RESEARCH PAPER

“APPLICATION OF OPERATIONS RESEARCH TO REVENUE

MANAGEMENT(HOTELS)”

SUBMITTED BY

ON
4 OCTOBER 2017

SIGNATURE MARKS
ACKNOWLEDGEMENT
We would like to express our special thanks of gratitude to our teacher (Ms. Tahereem Bardi)
as well as our dean (Ms. Sangeeta Kher) who gave us this great opportunity to do this wonderful
research paper on the topic (Application of Operation Research in Revenue Management in
Hotels), which also helped us in doing a lot of readings and research because of which we came
to know about so many new things for which we are really thankful to our teacher.

EXECUTIVE SUMMARY
 The application of Operations Research in the current scenario is of increasing importance
especially in revenue management. In this paper, we have tried to cover various models under
revenue management of hotels and how these models can help hotels in maximising their
profits. Models like booking limit model, overbooking limit model, duopoly occupancy rate
model, stochastic model, deterministic Model have been demonstrated in the given paper
giving an overview of each model. The paper contains objective, introduction, applications,
techniques, conclusion, appendix and webliography. Starting from the objective of revenue
management i.e why a company should manage their revenues to how they should manage, all
these questions have been answered in the given paper. The introduction answers the basic
questions i.e what is operations research, what is revenue management etc. The application
tells how operations research models are applied in revenue management and techniques gives
the different models that are/were used in real life scenarios. The Conclusion gives an insight
of all the above topics briefly. Appendix gives the meaning of keywords and webliography
tells from where all the data has been derived.

Keywords: Booking limit model, Overbooking limit model, Duopoly occupancy rate model,
Stochastic model, Deterministic Model, Revenue Management, Operations Research(OR)
INDEX

CHAPTER 1: OBJECTIVE
CHAPTER 2: INTRODUCTION
CHAPTER 3: APPLICATION OF OR TECHNIQUES IN REVENUE
MANAGEMENT.
CHAPTER 4: TECHNIQUES: USES, OBJECTIVES & CRITICISM (if
any)
CHAPTER 5: CONCLUSION
CHAPTER 6: APPENDIX
CHAPTER 7: WEBLIOGRAPHY
OBJECTIVE

The objective of the paper is to motivate various studies regarding the development of
techniques that offer solutions to the problems for achieving a revenue which will be
maximum for the hotel industry. To achieve this objective, we did an analysis of all those
techniques and applications of those techniques in hotel industry. After which we will look into
some ideas regarding the development of methodologies so as to reach the maximum revenue
in this industry.

Another objective behind this study is to help management develop maximum effectiveness
in their work whether in present or future to maximise revenue. Revenue Management is an
ongoing process so it needs help of some techniques from operation research.

The basic question arises during application of operation research on revenue management are.

1. Does the current method for revenue management give optimal output?
2. Is the resource available with us for applying different techniques sufficient for revenue
management?
INTRODUCTION

The airline industry is generally credited with the initial creation of a revenue management
strategy. The strategy implemented was forecasting and predicting the number of passengers
that would not show up for a flight booked in advance. Thus, overbooking the flight by those
many seats would help in maximising revenues. Many airlines also began offering discounted
fares to passengers who booked seats at least 3 or more weeks in advance. Then, in 1972, Ken
Littlewood of British Overseas Airway Company, which is now known as British Airways,
proposed a rule stating that discounted fares should only be agreed to if their revenue value
was more than the value of full fare bookings which were done in the future. Six years later in
1978, then United States President Jimmy Carter put forward the airline deregulation act which
made the airline industry a free market system. This was the start of yield management, which
is now known as revenue management.

Operations Research is the use of advanced techniques so that a firm can take better
decisions. OR’s history can be traced back to World War II. The Allied forces deployed a
group of scientists and mathematicians to solve their complex wartime problems. After the
war, the attention was turned to possibility of applying same principles to business problems
and civilian use.

Revenue Management is like a disciplined tactic that is used in predicting the consumer
behaviour at the small or micro level resulting in optimizing of product availability and price
to maximise the revenue. Operation Research is a method of problem-solving and decision-
making which helps the management of companies. The problems are broken down into small
units or components and are then solved in steps by using mathematical techniques. The
application of revenue management is most effective when used in operations which have the
following characteristics: Fixed capacity, Perishable inventory, High fixed cost, Low variable
cost, Varying customer price sensitivity.

Revenue management is important as it provides companies with competitive advantages

over its competitors. This process is now used often by many companies in the airline industry
– to ensure there are minimum number of empty seats on each flight- and the hotel industry –
to ensure that at a certain point of time maximum possible number of rooms are booked in a
hotel. Also, this practice has spread over to many other industries like media/telecom industry,
distribution industry and many such industries. Development in the field of revenue
management and new techniques of operation research will continue as new technologies enter
the market and hence, it is important to keep oneself up to date with them.
APPLICATION OF OR TECHNIQUES IN REVENUE MANAGEMENT

Hotel Industry is among the major areas of Revenue Management applications due to the
fact that hotel’s goods are perishable. Hotels also have a higher fixed cost than their variable
cost, and when we talk about their demand: it varies over time (Chiang, Chen and Xu ,2007).
O’Connor and Murphy (2008) said that “Because of hotels having higher fixed cost and fixed
capacity, it is important for hotels to maximise their revenue”. Management Problems can be
solved through quantitative approach. This will require the problem to be analysed which
includes collecting data, facts and figures and then solving the problem in a systematic way.
This is where OR techniques come into being.

Cross (1997) has believed that revenue management is a nine-step process to ensure the
successful implementation in hotels. Cross’ research gave attention to more areas including
forecasting, identifying variable costs, and determining the optimal room rate. Every time a
customer goes to the hotel to rent a room, the desk manager has to decide whether or not to
give it to the customer. For this, the manager will have to consider the number of reservations
already made. The operational research model in hotel assumes that the customer will come in
a Poisson distribution and will keep many rooms. The model assumes strong arrival of
customers from different regions and calculates the expected value of a room in the future. To
come up with the right value, the manager must keep fixed price for a certain class of customer,
the rejection cost, the total rooms available for each category and pending reservations for
different kind of customers. The model so made tells that the hotel should give the room if the
price plus the rejection cost is greater than or equal to the room’s fixed price, and it should not
rent out the room if the price plus rejection cost of the room is lesser than the room’s expected
value.
TECHNIQUES: USES, OBJECTIVES AND CRITICISMS (if any)

OR Techniques are widely used in the hotel industry to maximise their revenues.
Some of the techniques used are as follows:

1. DETERMINISTIC MODEL: [1] This model substitutes the demand for

each type of stay that a customer makes in a room and procure optimal division
of the rooms over the demand that is demand being equal to its expectations. The
main purpose or use is to maximise revenue under the condition that the total
number of bookings for a night will not exceed the given number of rooms in the
hotel. To keep all the rooms occupied, the number of rooms given to each customer
won’t exceed by the level of the demand, which in this model is exchanged by its
expectation.

Although we can’t say that the model is a single modular, past references (see
Williamson (1992) en De Boer et al. (2002)) with the modification of this model
show that when demand is a positive number greater than zero the LP solutions are
often the same too. It can be noted that when the solution is a fraction, the solution
can be obtained by branch-and-bound techniques.

2. STOCHASTIC MODEL: [2] The deterministic model never allocates more

rooms in any given condition more than the hotel expects to book for that type of
room. However, because demand can always not be equal to the supply, it can be
more profitable to allocate more rooms to the customers who are ready to pay more.
For this, the stochastic nature of demand has to be taken into account. We present
here a stochastic model first introduced by De Boer et al. (2002) for the airline
industry.
The model gives the best admission policy for hotel customers and the relation with
revenue under stochastic demand. The decision to have additional stays is shown as
a multi- period decision problem using dynamic programming over a given period.
To maximise revenue in hotel room administration, using Markov decision process
is a good option.
3. BOOKING LIMIT MODEL: [3] The purpose of this model is to distribute
the rooms according to leisure travellers and business travellers. The impression is
that leisure travellers come first and then business traveller will come looking for a
room. The number of rooms which is given out to leisure travellers is called booking
limit. After the rooms are given out to leisure travellers, then the remaining rooms
(protection level) will be provided to business travellers who are ready to pay full
price. If the hotel increases the booking limit, then the revenue could not reach may
not reach optimal point because there can be a situation when number of business
travellers are more than expected. If booking limit is too low, there is a chance of
having more unsold rooms. Therefore, it is good to have a booking limit and
protection limit.

4. Duopoly Occupancy Rate Model: [4] Based on the assumption of duopoly

competition and the theory that customer will act as myopically, hotel occupancy
rates can be manipulated by competitor and discount price. Talluri and Van Ryzin
(2004) stated the assumption used for this model of price competition is valid in
perfect competition, consumer will only buy the product from the company if they
get cheaper options. Considering this assumption, we can say that in this model
there is an inverse relation between the number of stays and the price of hotel room.

5. OVERBOOKING LIMIT MODEL: [5] Unlike the booking limit that is

developed for optimizing the room utilization by giving the rooms out to different
travellers, overbooking (O) is a plan to predict the cancellation and customers not
turning up after making the booking. Here, overbooking is shown as non-dynamic
model, so the cancellation is equal to people not turning up. There are three
concepts for this approach: probability, economics, and quality levels. To find cost
and quality level further analysis will be required, we consider probability
approach.
CONCLUSION
After referring through Secondary Data from multiple research papers, articles, essays, it can
be concluded that models of OR are good enough to be applied in the revenue management for
hotels. These methods can result in maximising profits of hotels. A lot of techniques can be
applied in the hotel industry with our focus being on the mathematical programming model.

Models like Booking limit model, Overbooking limit model, Duopoly occupancy rate model,
Stochastic model, Deterministic Model have been used and have proved to be quite effective
in solving different problems in the hotel industry. From keeping rooms for business travellers
at protection level to cutting down the prices of same category of rooms to having an advantage
over peers. These models have made a difference in revenues of different hotels. In order to
survive competition in the market and generating revenues, at the same time with the given
resources, it is necessary for hotel managers to make their bookings effectively by using the
above models or if they can come up with something innovative of their own.

Deterministic model is good in small hotels where they can predict their demands and hence,
maximise revenues. In a country like India where majority of the people prefer 2 or 3 star
hotels, this model can be applied effectively and can give good results to the hotel. However,
there is also a chance of customer dissatisfaction, or bad goodwill because of poor quality of
service, hotels should avoid using the overbooking model. Only if they feel confident about
the model after multiple stimulations, they should go with the given model.
APPENDIX

1. DETERMINISTIC MODEL: This is a mathematical model in which outcomes

are determined through relationship between events and tasks, without having a random
variation. In such models, the input will give the same outputs exactly like a chemical
reaction.
2. STOCHASTIC MODEL: Stochastic model is like a financial model that includes
more than one variable. The purpose of such models is to inform how the outcomes are
within the prediction for different situations. The Monte Carlo simulation is one of the
example; used in financial markets, various other methods of how an financial
instrument may perform are made based on probability distributions of individual
stock.

3. BOOKING LIMIT MODEL: This restricts the number of rooms that can be
given out per night to different set of customers with different room prices adjusting
the discounts and competition in the market.
4. Duopoly Occupancy Rate Model: Occupancy rate refers to the number of rooms
rented out to the customers as compared to the total number of rooms available.
5. REVENUE MANAGEMENT: Selling the Right Room to the Right Client at the
Right Moment at the Right Price on the Right Distribution Channel with the best
commission efficiency (Landman, 2011).

6. OVERBOOKING LIMIT MODEL: It is that state when the expected demand

of rooms in a given hotel is more than the given supply.
APPENDICES
7. Mathematical Model for Revenue Management with Overbooking and Costly Price
Adjustment for Hotel Industries

Nur Aini Masruroh*, Yun Prihantina Mulyani

Department of Mechanical and Industrial Engineering, Faculty of Engineering, Gadjah

Mada University, Indonesia

(Received: January 31, 2013 / Revised: July 10, 2013 / Accepted: September 10, 2013)

8. Cross, R. G. (1997) Revenue Management: Hard-Core Tactics for Market

Domination,
Broadway Books, Bantam Doubleday, Dell.
9. Linear Programming for Revenue Management in Hotel Industry
Mrs Shreelatha Rao, MSc, MBA, PGDHE
Welcome group Graduate School of Hotel Administration Manipal University
Manipal –576 104
Karnataka - India
10. Mathematics and Operations Research in Industry
By Dennis E. Blumenfeld, Debra A. Elkins, and Jeffrey M. Alden

11. The Application of Revenue Management in Beverage Operations

Milos Bujisic, Joe Hutchinson & Anil Bilgihan

Pages 336-352

Published online: 02 Oct 2014

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