Chapter 16

Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Chapter 16

Pricing and Revenue Management in a Supply Chain

Learning Objectives

• Understand the role of revenue management in a supply chain

• Identify conditions under which revenue management tactics can

be effective

• Describe trade-offs that must be considered when making

revenue management decisions

The Role of Pricing and Revenue Management in the Supply Chain

• Revenue management is the use of pricing to increase the profit

generated from a limited supply of supply chain 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

The Role of Pricing and Revenue Management in the Supply Chain

• Revenue management has a significant impact on supply chain

profitability when one or more of the following four conditions

The value of the product varies in different market segments

The product is highly perishable or product waste occurs

Demand has seasonal and other peaks

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 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 utilize the entire availability of the asset?

Figure 16-1

Figure 16-2

Pricing to Multiple Segments

Subject to

For capacity constrained by Q

Same price to both segments

Total production capacity is limited to 4,000 units

Subject to

Figure 16-3

Allocating Capacity to a Segment Under Uncertainty

• Basic trade-off is between committing to an order from a lower-

price buyer or waiting for a higher-price buyer to arrive

Spoilage

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 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

Allocating Capacity to Multiple Segments

Revenue from segment A, pA = $3.50 per cubic foot

Revenue from segment B, pB = $2.00 per cubic foot

Mean demand for segment A, DA = 3,000 cubic feet

Standard deviation of demand for A, sA = 1,000 cubic feet

Pricing and Revenue Managementfor Perishable Assets

• Any asset that loses value over time is perishable

• Two basic approaches

Vary price dynamically over time to maximize expected revenue

Overbook sales of the asset to account for cancellations

Dynamic Pricing

• Effective differential pricing increases the level of product availability for the consumer willing to pay full price and total profits for the retailer

Subject to

Dynamic Pricing

• Effective differential pricing increases the level of product availability for the consumer willing to pay full price and total profits for the retailer

d1 = 300 – p1, d2 = 300 – 1.3p2, and d3 = 300 – 1.8p3

Subject to

Dynamic Pricing

Figure 16-4

Dynamic Pricing

Figure 16-5

Evaluating Quantity with Dynamic Pricing

d1 = 300 – p1, d2 = 300 – 1.3p2, and d3 = 300 – 1.8p3

Subject to

Evaluating Quantity with Dynamic Pricing

Figure 16-6

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

Overbooking

Cost of wasted capacity, Cw = $10 per dress

Cost of capacity shortage, Cs = $5 per dress

Pricing and Revenue Managementfor Seasonal Demand

• Seasonal peaks of demand common in many supply chains

• 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

• 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

Pricing and Revenue Management for Bulk and Spot Contracts

• Problems constructing a portfolio of long-term bulk contracts and

short-term spot market contracts

• 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

Pricing and Revenue Management for Bulk and Spot Contracts

Long-Term Bulk Contracts versus the Spot Market

Bulk contract cost, cB = $10,000 per million units

Spot market cost, cS = $12,500 per million units

Using Pricing and Revenue Management in Practice

• Evaluate your market carefully

• Quantify the benefits of revenue management

• Implement a forecasting process

• Keep it simple

• Involve both sales and operations

• Understand and inform the customer

• Integrate supply planning with revenue management

Summary of Learning Objectives

• Understand the role of revenue management in a supply chain

• Identify conditions under which revenue management tactics can be effective

• Describe trade-offs that must be considered when making revenue management decisions

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