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Chopra and Meindl Supply Chain Management, 5e

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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall. Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall. Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
16-1
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
16
Pricing and
Revenue
Management in a
Supply Chain
16-2
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Learning Objectives
1. Understand the role of revenue
management in a supply chain
2. Identify conditions under which
revenue management tactics can be
effective
3. Describe trade-offs that must be
considered when making revenue
management decisions
16-3
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
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
16-4
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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 exist
1. The value of the product varies in different market
segments
2. The product is highly perishable or product waste
occurs
3. Demand has seasonal and other peaks
4. The product is sold both in bulk and on the spot
market
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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?
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Pricing and Revenue Management
for Multiple Customer Segments
Figure 16-1
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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Pricing and Revenue Management
for Multiple Customer Segments
Figure 16-2
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Pricing to Multiple Segments
Demand curve for segment i d
i
A
i
B
i
p
i
Supplier maximizes p
i
c
( )
A
i
B
i
p
i
( )
Optimal price p
i

A
i
2B
i
+
c
2
Max p
i
c
( )
A
i
B
i
p
i
( )
i1
k

A
i
B
i
p
i
( )
Q
i1
k

A
i
B
i
p
i
0 for i 1,...,k
Subject to
For capacity constrained by Q
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Pricing to Multiple Segments
Customers unwilling to commit d
1
5,000 20p
1
Customer willing to commit d
2
5,000 40p
1
c $10
p
1

5,000
2 20
+
10
2
125+5 $130
p
2

5,000
2 40
+
10
2
62.5+5 $67.5
d
1
5,000 20 130 2,400 and d
2
5,000 40 67.5 2,300
Total profit 130 2,400+67.5 2,300 10 4,700 $420,250
16-10
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Pricing to Multiple Segments
d
1
5,000 20 88.33 3,233.40
d
2
5,000 40 88.33 1,466.80
Total profit 88.3310
( )
3,233.40+1,466.80
( )
$368,166.67
Same price to both segments
p 10
( )
5,000 20p
( )
+ p 10
( )
5,000 40p
( )
p 10
( )
10,000 60p
( )
Optimal price p
10,000
2 60
+
10
2
$88.33
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Pricing to Multiple Segments
Total production capacity is limited to 4,000 units
Max p
1
10
( )
5,000 20p
1
( )
+ p
2
10
( )
5,000 40p
2
( )
Subject to
5,000 20p
1
( )
+ 5,000 40p
2
( )
4,000
5,000 20p
1
( )
, 5,000 40p
2
( )
0
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Pricing to Multiple Segments
Figure 16-3
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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
Spill

R
H
C
H
( )
Prob(demand from higher-price segment > C
H
) p
H
Prob(demand from higher-price segment > C
H
) p
L
/ p
H
C
H
F
1
1 p
L
/ p
H
, D
H
,
H
( )
NORMINV 1 p
L
/ p
H
, D
H
,
H
( )
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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
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Allocating Capacity to
Multiple Segments
Revenue from segment A, p
A
= $3.50 per cubic foot
Revenue from segment B, p
B
= $2.00 per cubic foot
Mean demand for segment A, D
A
= 3,000 cubic feet
Standard deviation of demand for A, s
A
= 1,000 cubic feet
C
A
NORMINV 1 p
B
/ p
A
, D
A
,
A
( )
NORMINV 1 2.00 / 3.50,3,000,1,000
( )
2,820 cubic feet
C
A
NORMINV 1 2.00 / 5.00,3,000,1,000
( )
3,253 cubic feet
16-16
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Pricing and Revenue Management
for 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

16-17
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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
Demand for period i d
i
A
i
B
i
p
i
Max p
i
A
i
B
i
p
i
( )
i1
k

A
i
B
i
p
i
( )
Q
i1
k

A
i
B
i
p
i
0 for i 1,...,k
Subject to
16-18
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
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
d
1
= 300 p
1
, d
2
= 300 1.3p
2
, and d
3
= 300 1.8p
3
Maxp
1
300 p
1
( )
+ p
2
300 1.3p
2
( )
+ p
3
300 1.8p
3
( )
Subject to
300 p
1
( )
+ 300 1.3p
2
( )
+ 300 1.8p
3
( )
400
300 p
1
,300 1.3p
2
,300 1.8p
3
0
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Dynamic Pricing
Figure 16-4
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Dynamic Pricing
Figure 16-5
16-21
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Evaluating Quantity with
Dynamic Pricing
d
1
= 300 p
1
, d
2
= 300 1.3p
2
, and d
3
= 300 1.8p
3
Maxp
1
300 p
1
( )
+ p
2
300 1.3p
2
( )
+ p
3
300 1.8p
3
( )
100Q
Subject to
300 p
1
( )
+ 300 1.3p
2
( )
+ 300 1.8p
3
( )
Q
300 p
1
,300 1.3p
2
,300 1.8p
3
,Q 0
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Evaluating Quantity with
Dynamic Pricing
Figure 16-6
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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
s* Prob cancellations O*
( )

C
w
C
w
+C
s
O* F
1
s*,
c
,
c
( )
NORMINV s*,
c
,
c
( )
O F
1
s*, L+O
( )
, L+O
( ) ( )
NORMINV s*, L+O
( )
, L+O
( ) ( )
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Overbooking
Cost of wasted capacity, C
w
= $10 per dress
Cost of capacity shortage, C
s
= $5 per dress
s*
C
w
C
w
+C
s

10
10+5
0.667
O* NORMINV s*,
c
,
c
( )
NORMINV 0.667,800,400
( )
973
O NORMINV 0.667,0.15, 5000+O
( )
,0.075 5000+O
( ) ( )
O* 1,115
16-25
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Pricing and Revenue Management
for 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
16-26
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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
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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Pricing and Revenue Management
for Bulk and Spot Contracts
Optimal value p*
c
S
c
B
c
S
Q* F
1
p*, ,
( )
NORMINV p*, ,
( )
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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Long-Term Bulk Contracts versus
the Spot Market
Bulk contract cost, c
B
= $10,000 per million units
Spot market cost, c
S
= $12,500 per million units
p*
c
S
c
B
c
S

12,500 10,000
12,500
0.2
Q* NORMINV p*, ,
( )
NORMINV 0.2,10,4
( )
6.63
16-29
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Using Pricing and Revenue
Management in Practice
1. Evaluate your market carefully
2. Quantify the benefits of revenue
management
3. Implement a forecasting process
4. Keep it simple
5. Involve both sales and operations
6. Understand and inform the customer
7. Integrate supply planning with revenue
management
16-30
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
Summary of Learning Objectives
1. Understand the role of revenue
management in a supply chain
2. Identify conditions under which
revenue management tactics can be
effective
3. Describe trade-offs that must be
considered when making revenue
management decisions
16-31
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.
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