Chapter 15

Pricing and Revenue Management in a Supply Chain

True/False

1. Revenue management is the use of marketing to increase the profit generated

from a limited supply of supply chain assets.
Answer: False
Difficulty: Moderate

2. Pricing may influence demand if customers are price sensitive.

Answer: True
Difficulty: Moderate

3. Revenue management may also be defined as the use of differential pricing

based on customer segment, time of use, and product or capacity availability to
increase supply chain surplus.
Answer: True
Difficulty: Moderate

4. Revenue management adjusts the pricing and available supply of assets to

maximize profits.
Answer: True
Difficulty: Easy

5. In theory, the concept of differential pricing decreases total cost for a firm.
Answer: False
Difficulty: Moderate

6. To differentiate between the various market segments, the firm must either
eliminate barriers that identify product or service attributes the segments value
differently.
Answer: False
Difficulty: Easy

7. In most instances of differential pricing, demand from the segment paying the
lower price arises earlier in time than demand from the segment paying the
higher price.
Answer: True
Difficulty: Moderate

8. The basic trade-off to be considered by the supplier with production capacity is

between committing to an order from a high-price buyer or waiting for a lower
price buyer to arrive later on.
Answer: False
Difficulty: Easy
9. Spoilage occurs when the capacity reserved for higher price buyers is wasted
because demand from the higher price segment does not materialize.
Answer: True
Difficulty: Easy

10. Wastage occurs if higher price buyers have to be turned away because the
capacity has already been committed to lower price buyers.
Answer: False
Difficulty: Moderate

11. An order from a lower price buyer should be accepted if the expected revenue
from a higher price buyer is lower than the current revenue from the lower price
buyer.
Answer: True
Difficulty: Easy

12. The amount of the asset reserved for the higher price segment is such that the
expected marginal revenue from the higher priced segment is less than the price
to the lower price segment.
Answer: False
Difficulty: Hard

13. Any asset that loses value over time is perishable.

Answer: True
Difficulty: Easy

14. Unused capacity from the past is extremely valuable.

Answer: False
Difficulty: Easy

15. The tactic of varying price over time is suitable for assets such as fashion apparel
that have a clear date beyond which they lose a lot of their value.
Answer: True
Difficulty: Easy

16. Effective differential pricing over time will generally increase the level of product
availability for the consumer willing to pay full price, but will decrease total profits
for the retailer.
Answer: False
Difficulty: Moderate

17. The tactic of overbooking or overselling the available asset is suitable in any
situation where customers are able to cancel orders and the value of the asset
drops significantly after a deadline.
Answer: True
Difficulty: Easy

18. The basic trade-off to consider during overbooking is between having wasted
capacity (or inventory) because of few cancellations or having a shortage of
capacity (or inventory) because of excessive cancellations.
Answer: False
 Difficulty: Moderate

19. The cost of wasted capacity is the margin that would have been generated if the
capacity had been used for production.
Answer: True
Difficulty: Moderate

20. The cost of a capacity shortage is the increase in productivity that results from
having to go to a backup source.
Answer: False
Difficulty: Moderate

21. The goal when making the overbooking decision is to maximize supply chain
profits by minimizing the cost of wasted capacity and the cost of capacity
shortage.
Answer: True
Difficulty: Moderate

22. Faced with seasonal peaks, an effective revenue management tactic is to charge
a higher price during the peak period and a higher price during off-peak periods.
Answer: False
Difficulty: Hard

23. Shifting demand from peak to off-peak periods is beneficial if the discount given
during the off-peak period is more than offset by the decrease in cost because of
a smaller peak and the increase in revenue during the off-peak period.
Answer: True
Difficulty: Easy

24. Firms must decide what fraction of the asset to sell in bulk and what fraction of
the asset to save for destructive testing.
Answer: False
Difficulty: Easy

25. The amount reserved for the spot market should be such that the expected
marginal revenue from the spot market equals the current revenue from a bulk
sale.
Answer: True
Difficulty: Moderate

26. The reserved quantity will be affected by the difference in margin between the
spot market and the bulk sale, but not the distribution of demand from the spot
market.
Answer: False
Difficulty: Moderate

27. Ultimately, a proper understanding of customer preferences and a quantification

of the impact of various tactics on consumer behavior are at the core of
successful revenue management.
Answer: True
Difficulty: Moderate
28. The forecasting function is not necessary for most revenue management
systems.
Answer: False
Difficulty: Moderate

29. The goal of optimization is to use forecasts of customer behavior to identify a

revenue management tactic that will be most effective.
Answer: True
Difficulty: Easy

30. Too high a level of overbooking will lead to unutilized assets and lost revenue.
Answer: False
Difficulty: Easy

31. Too low a level of overbooking will lead to unutilized assets and lost revenue.
Answer: True
Difficulty: Easy

32. Salespeople must understand the revenue management tactic in place so they
can align their sales pitch accordingly.
Answer: True
Difficulty: Easy

33. Customers will have a negative perception of revenue management tactics if they
are simply presented as a mechanism for extracting maximum revenue.
Answer: True
Difficulty: Easy

Multiple Choice

1. Pricing can be used to

a. change available supply.
b. reduce supply chain costs.
c. influence demand if customers are price sensitive.
d. all of the above
e. a and c only
Answer: c
Difficulty: Moderate

2. Revenue management is
a. the use of marketing tools to increase revenue.
b. the use of pricing to increase the profit generated from a limited supply of
supply chain assets.
 c. a process designed to determine the best use of funds generated through
sales.
d. the use of accounting tools to monitor cash flow.
e. none of the above
Answer: b
Difficulty: Hard

3. The two forms of supply chain assets are

a. capacity and inventory.
b. capacity and revenue.
c. inventory and revenue.
d. inventory and warehouse space.
e. none of the above
Answer: a
Difficulty: Easy

4. Revenue management may be defined as

a. the use of differential costing based on product or capacity availability to
decrease supply chain cost.
b. the use of differential costing based on customer segment, time of use, and
product or capacity availability to increase profitability.
c. the use of differential pricing based on customer segment, time of use, and
product or capacity availability to decrease supply chain surplus.
d. the use of differential pricing based on customer segment, time of use, and
product or capacity availability to increase supply chain surplus.
e. none of the above
Answer: d
Difficulty: Moderate

5. Revenue management has a significant impact on supply chain profitability when

which of the following four conditions exist?
a. The value of the product varies in different market segments.
b. The product is highly perishable or product wastage occurs.
c. Demand has seasonal and other peaks.
d. The product is sold both in bulk and the spot market.
e. any of the above
Answer: e
Difficulty: Easy

6. The use of differential pricing should

a. decrease total profits for a firm.
b. increase total profits for a firm.
c. increase capacity for a firm.
d. decrease capacity utilization for a firm.
e. None of the above are true.
Answer: b
Difficulty: Moderate
7. Which of the following are issues that must be dealt with in order for differential
pricing to be effective?
a. The firm must differentiate between the market segments and structure its
pricing to make one segment pay more than the other.
b. The firm must control demand such that the lower paying segment does not
utilize the entire availability of the asset.
c. The firm must secure enough capacity to meet demand from each segment.
d. all of the above
e. a and b only
Answer: e
Difficulty: Moderate

8. To differentiate between the various market segments, the firm must

a. create barriers by identifying product or service attributes that the segments
value differently.
b. eliminate barriers that identify product or service attributes that the segments
value differently.
c. negotiate separately with different market segments that value product or
service attributes differently.
d. develop pricing structures based on the volume of various product or service
attributes.
e. none of the above
Answer: a
Difficulty: Moderate

9. In most instances of differential pricing, demand from the segment paying the
lower price
a. arises earlier in time than demand from the segment paying the higher price.
b. arises later in time than demand from the segment paying the higher price.
c. arises about the same time as demand from the segment paying the higher
price.
d. arises both earlier and later in time than demand from the segment paying
the higher price.
e. none of the above
Answer: a
Difficulty: Moderate

10. The basic trade-off to be considered by the supplier with production capacity is
between
a. committing to an order from a high-price buyer or waiting for a lower price
buyer to arrive later on.
b. committing to an order from a lower price buyer or waiting for a high-price
buyer to arrive later on.
c. allowing the market to be controlled by price or capacity.
d. having marketing or operations establish the constraints within which orders
are accepted.
e. none of the above
Answer: b
Difficulty: Easy
11. When the capacity reserved for higher price buyers is wasted because demand
from the higher price segment does not materialize, this is
a. spill.
b. spoilage.
c. wastage.
d. excess.
e. none of the above
Answer: b
Difficulty: Moderate

12. If higher price buyers have to be turned away because the capacity has already
been committed to lower price buyers, this is
a. spill.
b. spoilage.
c. wastage.
d. excess.
e. none of the above
Answer: a
Difficulty: Moderate

13. An order from a lower price buyer

a. should always be accepted rather than waiting for potential revenue from a
higher price buyer .
b. should only be accepted if the expected revenue from a higher price buyer is
higher than the current revenue from the lower price buyer.
c. should be accepted if the expected revenue from a higher price buyer is
lower than the current revenue from the lower price buyer.
d. should not be accepted if the expected revenue from a higher price buyer is
lower than the current revenue from the lower price buyer.
e. none of the above
Answer: c
Difficulty: Easy

14. To successfully use revenue management when serving multiple customer

segments, a firm must use which of the following tactics effectively?
a. price based on the value assigned by each segment
b. use different prices for each segment
c. forecast at the segment level
d. all of the above
e. a and b only
Answer: d
Difficulty: Moderate

15. The amount of the asset reserved for the higher price segment is such that
a. all orders from the lower priced segment will be accepted and filled.
b. the expected marginal revenue from the higher priced segment is more than
the price to the lower price segment.
c. the expected marginal revenue from the higher priced segment is less than
the price to the lower price segment.
d. the expected marginal revenue from the higher priced segment equals the
price to the lower price segment.
 e. none of the above
Answer: d
Difficulty: Moderate

16. A perishable asset is

a. something that decays or deteriorates.
b. an item that has a short life span.
c. any asset that loses value over time.
d. all of the above
e. none of the above
Answer: c
Difficulty: Moderate

17. Which of the following is not a perishable asset?

a. fruits and vegetables
b. high fashion apparel
c. computers and cell phones
d. production, transportation, and storage capacity that is wasted if not fully
utilized
e. All of the above are perishable assets.
Answer: e
Difficulty: Moderate

18. Which of the following is (are) revenue management tactics appropriate for
perishable assets?
a. Vary price over time to maximize expected revenue.
b. Under book sales of the asset to account for unexpected demand.
c. Overbook sales of the asset to account for cancellations.
d. all of the above
e. a and c only
Answer: d
Difficulty: Moderate

19. The tactic of varying price over time is suitable for assets
a. that do not have a clear date beyond which they lose a lot of their value.
b. that have a clear date beyond which they lose a lot of their value.
c. where customers are able to cancel orders and the value of the asset drops
significantly after a deadline.
d. where customers are unable to cancel orders and the value of the asset
drops significantly after a deadline.
e. none of the above
Answer: b
Difficulty: Moderate

20. Effective differential pricing over time will generally

a. decrease the level of product availability for the consumer willing to pay full
price and also decrease total profits for the retailer.
b. decrease the level of product availability for the consumer willing to pay full
price but will increase total profits for the retailer.
c. increase the level of product availability for the consumer willing to pay full
price and also increase total profits for the retailer.
 d. increase the level of product availability for the consumer willing to pay full
price but will decrease total profits for the retailer.
e. none of the above
Answer: c
Difficulty: Moderate

21. The tactic of overbooking or overselling the available asset is suitable where
a. there is a clear date beyond which the asset loses a lot of its value.
b. there is no clear date beyond which the asset loses a lot of its value.
c. customers are able to cancel orders and the value of the asset drops
significantly after a deadline.
d. customers are unable to cancel orders and the value of the asset drops
significantly after a deadline.
e. none of the above
Answer: c
Difficulty: Moderate

22. The basic trade-off to consider during overbooking is between

a. having wasted capacity (or inventory) or a shortage of capacity (or inventory).
b. having lost sales or a shortage of capacity (or inventory).
c. having wasted capacity (or inventory) or excess capacity (or inventory).
d. having high sales or a shortage of capacity (or inventory).
e. none of the above
Answer: a
Difficulty: Moderate

23. Wasted capacity (or inventory) occurs when

a. there are excessive cancellations.
b. there are few cancellations.
c. an expensive backup needs to be arranged.
d. all of the above
e. a and c only
Answer: a
Difficulty: Easy

24. A shortage of capacity (or inventory) occurs when

a. there are excessive cancellations.
b. there are few cancellations.
c. an expensive backup needs to be arranged.
d. all of the above
e. b and c only
Answer: e
Difficulty: Easy

25. The cost of wasted capacity is

a. the reduction in margin that results from having to go to a backup source.
b. the margin that would have been generated if the capacity had been used for
production.
c. the productivity increase generated when the capacity is used for production.
d. the sales potential of excess capacity kept in reserve for emergency
production.
 e. none of the above
Answer: b
Difficulty: Moderate

26. The cost of a capacity shortage is

a. the reduction in margin that results from having to go to a backup source.
b. the margin that would have been generated if the capacity had been used for
production.
c. the productivity increase generated when the capacity is used for production.
d. the sales potential of excess capacity kept in reserve for emergency
production.
e. none of the above
Answer: a
Difficulty: Moderate

27. The goal when making the overbooking decision is to maximize supply chain
profits by
a. maximizing the value of wasted capacity and the cost of capacity shortage.
b. maximizing supply chain profits.
c. minimizing the cost of wasted capacity and the cost of capacity shortage.
d. minimizing the cost of wasted capacity and minimizing capacity shortages.
e. none of the above
Answer: c
Difficulty: Hard

28. An effective revenue management tactic when faced with seasonal peaks is to
charge a
a. high price during the peak period and a higher price during off-peak periods.
b. higher price during the peak period and a lower price during off-peak periods.
c. lower price during the peak period and a higher price during off-peak periods.
d. low price during the peak period and a lower price during off-peak periods.
e. none of the above
Answer: b
Difficulty: Moderate

29. Shifting demand from peak to off-peak periods is beneficial if the discount given
a. during the off-peak period is more than offset by the decrease in cost
because of a larger peak.
b. during the off-peak period is more than offset by the decrease in cost
because of a smaller peak.
c. during the peak period is more than offset by the decrease in cost because of
a smaller peak.
d. during the peak period is more than offset by the decrease in cost because of
a larger peak.
e. none of the above
Answer: a
Difficulty: Moderate

30. Most firms must decide what fraction of an asset to

a. sell in bulk and what fraction of the asset to discard.
b. save for the spot market and what fraction of the asset to discard.
 c. save for emergencies and what fraction of the asset to rework.
d. sell in bulk and what fraction of the asset to save for the spot market.
e. none of the above
Answer: d
Difficulty: Moderate

31. The fundamental trade-off between selling in bulk or on the spot market is
a. different from the situation where a firm serves two market segments.
b. similar to the case when a firm serves two market segments.
c. similar to the case where a firm must deal with seasonal demand.
d. similar to the case where a firm has a perishable asset.
e. none of the above
Answer: b
Difficulty: Hard

32. The amount reserved for the spot market should be

a. such that the expected marginal revenue from the spot market equals the
current revenue from a bulk sale.
b. such that the expected marginal revenue from the spot market exceeds the
current revenue from a bulk sale.
c. such that the expected marginal revenue from the spot market is less than
the current revenue from a bulk sale.
d. equal to the maximum revenue available from the spot.
e. none of the above
Answer: a
Difficulty: Hard

33. The reserved quantity for the spot market will be affected by
a. the difference in margin between the spot market and the bulk sale.
b. the distribution of demand from the bulk sale.
c. the distribution of demand from the spot market.
d. all of the above
e. a and c only
Answer: e
Difficulty: Moderate

34. Successful revenue management requires

a. a proper understanding of customer preferences.
b. a quantification of the impact of various tactics on consumer behavior.
c. a clear focus on profitability.
d. all of the above
e. a and b only
Answer: e
Difficulty: Moderate

35. The forecasting function is

a. the foundation of any revenue management system.
b. unnecessary for a revenue management system.
c. an added plus for any revenue management system.
d. likely to create problems for any revenue management system.
e. none of the above
 Answer: a
Difficulty: Moderate

36. The goal of optimization in revenue management is to identify a tactic

a. using forecasts of customer behavior that will be most effective.
b. using linear regression that will maximize revenue.
c. using linear regression that will minimize cost.
d. that will not have to be altered.
e. none of the above
Answer: a
Difficulty: Moderate

37. The decision to use overbooking will

a. lead to upset customers and a high cost of providing them space.
b. lead to unutilized assets and lost revenue.
c. lead to reduced profits.
d. depend upon optimization to be successful.
e. none of the above
Answer: d
Difficulty: Moderate

38. The sales force must understand the revenue management tactic in place
a. in order to align their sales pitch accordingly.
b. in order to identify those customers who truly need the supply chain asset
during the peak period.
c. in order to identify those customers that will benefit from moving their order to
the off-peak period.
d. all of the above
e. a and b only
Answer: d
Difficulty: Moderate

39. It is important for the firm to structure its revenue management program in a way
that
a. it is presented simply as a mechanism for extracting maximum revenue.
b. revenue increases while improving service along some dimension that is
important to customers that pay the highest price.
c. profit is maximized.
d. all of the above
e. b and c only
Answer: b
Difficulty: Moderate

40. In order to achieve the greatest value,

a. supply planning and revenue management should be performed separately.
b. supply planning should be completed first.
c. supply planning and revenue management should be combined.
d. revenue management should be completed first.
e. none of the above
Answer: c
Difficulty: Hard
Essay/Problems

1. Describe the role of revenue management.

Answer: Pricing is an important lever to increase supply chain profits by better

matching supply and demand. Pricing may influence demand if customers are
price sensitive. Revenue management is the use of pricing to increase the profit
generated from a limited supply of supply chain assets. Supply chain assets exist
in two forms—capacity and inventory. Capacity assets in the supply chain exist
for production, transportation, and storage. Inventory assets exist throughout the
supply chain and are carried to improve product availability.
Management decisions should try to maximize the total margin earned from
these assets. To increase the total margin, managers must use all available
levers, including price. This is the primary role of revenue management.
Traditionally, firms have often invested in or eliminated assets to reduce the
imbalance between supply and demand. Firms build additional capacity during
the growth part of a business cycle and shut some of the capacity down during a
downturn. Ideas from revenue management suggest that a firm should first use
pricing to achieve some balance between supply and demand, and only then
invest in or eliminate assets. Revenue management may also be defined as the
use of differential pricing based on customer segment, time of use, and product
or capacity availability to increase supply chain surplus.
Difficulty: Moderate

2. Explain how revenue management is beneficial.

Answer: Revenue management adjusts the pricing and available supply of assets
to maximize profits. Revenue management has a significant impact on supply
chain profitability when one or more of the following four conditions exist:
1. The value of the product varies in different market segments.
2. The product is highly perishable or product wastage occurs.
3. Demand has seasonal and other peaks.
4. The product is sold both in bulk and the spot market.
Revenue management can be a powerful tool for every owner of assets in a
supply chain. Owners of any form of capacity (production, transportation, or
storage) can use revenue management if there is seasonal demand or if there
are segments that are willing to pay different prices for different lead times to use
the capacity. Revenue management can be effective if there is a segment that
wants to use capacity at the last minute and is willing to pay for it, and there is
another segment that wants a lower price and is willing to commit far in advance.
Revenue management is essential for owners of any perishable inventory. Most
successful examples of the use of revenue management are from the travel and
hospitality industry and include airlines, car rentals, and hotels. Revenue
management can have a similar impact on all stages of a supply chain that
satisfy one or more of these four conditions.
Difficulty: Moderate

3. Explain how differential pricing can benefit a firm.

 Answer: If a supplier serves multiple customer segments with a fixed asset, he or
she can improve revenues by setting different prices for each segment. In theory,
the concept of differential pricing increases total profits for a firm. There are two
fundamental issues, however, that must be handled in practice. First, the firm
must differentiate between the two segments and structure its pricing to make
one segment pay more than the other. To differentiate between the various
segments, the firm must create barriers by identifying product or service
attributes that the segments value differently. Second, the firm must control
demand such that the lower paying segment does not utilize the entire availability
of the asset. The amount of the asset reserved for the higher price segment is
such that the expected marginal revenue from the higher priced segment equals
the price to the lower price segment. Prices must be set with barriers such that
the segment willing to pay more is not able to pay the lower price.
To successfully use revenue management when serving multiple customer
segments, a firm must use the following tactics effectively:
• Price based on the value assigned by each segment.
• Use different prices for each segment.
• Forecast at the segment level.
Difficulty: Moderate

4. How do firms address the problems of spoilage and spill?

Answer: In most instances of differential pricing, demand from the segment

paying the lower price arises earlier in time than demand from the segment
paying the higher price. The basic trade-off to be considered by the supplier with
production capacity is between committing to an order from a lower price buyer
and waiting for a high-price buyer to arrive later on. The two risks in such a
situation are spoilage and spill. 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.
The supplier should decide on the capacity to commit for the higher price buyers
so as to minimize the expected cost of spoilage and spill. A current order from a
lower price buyer should be compared with the expected revenue from waiting
for a higher price buyer. The order from the lower price buyer should be accepted
if the expected revenue from the higher price buyer is lower than the current
revenue from the lower price buyer.
Difficulty: Moderate

5. How can firms address the problem of perishable assets?

Answer: Any asset that loses value over time is perishable.

The two revenue management tactics used for perishable assets are
1. Vary price over time to maximize expected revenue.
2. Overbook sales of the asset to account for cancellations.
The tactic of varying price over time is suitable for assets such as fashion apparel
that have a clear date beyond which they lose a lot of their value. To effectively
vary price over time for a perishable asset, the asset owner must be able to
estimate the value of the asset over time and effectively forecast the impact of
price on customer demand. Effective differential pricing over time will generally
 increase the level of product availability for the consumer willing to pay full price
and also increase total profits for the retailer.
The tactic of overbooking or overselling the available asset is suitable in any
situation where customers are able to cancel orders and the value of the asset
drops significantly after a deadline. If the cancellation or the return rate can be
predicted accurately, the overbooking level is easy to determine. In practice,
however, the cancellation or return rate is uncertain.
The basic trade-off to consider during overbooking is between having wasted
capacity (or inventory) because of excessive cancellations and having a shortage
of capacity (or inventory) because of few cancellations, in which case an
expensive backup needs to be arranged. The cost of wasted capacity is the
margin that would have been generated if the capacity had been used for
production. The cost of a capacity shortage is the reduction in margin that results
from having to go to a backup source. The goal when making the overbooking
decision is to maximize supply chain profits by minimizing the cost of wasted
capacity and the cost of capacity shortage.
Difficulty: Moderate

6. Explain why forecasting is important to revenue management.

Answer: The foundation of any revenue management system is the forecasting
function. To use overbooking with any degree of success, a firm must be able to
forecast cancellation patterns. Forecasting does not mean obtaining an estimate
that is always accurate. Forecasting involves estimating demand and also
attributing an expected error to the forecast itself. Both the estimated value and
the expected error are important inputs into any revenue management model.
Finally, as new information becomes available, reforecast to see if the revenue
management tactics currently in place are still appropriate. The frequency of
forecasting will depend on the amount of market activity. Ideally, the forecast and
the revenue management decision should be evaluated after every transaction.
Difficulty: Moderate

7. A manufacturer of industrial seals has production capacity of 1,000 units per day.
Currently, the firm sells production capacity for $10 per unit. At this price, all
production capacity gets booked about one week in advance. A group of
customers have said that they would be willing to pay $15 per unit if capacity was
available on the last day. About ten days in advance, demand for the high-price
segment is normally distributed with a mean of 250 and a standard deviation of
100. How much production capacity should the manufacturer reserve for the last
day?

Answer: Revenue from segment A, pA = $15 per unit

Revenue from segment B, pB = $10 per unit
Mean demand for segment A, DA = 250 units
Standard deviation of demand for segment A, σA = 100 units

CA = NORMINV(1 - pB/pA, DA, σA)

= NORMINV(1 – 10/15, 250, 100)
= 206.9272 ≈ 207 units of capacity
Difficulty: Moderate
Note: Access to Excel will be necessary to complete this problem.