A Renaissance Revenue Management in Travel and Tourism?

A Renaissance for Revenue Management in Travel and Tourism? By Lamberto Biscarini, Alberto Guerrini, Pranay Jhunjhunwala, Nicolas Boutin, and Rich Hutchinson

ompanies in mature industries— price still matters. Low-cost airlines today Cincluding the travel-and-tourism repeatedly demonstrate that price is one sector—need new ways to increase reve- of the major success factors in travel and nues. They face plenty of barriers: feverish that companies should be more active in competition, excess capacity, and commod- managing price, not only to increase itized products, to name a few. Price is one revenues but also to fend off the competi- lever that companies can still pull, even at tion. a time when digital technologies give consumers near-total transparency. The An analysis by The Boston Consulting irony is that in the industry that invented Group of more than 2,800 companies dynamic pricing and revenue manage- across multiple industries indicates that a ment—travel and tourism—this high-im- 1 percent improvement in price has a far pact tool often lies unused or is employed greater impact on operating profit—more in ways that fall far short of realizing its than 11 percent—than a similar level of full potential. improvement in other critical factors, such as sales volume or variable or fixed costs. More than 30 years ago, American Airlines Yet while four out of five managers think demonstrated the impact that dynamic they have a good handle on costs, less than pricing can have on increasing revenues— two-thirds believe they understand their especially for a company with perishable product’s value to their customers, only inventory—with the first systematic one-third think they grasp the impact of a yield-management system. In succeeding price change, and only one-fifth believe decades, revenue management took a they are well informed about their custom- backseat to network and capacity expan- ers’ acceptance of prices charged. (See Ex- sion and to managing products, such as hibit 1.) The time is right for the renais- first class and business class, which became sance of one of the industry’s most the industry’s primary growth drivers. But significant revenue-enhancing tools.

For more on this topic, go to bcgperspectives.com Exhibit 1 | Pricing Is a Powerful but Often Underemployed Profit Lever

IMPACT ON OPERATING PROT % MANAGERS REPORTING FROM A 1% IMPROVEMENT IN CRITICAL FACTORS1 THAT THEY ARE WELL INFORMED %

Fixed costs 81 Fixed costs 2.8 Variable costs 84 Variable costs 7.6 Competitors’ prices 75 Product’s value to 61 Sales volume 3.8 their customers Impact of price change 34 Price 11.4 Customers’ 21 acceptance of prices 0510 15 050 100

Sources: Power Pricing: How Managing Price Transforms the Bottom Line, by Robert J. Dolan and Hermann Simon (New York: The Free Press, 1996); BCG analysis of Compustat data. 1Average across composite of 2,835 Compustat companies; assumes zero price elasticity.

From Source of Growth common problems the CEOs cite are poor to Source of Frustration execution because of inadequate reve- The impact of revenue management ex- nue-management-team capabilities, lack of tends beyond the lift it gives to revenues, support from systems that are either too cash flow, and earnings. Other benefits in- basic or too sophisticated for their users, clude the ability to keep abreast of compet- and unsupportive cultures within their or- itors that are building or improving their ganizations. If other company functions, own revenue-management systems and the such as finance, marketing, and sales, don’t quick-response capability that the systems believe in or collaborate with the revenue provide in volatile market conditions. management team, it’s hard for revenue Moreover, it’s not only the large, sophisti- management to achieve the results the cated players that can make better use of boss is looking for. revenue management. The tool has spread beyond traditional first movers (airlines, Ten problem areas emerge in our work hotels, and rental cars) to companies with with clients, not all directly or exclusively perishable inventory in other industry seg- linked with pricing. The first four have to ments, such as cruise lines, tour operators, do with a flawed understanding of how railways, and event managers. Companies consumers make their purchasing decisions. employing revenue management have ex- perienced revenue increases of up to 10 •• Limited sophistication in product design. percent. But individual companies vary Many companies do not design prod- widely in their performance. Those that ucts or product combinations that take use suboptimal programs often leave sub- advantage of consumers’ willingness to stantial revenue on the table. They compro- pay. Well-designed pricing bundles mise their profitability in the process, since (all-inclusive packages at resorts, for most of the incremental revenue generated example) and ancillary services can by revenue management systems drops generate enormous value. straight to the bottom line. •• A generic view of consumer elasticity in Many CEOs voice frustration with the sys- making pricing decisions. Consumers’ tems. They complain that they are expen- willingness to pay can vary substantially sive to build (or buy) and that it’s hard to over the booking period. A business know if their companies are realizing the traveler booking a ticket close to the full value of their investment. The most departure date needs to buy the ticket

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almost regardless of price, while a running them or inadequately calibrat- leisure traveler making reservations ed and thus provide misleading recom- well in advance can wait for the mendations. prospect of a better deal. Too often, in our experience, companies ad- •• Too much focus on matching the competi- dress one, two, or even several of these is- tion’s prices. In reality, prices do not sues, but other problems remain and under- often match—or need to. Companies mine overall performance. Revenue with strong brands or those that offer management is a complex practice, and the special services or features can avoid various challenges cited above are intercon- direct comparison with competitors and nected. Companies looking to build a capa- maintain price premiums. bility, or to improve what they have, should take a comprehensive approach. They need •• An assumption that pricing decisions to address three critical system components made for one market or customer segment in concert: methodology (pricing strategy, will work just as well in another. Compa- fare class structure, and inventory and ca- nies can benefit significantly from pacity management); enablement (organiza- developing individual pricing playbooks tion, capabilities, processes, and reporting for each market and customer segment and performance management); and tools that they operate in. (revenue-management-system components). (See Exhibit 2.) Companies that tackle prob- The next four problems involve execution. lems in a piecemeal fashion achieve only partial improvement (and sometimes not •• A shortage of revenue management even that), with the result that the revenue capabilities in the organization. These management team and system are often rel- may include both role-related technical egated to the lower levels of the organiza- skills and so-called soft skills, such as tion and deprived of a strategic role. communication.

•• An unclear or understaffed organization How You Build Depends structure, with no formal role for the on Where You Start revenue management team and a The approach that travel companies take to limited number of dedicated resources. methodology, enablement, and tools depends on their current use of revenue man- •• Business processes that are not formalized agement and the degree of sophistication or efficient. These can include an they have attained. Most companies fall unclear delineation of responsibilities into one of three categories: and cumbersome interactions among business units. •• Leaders—companies that have devel- oped sophisticated revenue-manage- •• No clear reporting lines or performance ment systems but still have room to objectives and metrics. optimize their practices, often because they are overwhelmed by complexity The last two problems involve support tools. •• Semipros—companies that employ revenue management techniques •• Systems that tend to be biased toward but could get much more bang for the volume over price. They seek to fill buck by structuring and executing capacity instead of maximizing revenue their programs more formally and or profit. effectively

•• Overinvestment in sophisticated reve- •• Sideliners—companies (or other nue-management tools. These are either organizations) that don’t yet use too complicated for the analysts revenue management

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Exhibit 2 | Most Companies Will Benefit from a Comprehensive Approach to Revenue Management METHODOLOGY ENABLEMENT TOOLS

PRICING STRATEGY ORGANIZATION REVENUE MANAGEMENT SYSTEM Customer segmentation Organization structure Demand forecast module Fare portfolio structure Role mandates Price elasticity module Ancillary revenues CAPABILITIES Competitive-intelligence system Competitive positioning Role-speciﬁc capabilities Product prioritization module Promotion management Product diagnostic module PROCESSES Channel management Business processes and interactions Fare opening / closing module Overbooking management module FARE CLASS STRUCTURE REPORTING AND Number of fare classes PERFORMANCE MANAGEMENT Group materialization module Price levels and update guidelines Business performance reference KPIs Performance management Operating performance reference KPIs and reporting system INVENTORY AND CAPACITY MANAGEMENT Pilot testing reference KPIs Demand forecast Price elasticity Competitive intelligence Revenue integrity calculation Fare opening / closing guidelines Group materialization calculation Overbooking management Dynamic capacity allocation1

Source: BCG analysis. 1Where applicable.

Leaders. Most airlines, hotels, and car rental open to new approaches and ways of work- companies have long experience with ing. We recently worked with one airline to revenue management, and many have built simplify its revenue-management capabili- or bought highly sophisticated systems to ties and approach by opening the “black manage their programs. For an increasing box” inventory-management system and number, however, these “black boxes” have applying a more customer-centric approach become overly complex, and some compa- in order to capture customers’ true willing- nies have become “slaves to the black box,” ness to pay. The airline also streamlined its sustaining systems that require massive pricing methodology by creating a process effort and investment—and not taking to systematically update its fare ladders. It anywhere near full advantage of their upgraded its tools with a customized soft- output. These companies also usually lack ware addition to its existing systems and the skills necessary to open the black box provided in-depth training in the new capa- and adjust or recalibrate its mechanisms. bilities to team members. This new approach helped the airline capture an im- For other companies, even off-the-shelf provement in revenue per average seat systems can be sufficiently complex to kilometer of more than 5 percent and a sig- overwhelm inadequately skilled or under- nificant increase in its net profit. staffed teams and to deliver subpar performance. In fact, in our experience, compa- Semipros. This category includes more nies that install off-the-shelf systems often recent converts to dynamic pricing, such as neglect the training that is necessary to railways, cruise lines, tour operators, theme maximize their performance. parks, and casinos. Many have experimented with various techniques, but revenue Leaders can often improve their perfor- management typically remains a largely mance by reducing complexity and being unstructured practice with limited skills

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and support tools. Not surprisingly, results do manage periods of peak demand, which suffer. brings a number of similar factors into play. These organizations can employ These companies have perhaps the biggest dynamic pricing both to increase revenue opportunity to increase revenues by for- and to support nonfinancial objectives. For malizing their programs and integrating example, the Interstate 15 express lanes in revenue management as a critical capabili- San Diego, California, employ a dynamic ty. In our experience, this generally in- tolling system, with tolls ranging from volves addressing all three components— $0.50 to $8.00 depending on the distance methodology, enablement, and tools—by traveled and the congestion level. defining a strategy and setting pricing guidelines, testing tools with ad hoc proto- Many infrastructure organizations don’t types, and establishing a formal organiza- recognize the value of dynamic pricing, tion structure with defined skills, roles, which is a mistake in our estimation, while training, processes, and rewards. others feel constrained by existing regula- tions from implementing pricing changes. Too often, we have seen companies that try The latter may have more leeway than they to leapfrog the more laborious design and think. installation of a purpose-built system by in- vesting in a top-of-the-line off-the-shelf sys- The first step in both instances is to ana- tem, usually adapted from a more ad- lyze the opportunities for dynamic pricing, vanced subsector, such as airlines. This including assessing the nonfinancial goals approach has three pitfalls: it relies on it can help achieve, and to build a business methodologies from other companies or case to support a pilot program or the abili- subsectors that may not address the pricing ty to experiment. This often entails balanc- issues the company actually faces; it limits ing the priorities of various interested par- the company’s ability to customize the new ties, including, for example, operators that system; and it doesn’t provide training and need to operate profitably, local govern- other measures to help the company use ments that want to ensure a fair pricing the system to maximum effect. scheme for end users (consumers and vot- ers), and higher levels of government, We helped a tour operator transform its which are responsible for maintaining the revenue-management system from a large- infrastructure and facilitating its optimum ly unstructured practice into a full business utilization. unit. We worked with the company to design the methodology and develop a proto- We believe that most infrastructure organi- type to test algorithms and tools before full zations can benefit from taking the first implementation. At the same time, we de- steps toward dynamic pricing—establishing signed the organization, assessed and a simple peak/off-peak pricing system, for trained existing employees, and helped fill example—and learning what outcomes us- staff vacancies. The company achieved an ers value (such as convenience or shorter increase in EBITDA of more than 12 per- routes) and at what cost. In the process, cent in the first six months of full opera- they will also begin to establish a pricing tion. organization and gain experience in the skills and tools necessary to implement Sideliners. While most travel-and-tourism more complex revenue-management pro- companies have at least experimented with grams, should they choose to do so. dynamic pricing, one large group of excep- tions is travel infrastructure organiza- Outside of travel and tourism, many indus- tions—the companies and government tries face similar issues of fixed capacity authorities that run roadways, airports, and and perishable inventory (restaurants, for marine ports. Unlike other travel-related example). Companies in these sectors could entities, these organizations don’t have to generate tremendous value from applying deal with perishable inventory, but many the techniques of dynamic pricing.

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he experiences of travel-and-tourism ting started is often the easy part; the chal- Tcompanies going back decades demon- lenges increase in complexity with the strate that when built and executed prop- system’s sophistication. But with improve- erly, revenue management systems deliver ments in methodology, enablement, and substantial increases in revenue and profit. tools come commensurate advances in per- Almost any organization can benefit. Get- formance.

About the Authors Lamberto Biscarini is a senior partner and managing director in the Milan office of The Boston Consult- ing Group. You may contact him by e-mail at [email protected].

Alberto Guerrini is a partner and managing director in the firm’s Milan office. You may contact him by e-mail at [email protected].

Pranay Jhunjhunwala is a partner and managing director in BCG’s London office. You may contact him by e-mail at [email protected].

Nicolas Boutin is a partner and managing director in the firm’s Moscow office. You may contact him by e-mail at [email protected].

Rich Hutchinson is a senior partner and managing director in BCG’s Atlanta office. You may contact him by e-mail at [email protected].

The Boston Consulting Group (BCG) is a global management consulting firm and the world’s leading advi- sor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 82 offices in 46 countries. For more information, please visit bcg.com.

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