Yield Management

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Yield Management

Serguei Netessine 1 The Wharton School University of Pennsylvania Robert Shumsky2 W. E. Simon Graduate School of Business Administration University of Rochester February 1999, revised February 2002.

1 2

netessin@wharton.upenn.edu shumsky@simon.rochester.edu

1. Introduction
A variety of concepts and analytical tools fall under the label yield management. The term is used in many service industries to describe techniques to allocate limited resources, such as airplane seats or hotel rooms, among a variety of customers, such as business or leisure travelers. Since these techniques are used by firms with extremely perishable goods, or by firms with services that cannot be stored at all, these concepts and tools are often called perishable asset revenue management or simply revenue management. The techniques of yield management are relatively new – the first research to deal directly with these issues appeared less than 20 years ago. These days, yield management, including overbooking and dynamic pricing, has been an enormously important innovation in the service industries. American Airlines credits yield management techniques for a revenue increase of $500 million/year and Delta Airlines uses similar systems to generate additional revenues of $300 million per year. 3 While the airlines are the oldest and most sophisticated users of yield management, these practices have begun to appear in other service industries. For example, Marriott hotels credits their yield management system for additional revenues of $100 million per year. All of these revenue increases have been achieved with relatively small increases in capacity and costs. This note describes yield management's basic concepts and provides details about a particular application. Our real-world example is provided by the Hyatt Regency hotel at 125 East Main Street in Rochester, NY. The hotel has 210 King/Queen rooms used by both business and leisure travelers. The hotel must decide whether to sell rooms well in advance at a relatively low price (i.e. to leisure travelers), or to ‘hold out’ and wait for a sale at a higher price to late-booking business travelers. Before we examine a specific solution to this problem, we will first identify the environments in which yield management techniques are most successful.

2. Where and Why Firms Practice Yield Management
Business environments with the following five characteristics are appropriate for the practice of yield management (in parentheses we apply each characteristic to the Hyatt hotel): 3

Andrew Boyd, "Airline Alliance Revenue Management". OR/MS Today, Vol. 25, October 1998.


1. It is expensive or impossible to store excess resource (we cannot store tonight’s room for use by tomorrow night’s customer). 2. Commitments need to be made when future demand is uncertain (we must set aside rooms for business customers – “protect” them from low-priced leisure travelers before we know how many business customers will arrive). 3. The firm can discriminate among customer segments, and each segment has different demand curves (purchase restrictions and refundability requirements help to segment the market between leisure and business customers. The latter are more indifferent to the price.). 4. The same unit of capacity can be used to deliver many different products or services (rooms are essentially the same, whether used by business or leisure travelers). 5. Producers are profit-oriented and have broad freedom of action (in the hotel industry, withholding rooms from current customers for future profit is not illegal or morally irresponsible. On the other hand, such practices would be questionable in emergency wards or with organ transplants). Given these characteristics, how does Yield Management work? Suppose that our hotel has established two fare classes or buckets: full price and discount price. The hotel has 210 rooms available for March 29 (let us assume that this March 29 is a...
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