Pricing is a factor that gears up profits in the supply chain through an appropriate match of supply and demand. Revenue management can be defined as the application of pricing to increase the profit produced from a limited supply of supply chain assets.
Ideas from revenue management recommend that a company should first use pricing to maintain a balance between the supply and demand and should think of further investing or eliminating assets only after the balance is maintained.
The assets in the supply chain are present in two forms, namely capacity and Inventory.
Capacity assets in the supply chain are present for manufacturing, shipment, and storage while inventory assets are present within the supply chain and are carried to develop and improvise product availability.
Thus, we can further define revenue management as the application of differential pricing on the basis of customer segment, time of use and product or capacity availability to increment supply chain surplus.
Revenue management plays a major role in supply chain and has a share of credit in the profitability of supply chain when one or more of the following conditions exist:
• The product value differs in different market segments
• The product is highly perishable or product tends to be defective.
• Demand has seasonal and other peaks.
• The product is sold both in bulk and the spot market.
The strategy of revenue management has been successfully applied in many streams that we often tend to use but it is never noticed. For example, the finest real life application of revenue management can be seen in the airline, railway, hotel and resort, cruise ship, healthcare, printing and publishing.
RM for Multiple Customer Segments
In the concept of revenue management, we need to take care of two fundamental issues. The first one is how to distinguish between two segments and design their pricing to make one segment pay more than the other. Secondly, how to control the demand so that the lower price segment does not use the complete asset that is available.
To gain completely from revenue management, the manufacturer needs to minimise the volume of capacity devoted to lowering price segment even if enough demand is available from the lower price segment to utilise the complete volume. Here, the general trade-off is in between placing an order at a lower price or waiting for a high price to arrive later on.
These types of situations invite risks like spoilage and spill. Spoilage appears when volumes of goods are wasted due to demand from the high rate that does not materialise. Similarly, spill appears if higher rate segments need to be rejected due to the commitment of volume goods given to the lower price segment.
To reduce the cost of spoilage and spill, the manufacturer can apply the formula given below to segments. Let us assume that the anticipated demand for the higher price segment is generally distributed with a mean of DH and standard deviation of σH:
CH = F-1(1-pL/pH,DH,σH) = NORMINV(1-pL/pH,DH,σH)
CH = reserve capacity for higher price segment pL = the price for lower segment
pH = the price for higher segment
An important point to note here is the application of differential pricing that increments the level of asset availability for the high price segment. A different approach that is applicable for differential pricing is to build multiple versions of the product that focus on different segments. We can understand this concept with the help of a real life application of managing revenue for multiple customer segments, that is, the airlines.