Operations and Supply Chain Management The Core

252 OPERATIONS AND SUPPLY CHAIN MANAGEMENT
MANY HOTEL CHAINS USE
PRICELINE TO SELL EXCESS
CAPACITY AT A DISCOUNT.
©NetPhotos/Alamy
Yield management has existed as long as
there has been limited capacity for serving
customers. However, its widespread scientific
application began with American Airlines’
computerized reservation system (SABRE),
introduced in the mid-1980s. The system
allowed the airline to change ticket prices
on any routes instantaneously as a function
of forecast demand. Peoples’ Express, a nofrills,
low-cost competitor airline, was one of
the most famous victims of American’s yield
management system. Basically, the system
enabled hour-by-hour updating on competing
routes so that American could match or
better prices wherever Peoples’ Express was
flying. The president of Peoples’ Express
realized that the game was lost when his mother flew on American to Peoples’ hub for a
lower price than Peoples’ could offer!
From an operational perspective, yield management is most effective when
1. Demand can be segmented by customer.
2. Fixed costs are high and variable costs are low.
3. Inventory is perishable.
4. Product can be sold in advance.
5. Demand is highly variable.
Hotels illustrate these five characteristics well. They offer one set of rates during the week
for the business traveler and another set during the weekend for the vacationer. The variable
costs associated with a room (such as cleaning) are low in comparison to the cost of
adding rooms to the property. Available rooms cannot be transferred from night to night,
and blocks of rooms can be sold to conventions or tours. Finally, potential guests may cut
short their stay or not show up at all.
Most organizations (such as airlines, rental car agencies, cruise lines, and hotels) manage
yield by establishing decision rules for opening or closing rate classes as a function
of expected demand and available supply. The methodologies for doing this can be quite
sophisticated. A common approach is to forecast demand over the planning horizon and
then use marginal analysis to determine the rates that will be charged if demand is forecast
as being above or below set control limits around the forecast mean.
Operating Yield Management Systems
A number of interesting issues arise in managing yield. One is that pricing structures must
appear logical to the customer and justify the different prices. Such justification, commonly
called rate fences, may have either a physical basis (such as a room with a view)
or a nonphysical basis (like unrestricted access to the Internet). Pricing also should relate
to addressing specific capacity problems. If capacity is sufficient for peak demand, price
reductions stimulating off-peak demand should be the focus. If capacity is insufficient,
offering deals to customers who arrive during nonpeak periods (or creating alternative
service locations) may enhance revenue generation.
A second issue is handling variability in arrival or starting times, duration, and time
between customers. This entails employing maximally accurate forecasting methods (the