Yield Management

Chapter 12
 Services Versus Manufacturing

• Capacity planning task more difficult

– Inventory
– Timing
• Capacity planning mistakes (stock-outs) more
expensive

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Services Versus Manufacturing
Known Demand
5 5 5 5 5 50 30
Manufacturing capacity needed: 105/7=15
Service capacity needed?
Depends on General Service Capacity Strategy
– Provide: sufficient capacity at all times
– Match: change capacity as needed
– Influence: change demand pattern
– Control: maximize capacity utilization
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 Capacity Strategies

• Capacity issues in services are:

– More complex than in manufacturing
• Timing may be important, for example if there are peaks
in demand at different times of day
– More critical than in manufacturing
• Often no backorders can occur
• Excess capacity may be perishable
– An imbalance in supply and demand can result in
lost sales or idle employees

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 Capacity Strategies

• Influence: Alter demand patterns to fit firm

capacity
– Pricing, marketing and appointment systems

• Control: Maximize capacity utilization

– Compete on cost by driving idle time to zero

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 Capacity Strategies

• Provide: Ensure sufficient capacity at all times

– High quality/high cost; greater amount of idle time
for employees

• Match: Change capacity as needed

– Balance quality/cost; part-time workers

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 Techniques for Managing Capacity

• Work-shift scheduling

• Increased customer participation

• Adjustable (surge) capacity

• Shared capacity

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 Techniques for Managing Capacity

• Partitioned demand

• Price incentives for and promotion of off-peak

demand

• Development of complementary services

• Yield management

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 Managerial Options

• Supply Management
– Capacity
– Work-shift scheduling
– Increasing customer participation
– Adjustable (surge) capacity
– Sharing Capacity
– Personnel – cross training, part-timers

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 Managerial Options

• Demand Management
– Partitioning demand
– Price incentives
– Promoting off-peak demand
– Develop complementary services
• Yield Management

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 Yield Management
• “Selling the right capacity
to the right customer at the right price”
• Business Requirements
– Limited Fixed Capacity
– Business environment where YM can help
• Ability to segment markets
• Perishable inventory
• Advance sales
• Fluctuating demand
• Accurate, detailed information systems

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 Industries that Fully
Use YM Techniques
• Transportation-oriented industries
– Airlines
– Railroads
– Car rental agencies
– Shipping
• Vacation-oriented industries
– Tour operators
– Cruise ships
– Resorts
• Hotels, medical, broadcasting

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 Elements of a Yield
Management System
• Overbooking
• Pricing
• Capacity Allocation
– Distinct versus nested
– Static versus dynamic

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 Overbooking

• Two basic costs:

– Stock outs
• customers have a reservation and there
are no rooms left
– Overage
• customers denied advance reservation
and rooms are unoccupied

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 Example: Hotel California

Stock outs: 0.8 x $150 = $120

Overage: $50

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Hotel California No-Show Experience

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 Overbooking Approach 1:
Using Averages
In Table 12.1 the average number of no-
shows is calculated by 0x0.05 + 1x0.10 + 2x0.20 +
3x0.15 +…+ 10x0.05 = 4.05.

Take up to four overbookings.

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 Overbooking Approach 2:
Spreadsheet Analysis

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 Overbooking Approach 3:
Marginal Cost Approach
Book more guests until:

E(cost of dissatisfied customer) = E(cost of

empty room)

• Cost of dissatisfied customer *

Probability that there are fewer no-shows
than overbooked rooms =
• Cost of empty room *
Probability that there are more no-shows
than overbooked rooms

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 Example: Hotel California

• Co/(Cs + Co) = P(Overbook No Shows)

Hotel Data
• Cs = $120, Co = $50.00
• Co/(Cs + Co) = 29.%
– Overbook 2 rooms

Table 9.1: Hotel California No-Show Experience

No-Shows % of Experiences Cumulative % of
Experiences
0 5 5 29%
1 10 15
2 20 35
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 Actual Versus Linear
Overbooking Cost Curve

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 Dynamic Overbooking

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 Cumulative Reservation Activity

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 Capacity Allocation with
Exogenous Prices
• Methods
– Nested vs. Distinct
– Static vs. Dynamic

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Yield Management Successful Service Operations 18
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 Capacity Allocation with
Exogenous Prices
Example (Chancey Travel)
Business capacity = 100
Demand forecast: premium profit ($10,000/seat)
demand: uniformly distributed (51, 100)
[meaning: 2% chance demand = 51, 2% chance
demand = 52,…, 2% chance demand = 100,
average demand = 75]

Discount price ($2,500/seat) demand:

unlimited demand at this price – infinite
discounters book earlier than premium
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 Static Methods

• Fixed Number, Fixed Time Rules

• Fixed Time Rule
– Accept discount bookings until a specific date
– Motivation
– Distinct, Static System – Fixed Number Rule
– Average of 75 premium bookings, so reserve
» exactly 75 slots for premium customers
» exactly 25 slots for discount customers

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 Static Methods

• Fixed Number, Fixed Time Rules

– Nested, Static system – Fixed Number Rule
Average of 75 premium bookings, so reserve
75 slots for premium customers
remaining 25 go FCFS
– Example:
85 premium and 15 passengers wish to book
– Distinct, Static system: 75 premium,15 discount
Nested, Static system: 85 premium,15 discount

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 Nested, Static System – Fixed
Number Rule
• EMSR heuristic (Expected Marginal Seat
Revenue)
– Allocating first through 51st seats
revenue per seat:
100% certain of $10,000 premium vs. $2,500 discount
Allocating 52nd seat
98% certain of $10,000
= $9,800 expected revenue vs. $2,500 discount
Allocating 53nd seat
96% certain of $10,000
= $9,600 expected revenue vs. $2,500 discount

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 Nested, Static System – Fixed
Number Rule
– 88th seat
24% certain of $10,000 = $2,400 vs. $2,500 discount
On average flight:
75 premium passengers
13 discount passengers
12 empty seats
Optimal Allocation
87 seats premium, 13 seats discount

– Rule:
Accept discount passenger until
pr(spill) < discount revenue/premium revenue

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 Dynamic Capacity Allocation

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 Traditional Supply and Demand
Equilibrium

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 Supply and Demand Equilibrium in
Yield Management

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 Pricing and Capacity Allocation

City Pair Airline Coach 7 Cheapest

Wash.-Nashville USAir $ 811 761 251
Newark-Salt Lake Cont. $1,317 571 257
Dallas-Cleveland American $ 639 471 304

• Effects:
– Expands overall industry
– Shifts consumer surplus to supplier
• Two views
– Using imaginative methods to expand the economy and give
consumers what they want
– Capitalist pig price gouging

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 Pricing and Capacity
Allocation – Event
• Uncapacitated
Possible unit prices $100 110 90
Associated demand 100 80 120
Total Revenue $10,000 8,800 10,800
• Capacitated With Two Classes
Capacity of 100
Discount class unlimited demand at $50
Premium price $100 110 90
Premium demand 100 80 100

Premium revenue 10,000 8,800 9,000

Discount revenue 0 1,000 0
Total revenue $10,000 9,800 9,000
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Yield Management – Implementation

• Alienating Customers
• Difficulty of customer understanding
• Customer cheating
• Employee Issues
• Limiting decision power
• Sabotage: add, not subtract responsibility
• Reward system: in-synch with managerial goals
- Consistency across personnel and units
• Exception processing
• Monitoring
• Cost/Time of Implementation
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 Chapter Summary
• Yield management systems are used in a variety
of industries that have limited capacity
• Components of a yield management system
include overbooking, capacity allocation, and
pricing
– For overbooking and capacity allocation, numerical
methods can help to solve those problems
– The pricing problem still remains out of reach
• The human elements of a yield management
system must be attended to carefully
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