Why CEOs Should Care About Revenue Management

by Anil Lahoti

Businesses worldwide are under tremendous pressure to maximize revenues from their perishable capacity, products and/or services. These companies also have huge capital investments tied to their capacity/resources, and any incremental revenues from existing resources can go directly to the bottom line.

In rapidly changing supply and demand scenarios, how do you manage your resources and price your products and services? The challenges are determining the following:
- How do you forecast demand for different products and services?

- How do you allocate and reserve the capacity/resources for high revenue/profit customers and products?

- How do you maximize capacity utilization as well as revenue realization?

- How do you revise capacity/resource allocations based on demand on a regular basis to maximize revenues?

- How do you optimize overbooking to minimize service failures costs?

- How do you differentiate product configurations to maximize revenues?

- How do you track excess capacity and offer discounts at the right time to stimulate demand without diluting revenues.

- When do you change capacity/resources to match long-term supply and demand?
The answers to these questions are rooted in revenue management (RM), which is based on operations research and management science methodology and tools. While management scientists have developed cutting-edge tools such as RM in the last two decades, they have often had a tough time "selling" the tools to management. So, why should a CEO care about RM, and what can be done to implement RM successfully?

From a CEO's perspective, revenue management is critical because it empowers companies to successfully address the challenges of supply and demand and other issues. Revenue management processes and systems bring discipline to a company, giving it a strategic advantage over the competition by enabling the company to sell the "right product to the right customer, at the right price, at the right time." Revenue management strategies balance the tradeoffs among revenues, capacity utilization and service failures. Revenue management has been proven, in many applications, to provide strategic, competitive and financial advantages.

Revenue management systems and processes afford companies tremendous strategic advantages by helping them increase revenues. American Airlines pioneered yield/revenue management immediately after airline deregulation, and the airline subsequently saw more than a billion dollars in incremental annual revenues as a direct result of implementing such systems and processes.

Many travel and hospitality companies have been subject to the "adapt or perish" mantra when it comes to revenue management. Revenue management processes and systems can be applied in a variety of industries, including travel and hospitality, transportation, energy, hi-tech manufacturing, advertising, telecommunications and retail. In the future, companies that neglect revenue management will be at a serious disadvantage.

Although RM concepts are fairly simple, implementation of revenue management systems has remained very complex. Current RM systems are either homegrown or vendor-specific. These systems are very expensive and time consuming to implement, disrupt people and processes during and after implementation, and are very complex to use. Unfortunately, revenue management implementation and usability have not been addressed properly and remain two of the biggest obstacles for companies to fully commit to and benefit from such systems. Several users of current systems complain about the "black box" approach taken in implementing complex revenue management forecasting and optimization models.

Easing the Implementation Pain

So how do you minimize the pain associated with revenue management implementation and usability? Here are some suggestions:

Open Systems (Internet, Intranet or LAN client/server platform): Companies should leverage universally adapted Internet / Wireless application standards, protocols and platforms. By implementing software that is built using open standards, investment in IT infrastructure can be preserved and extended for long periods of time. Revenue management software should complement a company's existing investment in the infrastructure. By leveraging existing software/hardware/networking infrastructure, companies can minimize the cost of implementation and avoid training or failure costs.

Flexible Framework: Revenue management software solutions should be components-based and completely integrated. Software built on a flexible framework can be easily integrated with existing database and Web/application servers. Companies planning to implement revenue management systems should avoid monolithic proprietary systems that offer very little flexibility for ad-hoc decision support or future enhancements and software that does not integrate with the legacy systems well.

Phased Implementation: Revenue management encompasses complex forecasting and optimization models. When implementing such systems today, benefits cannot be fully realized until all models are completely integrated. This could take more than two years and cost millions of dollars. Companies should avoid initiatives that require 2 to 3 years and multi-million dollars. A phased approach that provides access to basic revenue management metrics should be considered. Although optimization models will be needed to optimize supply and demand or optimize resource allocation, the real emphasis in Phase I should be to identify and gather the right data, get users comfortable with RM metrics, and implement and fine tune forecasting models until sufficient historical data is collected. This will minimize forecasting errors and establish confidence in forecasting models leading to better RM usability. Optimization models should be implemented in Phase II or later. Revenue management systems and processes should address business problems and provide functionality that creates a path for optimization 12 months after implementing Phase I (reporting and forecasting).

Front-End Platform (as opposed to back-end transaction processing platform): Revenue management systems implemented at large companies are highly automated and tightly integrated with reservation or transaction systems. The systems are run in the back-end and require very skilled analysts to control and manage these processes. A user-friendly front-end to the complex revenue management system can improve analyst productivity and improve results. Revenue management systems should allow users to perform what-if analysis to study the impact of parameter or input changes on the forecasting and optimization model outputs. Also, users should be able to create any type of ad hoc report as they think and analyze.

Cost and Time: Revenue management systems generally cost between $1 million to $3 million and take more than two years to implement. Companies should explore low-cost, high-value alternatives and prefer solutions with reduced inefficiencies in designing, developing and implementing revenue management software. By dedicating resources to high-priority issues and functionality and by insisting on eliminating unnecessary functionality and consulting activities, costs and implementation time can be significantly lowered.

Demand Forecasting and Pricing: CEOs should pay attention to demand forecasting since this is an Achilles heel when implementing revenue management systems. No optimization of resource allocation to products/customers is complete without accurate demand forecasting. For example, in the travel industry, there is a lot of focus on advanced origin and destination (O&D;) optimization, but not enough emphasis on the importance of O&D; demand forecasting. Demand forecasts at an appropriate level are main inputs to the optimization models. It is imperative to implement accurate demand forecasting and allow it to stabilize prior to implementing O&D; optimization. Pricing should be tightly aligned with the segmented demand for different products. In this situation, no CEO should rush to embrace O&D; optimization without first fully implementing accurate demand forecasting.

Revenue Management Automation: In many mid-size companies, revenue management is either not applied properly, or is inefficient, manual and time consuming. Automating the process of extracting, transforming and loading data into revenue management data warehouse, running statistical and mathematical models on a periodic basis, and providing easy interfaces to perform what-if analysis and ad-hoc reporting can significantly enhance analyst productivity and business performance.

Inventory Control and Sales Management: Whether it is automated inventory control or relationship-based sales, companies realize significant improvement in revenues if RM principles are integrated at all sales levels. The buy-in from sales management and cooperation in establishing guidelines to follow RM techniques and in creating commensurate incentives program is critical for long-term success.

Companies that want to succeed — not just survive — must implement strategic technologies that allow them to continually adjust to dynamic and real-time supply and demand situations. Although airlines pioneered and developed revenue management, it is proving to be a very effective competitive tool in many industries. Unlike other technology fads, revenue management is deeply rooted in management science and information technology and above all, brings discipline to an organization. The future of revenue management was aptly described in The Wall Street Journal as follows: "Re-engineering has run its course. You manage your quality totally. Where do you turn for future gains? Perhaps to the marketplace, with 'revenue management.' ... Now with computing costs plunging, revenue management is poised to explode."

The Benefits of Revenue Management

Gain strategic advantage: The Wall Street Journal identifies revenue management as "the number one emerging business strategy, a practice poised to explode."

Gain Competitive advantage: According to a Wall Street analyst, "By 2001, companies that neglect to implement yield management techniques will become uncompetitive."

Maximize Revenues: According to Robert Cross, the author of "Revenue Management: Hard-Core tactics for Market Domination," "Firms employing revenue management techniques have seen revenues increase between 3% and 7% without significant capital expenditures, resulting in a 50% to 100% increase in profits!"

Maximize Profits: According to the Score Card, a Revenue Management periodical, "Implementing consistent pricing and revenue management processes along with supporting decision support systems can lead to substantial improvements in corporate profitability — often on the order of 1-2% of revenue or even more."

Maximize ROI: When RM is effectively applied, ROI calculations become a no-brainer. With a proven track record in increasing revenues applied directly to the bottom line, investment in revenue management can be easily justified.

Use Science not Guesswork: In a dynamic pricing and demand environment, there is no room for gut-feel and subjective decision making. Companies implementing revenue management basically employ proven principles of management science and information technology, including historical data analysis, accurate data modeling, and statistical and mathematical optimization.

Achieve Leadership: Companies that constantly monitor customer buying patterns and behavior, internal processes and channels of execution, and resource utilization will become the market leaders.

Dr. Anil Lahoti is an independent consultant and the founder and president of VeriProfit, Inc., a revenue management decision-support firm serving clients in the transportation industry. He has held management positions at SABRE Decisions Technologies and PROS Strategic Solutions. Lahoti earned a Ph.D. and a master's degree in Industrial Engineering at Clemson University. He can be reached at alahoti@veriprofit.com