16

Pricing and
Revenue
Management in a
Supply Chain
PowerPoint presentation to accompany
Chopra and Meindl Supply Chain Management, 5e
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall.

16-1
1-1
 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

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 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

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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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 Pricing and Revenue Management
for Multiple Customer Segments

Figure 16-2

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 Pricing to Multiple Segments
Demand curve for segment i = di = Ai – Bi pi
Supplier maximizes pi – c Ai – Bi pi ( )( )
Ai c
Optimal price = pi = +
2Bi 2
For capacity constrained by Q
k
Maxå pi – c Ai – Bi pi( )( )
i=1
Subject to
k

å( A – B p ) £ Qi i i
i=1

Ai – Bi pi ³ 0 for i = 1,...,k

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 Pricing to Multiple Segments
Customers unwilling to commit d1 = 5,000 – 20 p1
Customer willing to commit d2 = 5,000 – 40 p1
c = $10
5,000 10
p1 = + = 125 + 5 = $130
2 ´ 20 2
5,000 10
p2 = + = 62.5 + 5 = $67.5
2 ´ 40 2

d1 = 5,000 – 20 ´130 = 2,400 and d2 = 5,000 – 40 ´ 67.5 = 2,300

Total profit = 130 ´ 2,400 + 67.5 ´ 2,300 – 10 ´ 4,700 = $420,250

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 Pricing to Multiple Segments

Same price to both segments

( p – 10) (5,000 – 20 p) + ( p – 10) (5,000 – 40 p)

= ( p – 10) (10,000 – 60 p)

10,000 10
Optimal price p = + = $88.33
2 ´ 60 2
d1 = 5,000 – 20 ´ 88.33 = 3,233.40
d2 = 5,000 – 40 ´ 88.33 = 1,466.80

(
Total profit = 88.3310 ´ 3,233.40 +1,466.80 = $368,166.67 ) ( )
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 Pricing to Multiple Segments

Total production capacity is limited to 4,000 units

( )(
Max p1 – 10 5,000 – 20 p1 + p2 – 10 5,000 – 40 p2 ) ( )( )
Subject to

(5,000 – 20 p ) + (5,000 – 40 p ) £ 4,000

1 2

(5,000 – 20 p ) ,(5,000 – 40 p ) ³ 0
1 2

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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

( )
RH C H = Prob(demand from higher-price segment > C H ) ´ pH
Prob(demand from higher-price segment > C H ) = pL / pH
( )
C H = F –1 1– pL / pH , DH ,s H = NORMINV 1– pL / pH , DH ,s 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, pA = $3.50 per cubic foot
Revenue from segment B, pB = $2.00 per cubic foot
Mean demand for segment A, DA = 3,000 cubic feet
Standard deviation of demand for A, sA = 1,000 cubic feet

(
C A = NORMINV 1– pB / pA , DA,s 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

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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

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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 = di = Ai – Bi pi
k
Maxå pi Ai – Bi pi( )
i=1
Subject to
k

å( A – B p ) £ Q
i i i
i=1

Ai – Bi pi ³ 0 for i = 1,...,k

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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

d1 = 300 – p1, d2 = 300 – 1.3p2, and d3 = 300 – 1.8p3

( )
Maxp1 300 – p1 + p2 300 – 1.3 p2 + p3 300 – 1.8 p3( ) ( )
Subject to

(300 – p ) + (300 – 1.3 p ) + (300 – 1.8 p ) £ 400

1 2 3

300 – p1,300 – 1.3 p2 ,300 – 1.8 p3 ³ 0

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 Dynamic Pricing

Figure 16-4

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 Dynamic Pricing

Figure 16-5

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 Evaluating Quantity with
Dynamic Pricing
d1 = 300 – p1, d2 = 300 – 1.3p2, and d3 = 300 – 1.8p3

( ) (
Maxp1 300 – p1 + p2 300 – 1.3 p2 + p3 300 – 1.8 p3 – 100Q ) ( )
Subject to

(300 – p ) + (300 – 1.3 p ) + (300 – 1.8 p ) £ Q

1 2 3

300 – p1,300 – 1.3 p2 ,300 – 1.8 p3 ,Q ³ 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
Cw
(
s* = Prob cancellations £ O * =
Cw + C s
)
( )
O* = F –1 s*, mc ,s c = NORMINV s*, mc ,s c ( )
( ( ) (
O = F –1 s*, m L + O ,s L + O = NORMINV s*, m L + O ,s L + O )) ( ( ) ( ))

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 Overbooking

Cost of wasted capacity, Cw = $10 per dress

Cost of capacity shortage, Cs = $5 per dress

Cw 10
s* = = = 0.667
Cw + Cs 10 + 5

(
O* = NORMINV s*, mc ,s c = NORMINV 0.667,800,400 = 973 ) ( )
(
O = NORMINV 0.667,0.15, 5000 + O ,0.075 5000 + O ( ) ( ))
O* = 1,115

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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
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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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 Pricing and Revenue Management
for Bulk and Spot Contracts

cS – c B
Optimal value p* =
cS

(
Q* = F –1 p*, m,s = NORMINV p*, m,s) ( )

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 Long-Term Bulk Contracts versus
the Spot Market

Bulk contract cost, cB = $10,000 per million units

Spot market cost, cS = $12,500 per million units

cS – cB 12,500 – 10,000
p* = = = 0.2
cS 12,500
(
Q* = NORMINV p*, m,s = NORMINV 0.2,10,4 = 6.63 ) ( )

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 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

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 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
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall. 16-30
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