Yield management

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Yield management, also known as Revenue Management, is the process of understanding, anticipating and reacting to consumer behaviour in order to maximize revenue or profits. Firms that engage in yield management usually use computer yield management systems to do so. The Internet has greatly facilitated this process. Other terms to describe this process are revenue optimization and demand management. Yield management can result in price discrimination, where a firm charges customers consuming otherwise identical goods or services a different price for doing so.

Three industries where yield management is used most heavily are passenger air transport, lodging and rental car. Airlines monitor through the use of specialized software how seats are being reserved and react accordingly, as for example by offering discounts when it appears as if seats will otherwise be vacant. Hotels use Revenue Management in largely the same way, to calculate the rates, rooms and restrictions on sales in order to best maximize the return for the property. In the rental car industry, Revenue 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.

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[edit] Yield management system

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:

  • 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 house 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, ie 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 theatre 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 demand by selectively introducing many more price points, as they learn about and react to the diversity of interests and purchase drivers of their customers.

[edit] Ethical Issues

As Yield Management can result in price discrimination, some question the morality of the participating firms’ motives. The ethical issues include the firms manipulation of personal information to judge one’s demand for a service or product; for example, it is rumored[Please name specific person or group] that airlines see who the purchaser is and use the frequent flyer information (say for example, age) as an input to the formula or algorithm (sometimes using a neural network)[citation needed] which decides the price. [1]

Another ethical issue is due to the underlying principle of yield management. That is, different prices are charged to different people for the same product or service to increase revenue. A firm that practices yield management through yield management systems relies on forecasts, and the manipulation of information via online transaction processing systems to find out the price to maximize revenue. It is understandable that some consumers see yield management as unfair and discriminatory. In the end it is up to the consumer whether to support a firm that relies on yield management. However this can be difficult in industries where it has become the norm, such as the airline industry.

These ethical "issues" are mitigated by the fact that for yield management to be a successful strategy to distribute inventories, those inventories must have different values in time. For example, a seat from Los Angeles to New York on the Sunday after Thanksgiving does not have the same value as that same seat one week later. Even more relevant, a seat on the same Sunday after Thanksgiving flight sold the day before departure has an immediacy value that the same seat sold six months prior does not. While true that businesses employing yield management make maximum use of the fact that these resources have different values in time, it is these different values that drive the variances in price. Another way to state this argument is to say that although 12A and 12F appear to be providing the exact same service on a given flight, their values are not driven by the fact that they fly the same routes, but by agreeing to supply itself to a demander at a point in time.

[edit] Questions of Effectiveness

There have recently been questions about how effective YM is in the big picture. A firm that wants to satisfy its customers and have them come back are putting their customer relations in jeopardy by using YM practices. For example, American Airlines, which was a pioneer in the innovation of yield management systems, estimated that the utilization of YM increased its revenue by $1.4 billion between 1989 and 1991 [2]. While this stat is impressive and shows how YM can be effective, it is also misleading. Many argue that the benefits of offering different price points to customers, which results in additional revenue by stimulating demand, are felt upfront and are short-lived. The costs of lower customer satisfaction and loyalty and the loss of relationship marketing can have longer more serious effects and in the end might make the implementation detrimental to the firm. Because American Airlines was a pioneer with yield management, it is obvious that the innovation will result in a large increase in revenue. However, as the rest of the industry catches up with the technology of the YM systems, the competitive advantage can be lost, while the long lasting costs might remain. If the firm stops or relaxes its YM practices it will likely suffer short term revenue loss unless the rest of the industry also stops or relaxs its YM practices. So it comes down to a cost-benefit situation for the firm. The extra revenue now is the benefit and loss of goodwill and possibly a drop in revenue in the future is the cost. It is of course up to the firm to forecast if the benefits outweigh the costs.

[edit] History of Yield Management: SABRE

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Although yield management systems have been in existence since the late 1980’s, their development was actually initialized during the 1960’s. The original product offered by Sabre Airline Solutions [3] was a simple and primitive computer based program that allowed airline companies to enter reservation information into a computer instead of by a hand written entry. It wasn’t until 1986 that Sabre (Semi-Automatic Business Research Environment) released the product that first created revenue-managing systems. Sabre Airline Solutions have continued to provide yield management systems since they were first introduced and now offer a product called AirMax Revenue Manager that is widely used in the airline industry.

[edit] See also

[edit] References

  • Haag, Steven. Management Information Systems for the Information Age. Canada. McGraw Hill Ryerson Ltd. 2001, 2004-2006.

[edit] External Links

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