue = 200*( ) = $400,000 Business class p q

15 Airfare example Maximum revenue = $500,000 Perfect price discrimination Charging a different price to a different buyer for the same product without any true cost differential to justify the different price p q

16 Is Revenue Management Price Discrimination? The same product sold at different times for different prices is not necessarily price discrimination, because at different times... –The production or distribution costs may be different –Inventory costs were incurred to keep the product in stock until a later time –Consumers value products differently at different points in time –The product value may change over time, such as perishable or maturing or seasonal products, fashion goods, antiques. –Interest is earned if product is sold at an earlier time –Locking sales in early reduces uncertainty

17 Revenue Management for Multiple Customer Segments If a supplier serves multiple customer segments with a fixed asset, the supplier can improve revenues by setting different prices for each segment –What price to charge each segment? –How to allocate limited capacity among the segments? Prices must be set with barriers such that the segment willing to pay more is not able to pay the lower price

18 Revenue Management Hotels, airlines, opera houses hope this tool will help them maximize sales and profits –The real beneficiary of revenue management has been the consumer Clearly, customers for which revenue management has decreased the cost of air travel, have benefited from revenue management. Could customers for which revenue management has increased the cost of air travel, also have benefited from revenue management?

19 What is Revenue Management? p q p q

20 Example 15-1: Pricing to multiple segments A contract manufacturer has identified two customers segments for its production capacityone willing to place an order more than one week in advance and the other willing to pay a higher price as long as it can provide less than a weeks notice for production. The customers that are unwilling to commit in advance are less price sensitive and have a demand curve d 1 = 5,000 – 20p 1. Customers willing to commit in advance are more price sensitive and have a demand curve of d 2 = 5,000 – 40p 2. Production cost is c = $10 per unit. What price should the contract manufacturer charge each segment if its goal is to maximize profits?

21 Example 15-1: Pricing to multiple segments d 1 = 5,000 – 20p 1 c = 10

22 Example 15-1: Pricing to multiple segments d 1 = 5,000 – 20p 1 c = 10 Profit p - c

23 Pricing Multiple Segments Assume that the demand curve for segment i is given by –d i = A i – B i p i The goal of the supplier is to price so as to maximize profits –Max (p i – c)(A i – B i p i ) Profit

24 Pricing Multiple Segments The optimal price for segment i is given by –p i = A i /2B i + c/2

25 Example 15-1: Pricing to multiple segments For segment 1: –p i = A i /2B i + c/2p i = 5,000/(2*20) + 10/2 = $130 –Profit (p i – 10)(5,000 – 20p i ) = (130 – 10)(5,000 – 20*130) = $288,000 For segment 2: –p i = A i /2B i + c/2p i = 5,000/(2*40) + 10/2 = $67.50 –Profit (p i – 10)(5,000 – 40p i ) = (67.5 – 10)(5,000 – 40*67.5) = $127,650 Total profit $415,650

26 Example 15-1: Pricing to multiple segments If total capacity is limited to 4,000 units, what should the contract manufacturer charge each segment? –For segment 1: p 1 = $130 Demand d 1 = (5,000 – 20p 1 ) = 2,400 –For segment 2: p 2 = $67.50 Demand d 2 = (5,000 – 40p 2 ) = 2,300 –Total demand = 2, ,300 = 4,700 Total demand exceeds production capacity of 4,000

27 Pricing Multiple Segments The goal of the supplier is to price so as to maximize profits –Max k i=1 (p i – c)(A i – B i p i ) –Subject to: k i=1 (A i – B i p i ) Q p i 0 Maximize profits Production capacity Price

28 Example 15-1: Pricing to multiple segments If the contract manufacturer were to charge a single price over both segments, what should it be? d 1 = 5,000 – 20p 1 d 2 = 5,000 – 40p 2 d = (5,000 – 20p) + (5,000 – 40p) = 10,000 – 60p

29 Example 15-1: Pricing to multiple segments For segment 1 and 2: –p = A i /2B i + c/2p = 10,000/(2*60) + 10/2 = $83.33 –Max (p – c)(A – Bp) Max (p – 10)(10,000 – 60p) = (83.33 – 10)(10,000 – 60*83.33) = $366,650 Differential pricing raises profit from $366,650 to $415,650

30 Revenue Management for Multiple Customer Segments If a supplier serves multiple customer segments with a fixed asset, the supplier can improve revenues by setting different prices for each segment –What price to charge each segment? –How to allocate limited capacity among the segments? What if demand is uncertain?

31 The Park Hyatt Philadelphia 118 King/Queen rooms. Hyatt offers a p L = $128 (low fare) targeting leisure travelers. Regular fare is p H = $181 (high fare) targeting business travelers. Demand for low fare rooms is abundant. Let D H be uncertain demand for high fare rooms. Assume demand for the high fare (business) occurs only within a few days of the actual stay How much capacity should Hyatt save for the higher priced segment?

32 Allocating Capacity to a Segment Under Uncertainty Basic tradeoff between committing to an order from a lower-price buyer or waiting for a high- price buyer to arrive later on –Spoilage occurs when the capacity reserved for higher-price buyers is wasted because demand from the higher-price segment does not materialize –Spill occurs if higher-price buyers have to be turned away because the capacity has already been committed to lower-price buyers

33 Allocating Capacity to a Segment Under Uncertainty Expected revenue = sales probability x sales price Never sell a unit of capacity for less than the expected revenue $128 $ = 1.0 x 181 $128 $ = 0.9 x 181 $128 $ = 0.8 x 181 $128 $ = 0.7 x 181

34 Allocating Capacity to a Segment Under Uncertainty R H (C H ) = Prob(demand from higher-price segment > C H ) x p H Expected revenue = sales probability x sales price Never sell a unit of capacity for less than the expected revenue $ = 0.7 x 181

35 Allocating Capacity to a Segment Under Uncertainty R H (C H ) = Prob(demand from higher-price segment > C H ) x p H p L = Prob(demand from higher-price segment > C H ) x p H Prob(demand from higher-price segment > C H ) = p L /p H Expected revenue = sales probability x sales price Never sell a unit of capacity for less than the expected revenue $128 $ = 0.7 x 181

36 Allocating Capacity to a Segment Under Uncertainty Prob(demand from higher-price segment > C H ) = p L /p H C H = F -1 (1 – p L /p H, D H, H ) Prob(demand from higher-price segment C H ) = 1 – p L /p H Prob CHCH pL/pH1 – pL/pH

37 Example: Allocating Capacity to a Segment Under Uncertainty Assume that demand for rooms at the high rate is normally distributed with mean 102 and standard deviation Also assume that the high rate is 181 dollars and low rate (discount rate) is 128 dollars –Determine probability that expected marginal revenue of higher rate class will exceed marginal revenue of lower rate class p L = 128 p H = – p L /p H = 1 – 128/181 = –Convert that probability into the number of rooms NORMINV(1 – p L /p H, D H, H ) = NORMINV(0.2928, 102, 20.8) = 91 Hence, 91 rooms should be reserved for the high rate class

38 Example 15-2 Allocating Capacity to Multiple Segments ToFrom Trucking serves two customer segments. One segment (A) is willing to pay $3.50 per cubic feet but wants to commit with only 24 hours notice. The other segment (B) is willing to pay only $2.00, but is willing to commit to a shipment with up to one week notice. With two weeks to go, demand for segment A is forecast to be normally distributed, with a mean of 3,000 cubic feet and a standard deviation of 1,000. How much of the available capacity should be reserved for segment A?

39 Example 15-2 Allocating Capacity to Multiple Segments Revenue from segment Ap A = Revenue from segment Bp B = Mean demand for segment A D A = Standard deviation of demand for segment A A = Capacity to be reserved for segment A C A = $3.50 $2.00 3,000 1,000 F -1 (1 – p B /p A, D H, H ) = F -1 (0.4286,3000,1000) = 2,820

40 Example 15-2 Allocating Capacity to Multiple Segments ToFrom Trucking serves two customer segments. One segment (A) is willing to pay $3.50 per cubic feet but wants to commit with only 24 hours notice. The other segment (B) is willing to pay only $2.00, but is willing to commit to a shipment with up to one week notice. With two weeks to go, demand for segment A is forecast to be normally distributed, with a mean of 3,000 cubic feet and a standard deviation of 1,000. How much of the available capacity should be reserved for segment A? How should ToFrom change it decision if segment A is willing to pay $5 per cubic foot?

41 Example 15-2 Allocating Capacity to Multiple Segments Revenue from segment Ap A = Revenue from segment Bp B = Mean demand for segment A D A = Standard deviation of demand for segment A A = Capacity to be reserved for segment A C A = $5.00 $2.00 3,000 1,000 F -1 (1 – p B /p A, D H, H ) = F -1 (0.6, 3000, 1000) = 3,253


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