From Product Centered to Customer Centered Revenue Management

From “Product Centric” to “Customer Centric” Revenue Management

To understand the coming revolution in the pricing field, it is interesting to analyze the revolution that began a few years ago in the air transport industry thanks to Revenue/Yield Management techniques. Despite its success Revenue Management (RM) has some shortcomings. One of them is its potential contradiction and practical frictions with Customer Relationship Management (CRM) objectives. 1:1 (one to one) Revenue Management reconciles the two approaches of RM and CRM and seems clearly to be the point of convergence and the future of both disciplines.

1. A Short History of RM

Revenue Management (RM) can be defined as the dynamic adjustment of product and prices availabilities in order to maximize the profit generated by a set of resources.

1.1 The airlines – Revenue Management pioneers in the mid-1980’s The first applications of Revenue Management were developed at the end of the 1980's by the airlines to manage availability of their various fares. The fact is that, to deal with very sharp competition connected with deregulation of that industry in the 1980's, the American airlines carried out very strong differentiation of their prices1. Then they developed software making it possible to calculate, every day and for each future flight, the number of seats to be sold at each fare level. These Revenue Management software analyse the sales transactions carried out in the GDS2 (Global Distribution Systems), reservation systems to which more than 50,000 travel agencies in the world are connected. On the basis of these data, the Revenue Management software models the behaviour of various clientele segments (traffic by price and day of the week, booking curve3…) so as to forecast, several months in advance, the potential demand for each flight at each price level. As a function of these various micro-forecasts, the software calculates the number of seats to be put on sale at each of the various fare levels. These sales quotas, which are updated every day on the basis of the trend of sales, are transmitted to the GDS, after validation by the analysts responsible for Revenue Management. The following figure illustrates the operation of the Revenue Management system used by the airlines.

1 For instance, the Paris-New York round trip ticket in economy class is now sold with a range of prices from 300 EUR to 1,200 EUR. 2 The GDS are networks that are proper to the airlines and to the travel agencies. Thanks to these systems, a network of almost 50,000 travel agents in the world can obtain a fare, verify availability and make a reservation in real time with all world airlines. 3 Booking curve: curve showing the rising level of reservations as a function of days before departure.

Segmentation Modelling

Sale Orders Price Availabilities

Optimisation Forecast

Inventory Levels

The previous optimization loop is applied daily to calculate the availability of the various prices. In the year 2001, no airline could survive without the systematic application of the Revenue Management methods. A company such as Air France, for instance, has to manage more than 500 flight departures per day. Tens of different rates for tens of origins and destinations (O&D) are offered on each flight grouped into at least 20 reservation classes. The trading room flight managers control each flight from the opening of reservations 365 days before departure. Every day they have to decide on the availability of more than 500 x 20 x 365 = 3.6 million fare classes. Such a complex task is impossible without specific tools for aid in decision-making. Revenue Management is now an indispensable tool for the airlines: an essential profitability lever and a powerful competitive weapon. Bob Crandall, former President of American Airlines (AA), one of the first users of this technology, mentioned three strategic disciplines for his company: control of electronic distribution – a domain in which AA dominated with its GDS Sabre – the loyalty program (frequent flyers) known as AAdvantage, and finally Revenue Management. The Dynamo software calculated the daily availabilities of seats at each fare level, which were put on line in real time in the GDS Sabre.

1.2 RM tools have become vital These days a large number of companies that, like the airlines, operate in more complex and competitive environments have the same strategic priorities: • conquer new customers and win their loyalty thanks to the CRM and electronic distribution techniques4; • optimise the profitability of sales thanks to intelligent pricing/Revenue Management tools.

1.3 Extension of Revenue Management to Many Industries: 1990 - 2000 After its success in the airline industry, Revenue Management has been adopted by other travel & tourism industries (Hotel, Car rentals, Cruise lines, Tour operators), Transport (Air Cargo, Parcel Delivery Services...), Media (TV, radio, outdoor advertising) and more recently Retail.

4 The Internet is a GDS to the 10th power.

Despite its success Revenue Management has some shortcomings. Traditional Revenue Management is product centric: • Demand is predicted for each type of product and each delivery period; • Then, resources and products are priced and allocated to each market segment in order to optimise revenue or profit. For example an hotel Revenue Management software will calculate future demand for each day in the future by rate class and length of stay and allocate demand into available capacity in order to optimize revenue. Traditional Revenue Management views the customers in aggregated terms and bring answers to such questions as: • How many customers of this segment will buy this product at a particular moment (booking curve)? • How many customers will buy this product at this price (forecast by rate class? Traditional Revenue Management does not consider the customer’s history and lifetime value (LTV) when pricing and providing product availability.

2.1 Revenue Management Vs Customer Relationship Management These are two opposite paradigms • Revenue Management goal is: Extract the maximum revenue from each product. • CRM goal is: Extract the maximum revenue from each customer. There are basic contradictions between the two approaches • Contradiction # 1: Revenue Management will restrict product availability to customers with discounts whereas CRM will take care of high-value customers demand for greater recognition, more differentiated service and higher discounts. For example if a company has negotiated a 20% corporate discount rate with an hotel for the accommodation of its executives on business trip, the hotel yield manager will try to restrict the availability of this rate in peak occupancy periods. However, as a high value customer, the company will require special attention and the purchasing director may have negotiated Last Room Availability5. This situation may typically create a conflict between Sales and Revenue Management departments. • Contradiction # 2: Revenue Management needs price variability to match supply and demand whereas CRM will give priority to satisfying customers who request price stability to figure out their costs. The company purchasing manager may have also negotiated a fix price with the hotel. Ex: 150 EUR per room. However the yield manager would like to charge a premium rate of 200 EUR in peak occupancy periods because there is a potential of demand willing to pay for higher rates. This situation is a second potential source of conflict between the Revenue Management approach and the CRM approach. Enterprises willing to apply traditional Revenue Management and CRM will have to solve the following dilemma: Optimise short term revenue or optimise customer life time value?

5 Last Room Availability: a contractual clause stating that the hotel commits to always keep a room available for the company.

© Open Pricer 2011. All rights reserved 4 of 5 For these reasons, B2B contracts fall generally outside the scope of traditional Revenue Management system (as so called non « yieldable » business). For example, a major car rental that implemented a sophisticated Revenue Management system that deals with 50% of its non- contracted business: contracted business with enterprises and tour operators falls outside the scope of this system because once the prices are fixed during upfront negotiation they cannot be changed and limiting the availability of the product for key customers is contradictory with CRM objectives. Some Revenue Management systems even forecast contracted business in order to protect sufficient space in order to smoothly delivering products and service to key customers.

3. Towards 1:1 Revenue Management

1:1 RM reconciles the two approaches of Revenue Management and CRM. This introduces a radical change of perspective. The focus of Intelligent Pricing is on the client: “Instead of focusing on each product and trying to sell to as many clients as possible, focus on each client and try to sell as many products as possible.” (Don Peppers & Martha Rogers) Intelligent Pricing optimizes the price and other terms with the scope of contracts/agreements and long term relationship with the customer whereas traditional Revenue Management optimises the price and availability of each purchase transaction. This breakthrough requires completely new customer-centric databases and algorithms. Specifically: • An aggregated view of the purchase pattern, costs and profitability of each customer. • An holistic perspective of the customer relationship history and LTV. • Tools for handling global negotiations with customers.

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