Supply Chain Management

Chapter 15
Pricing and Revenue
Management in the Supply Chain
Lecturer:
Wilmer Jorge
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 Outline
 The Role of Revenue Management in the
Supply Chain
 Revenue Management for Multiple Customer Segments
 Revenue Management for Perishable Assets
 Revenue Management for Seasonable Demand
 Revenue Management for Bulk and Spot Customers
 Using Revenue Management in Practice
 Summary of Learning Objectives

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 The Role of Pricing and Revenue
Management in a Supply Chain
 We can increase supply chain profits by
altering inventories and capacity to change
available supply.
Pricing is an important lever to increase
supply chain profits by better matching
supply and demand.
Revenue management is the use of pricing to
increase the profit generated from a limited
supply of supply chain assets.
SC assets: Capacity (production,
transportation and storage) and inventory.
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 The Role of Pricing and Revenue
Management in a Supply Chain
 Firms should first use pricing to achieve
some balance between supply and demand
and only then invest in or eliminate assets.
A trucking company owns 10 trucks. One
approach is to set a fixed price for its
services. Using revenue management the firm
could do the following:
Charge a lower price to customers willing to
commit their orders far in advance and a
higher price to customers looking for
transportation capacity at the last minute
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 The Role of Pricing and Revenue
Management in a Supply Chain
- Another approach is to charge a lower price
to customer with long-term contracts and a
higher price to customers looking to
purchase capacity at the last minute.
- A third approach is to charge a higher price
during periods of high demand and lower
prices during periods of low demand.
A strategy that adjust prices based on
product availability, customer demand, and
remaining duration of the sales season will
result in higher supply chain profits.
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 The Role of Pricing and Revenue
Management in a Supply Chain

 Rather than lower prices of all of its seats,

American lowered the prices of a portion of
the seats to price at or below PeopleExpress.
Before the end of 1986, PeopleExpress
collapsed.
American Airlines used differential pricing to
lower prices and attract passengers who
would otherwise have flown PeopleExpress.
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 The Role of Pricing and Revenue
Management in a Supply Chain
Revenue management adjusts the pricing and
available supply of assets to maximize
profits.
One or more of the following conditions exist:
- The value of the product varies in different
market segments.
- The product is highly perishable or product
wastage occurs.
- Demand has seasonal and other peaks.
- The product is sold bulk and on the spot
market.
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Conditions Under Which Revenue
Management Has the Greatest Effect
The value of the product varies in different
market segments (Example: airline seats).
The product is highly perishable or product
waste occurs (Example: fashion and seasonal
apparel).
Demand has seasonal and other peaks
(Example: products ordered at Amazon.com).
The product is sold both in bulk and on the
spot market (Example: 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).
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 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.

Prices must be set with barriers such that the

segment willing to pay more is not able to pay
the lower price.

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 Revenue Management for
Multiple Customer Segments
For example: Business travelers on an airline want to book
at the last minute and stay only as long as they must.
Leisure travelers are willing to book far in advance and
adjust the duration of their stay.
Plans for business travelers are subject to change. Thus,
advance booking , a required Saturday-night stay, and a
penalty for changes on the lower far separate the leisure
traveler from the business traveler.

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 15-11

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 15-12

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 Revenue Management
for Perishable Assets
 Any asset that loses value over time is perishable
 Examples: high-tech products such as computers and
cell phones, high fashion apparel, underutilized
capacity, fruits and vegetables
- In the apparel retailer the merchandise first is sold at the
main store at full price. Leftover merchandise is moved to
the basement and its price reduced incrementally over a
certain period of time until it is sold. Any unsold
merchandise is sometimes given away to charity.

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 Revenue Management
for Perishable Assets
- Another example of revenue management for a perishable
asset is the use of overbooking by the airline industry.
- An airplane seat losses all value once the plane takes off.
Given that people often do not show up for a plane even
when they have a reservation, airlines sell more
reservations than the capacity of the plane.
 Two basic approaches:
 Vary price over time to maximize expected revenue
 Overbook sales of the asset to account for
cancellations

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 Revenue Management
for Perishable Assets

Overbooking or overselling of a supply chain

asset is valuable if order cancellations occur
and the asset is perishable.
The level of overbooking is based on the trade-
off between the cost of wasting the asset if too
many cancellations lead to unused assets and
the cost of arranging a backup if too few
cancellations lead to committed orders being
larger than the available capacity.

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 Revenue Management
for Seasonal Demand
Seasonal peaks of demand are common in
many supply chains.
Examples: Most retailers achieve a large
portion of total annual demand in December
(Amazon.com).
Off-peak discounting can shift demand from
peak to non-peak periods.
Charge higher price during peak periods and a
lower price during off-peak periods.

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 Revenue Management for
Bulk and Spot Customers
 Most consumers of production, warehousing, and
transportation assets in a supply chain face the
problem of constructing a portfolio of long-term bulk
contracts and short-term spot market contracts.
 The basic decision is the size of the bulk contract.
 The fundamental trade-off is between wasting a
portion of the low-cost bulk contract and paying more
for the asset on the spot market.
 Given that both the spot market price and the
purchaser’s need for the asset are uncertain, a
decision tree approach as discussed in Chapter 6
should be used to evaluate the amount of long-term
bulk contract to sign.
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 Revenue Management for
Bulk and Spot Customers
For the simple case where the spot market price is known
but demand is uncertain, a formula can be used
cB = bulk rate
cS = spot market price
Q* = optimal amount of the asset to be purchased in bulk
p* = probability that the demand for the asset does not
exceed Q*
Marginal cost of purchasing another unit in bulk is cB. The
expected marginal cost of not purchasing another unit in
bulk and then purchasing it in the spot market is (1-p*)cS.

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 Using Revenue Management
in Practice
 Evaluate your market carefully
 Quantify the benefits of revenue management
 Implement a forecasting process
 Apply optimization to obtain the revenue management
decision
 Involve both sales and operations
 Understand and inform the customer
 Integrate supply planning with revenue management

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 15-20

Apartments Prices
$52 /night (1 night stay)
$50 /night (2-5 nights stay)
$47 /night (6-10 nights stay)
$45 /night (11-20 nights stay)
$42 /night (21 or more nights
stay)
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 Summary of Learning Objectives
What is the role of revenue management in a
supply chain?
Under what conditions are revenue
management tactics effective?
What are the trade-offs that must be
considered when making revenue
management decisions?

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