S4 - Pricing and Revenue Management in A Supply Chain

S4 - Pricing and Revenue Management in a Supply Chain
Session 4
• Pricing and Revenue

Management in a Supply
Chain
Copyright ©2019 Pearson Education. 4-1

Learning Objectives
• Role of Revenue Management (RM) in a
Supply Chain.
• Conditions under which RM tactics can be
effective.
• Trade-offs that must be considered when
making RM decisions.

ROLE OF PRICING AND RM IN THE SC

• Revenue management is the use of pricing to
increase the profit generated from a limited supply
of SC assets.
• Supply assets exist in two forms – capacity and
inventory.
• 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 profits.

Role of Pricing and RM in the SC

• RM has a significant (and tremendous) impact
on SC profitability when one or more of the
following four conditions exist:
a. the value of the (same) product varies in different
market segments.
b. the product is highly perishable or product wastage
occurs.
c. demand has seasonal and other peaks (and variations)
d. the product is sold both in bulk and on the spot
market.

Summary of Learning Objective

Revenue management (RM) uses differential pricing to better
match supply and demand and increase SC profits.
Traditionally, firms have changed the availability of assets to
match supply and demand.
RM aims to reduce any supply/demand imbalance by using
pricing as a lever.
A big advantage of using revenue management is that a change in
pricing is much easier to reverse compared with an investment in
supply chain assets.

Summary of Learning Objective – cont’d

When it is used properly, revenue management increases firm
profits while leaving service sensitive customers more satisfied
through greater asset availability and price sensitive customers
more satisfied with lower prices.
Revenue management is most effective in a supply chain when the
value of the product varies by market segment, the product is
highly perishable, product demand is seasonal, or the product is
sold both in bulk and on the spot market.

Pricing and Revenue Management for

Multiple Customer Segments
• Differential pricing increases total profits for
a firm.
• Two fundamental issues must be handled in
practice:
– how can the firm differentiate between the two
market segments and structure its pricing to make
one segment pay more than the other?
– how can the firm control demand such that the
lower-paying segment does not utilise the entire
availability of the SC asset?

d = 10,000 – 2,000p


d = 10,000 – 2,000p


• Two problems to solve when using revenue
management across multiple segments:
a. what price should be charged for each segment?
b. how should limited capacity be allocated among
the market segments?

Allocating Capacity to a Segment Under Uncertainty
• How much capacity to save for the higher-price

segment, whose demand typically arrives later?
• Basic trade-off to be considered by the supplier is
between ‘committing’ to an order from a lower-price
buyer or waiting for a higher-price buyer to arrive:
– Spoilage
– Spill
• Expected revenue waiting for a higher price; order
should be accepted if the expected revenue from the
higher-price buyer is lower than the current revenue
from the lower-price buyer.
Allocating Capacity to a Segment Under Uncertainty
• Effective use of revenue management increases

firm profits, and improves service for the more
valuable customer segment.
• Create different versions of a product (same
product) targeted at different segments.
• Tactics for multiple customer segments:
– price based on the value assigned by each segment
– use different prices for each segment
– forecast at the segment level

Key Point
If a supplier serves multiple customer segments with a
fixed asset, it 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.
The amount of the asset reserved for the higher-price
segment is such that the expected marginal revenue
from the higher-price segment equals the price to the
lower-price segment.


If a supplier serves multiple customer segments with a fixed
asset, it can improve revenues by setting different prices for each
segment.
Compared to charging a single fixed price to all customers,
differential pricing charges the less price sensitive segment a
higher price and the more price sensitive segment a lower price.
Segments are typically separated along a dimension such as lead
time so that the segment willing to pay more must pay a higher
price to take advantage of shorter lead times.
Given that demand is uncertain, the amount of the asset reserved
for the higher-price segment is such that the expected marginal
revenue from the higher-price segment equals the price to the
lower-price segment.

Pricing and RM for Perishable Assets

• Any asset that loses value over time is perishable.
• Two basic approaches:
a. vary price dynamically over time to maximise
expected revenue, dynamic pricing.
b. overbook sales of the asset to account for
cancellations – airline industry practice.
• Dynamic Pricing:
– effective differential pricing generally increases the
level of product availability for the consumer
willing to pay full price and total profits for the
retailer.
Key Point
Dynamic pricing can be a powerful tool to increase profits
if the customers’ sensitivity to price changes in the
course of the season.
This is often the case for fashion products, for which
customers are less price sensitive early in the season but
become more price sensitive toward the end of the
season.
Dynamic pricing should, however, carefully consider
strategic behaviour by customers who may anticipate
future price drops and delay their purchase. With
strategic customers it may be better to have a fixed price
or reduce the quantity offered.

Overbooking
• Basic trade-off is between having wasted
capacity because of excessive cancellations or
having a shortage of capacity because of few
cancellations, requiring expensive backup to be
arranged.

Key Point
Overbooking or overselling of a supply chain asset is

a valuable tactic 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.

Pricing and Revenue Management

for Seasonal Demand
• Seasonal peaks of demand common in many

SCs
• 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, if legal.
• Increases profits for the owner of assets,
decreases the price paid by a fraction of
customers, and brings in new customers during
the off-peak discount period.

A combination of off-peak discounting and peak pricing can
be an effective revenue management tactic for owners of
production or transportation capacity in any supply chain
facing seasonal peak demand.
This tactic increases profits for the owner of assets, provides
better service to customers served during the peak,
decreases the price paid by a fraction of customers, and also
brings in potentially new customers during the off-peak
discount period.

Pricing and Revenue Management

for Bulk and Spot Contracts
• Problems constructing a portfolio of long-term
bulk contracts and short-term spot market
contracts, the latter having higher prices.
• Decide what fraction of the asset to sell in bulk
and what fraction of the asset to save for the
spot market.
• 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.
Key Point
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
spot market purchasing.
The basic decision is the size of the bulk contract.
The fundamental trade-off is between wasting a portion of
a low-cost bulk contract and paying more for the asset
on the spot market.

Using Pricing and RM in Practice

a. Evaluate your market carefully
b.Quantify the benefits of revenue management.
c. Implement a forecasting process
d.Keep it simple – IT IS & CAN GET MIGHTY
COMPLICATED.
e. Involve both sales and operations
f. Understand and inform the customer
g.Integrate supply planning with revenue
management.


The failure to anticipate consumer behavior when using revenue
management and to develop an appropriate response can have
significant negative consequences.
It is important for firms to ensure that revenue management
techniques do not diminish customer loyalty and encourage them
to game the system.
This is only possible if revenue management improves service for
the segment of valuable customers along some dimension they
consider important.
These dimensions should be clearly communicated to the
salesforce and operations must be prepared to respond
appropriately when customers face negative outcomes resulting
from revenue management.

S4 - Pricing and Revenue Management in A Supply Chain

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S4 - Pricing and Revenue Management in a Supply Chain

• Pricing and Revenue

Copyright ©2019 Pearson Education. 4-1

Copyright ©2019 Pearson Education. 4-2

ROLE OF PRICING AND RM IN THE SC

Copyright ©2019 Pearson Education. 4-3

Role of Pricing and RM in the SC

Copyright ©2019 Pearson Education. 4-4

Summary of Learning Objective

Copyright ©2019 Pearson Education. 4-5

Summary of Learning Objective – cont’d

Copyright ©2019 Pearson Education. 4-6

Pricing and Revenue Management for

Pricing and Revenue Management for

Copyright ©2019 Pearson Education. 4-8

Pricing and Revenue Management for

Copyright ©2019 Pearson Education. 4-9

Pricing and Revenue Management for

Copyright ©2019 Pearson Education. 4-10

Allocating Capacity to a Segment Under Uncertainty

• How much capacity to save for the higher-price

Allocating Capacity to a Segment Under Uncertainty

• Effective use of revenue management increases

Copyright ©2019 Pearson Education. 4-12

Copyright ©2019 Pearson Education. 4-13

Summary of Learning Objective

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Pricing and RM for Perishable Assets

Copyright ©2019 Pearson Education. 4-16

Copyright ©2019 Pearson Education. 4-17

Overbooking or overselling of a supply chain asset is

Copyright ©2019 Pearson Education. 4-18

Pricing and Revenue Management

• Seasonal peaks of demand common in many

Summary of Learning Objective

Copyright ©2019 Pearson Education. 4-20

Pricing and Revenue Management

Copyright ©2019 Pearson Education. 4-22

Using Pricing and RM in Practice

Copyright ©2019 Pearson Education. 4-23

Summary of Learning Objective

Copyright ©2019 Pearson Education. 4-24

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