A Forecasting and Capacity Management Case
Production and Operations Management: An Applied Modern Approach
This case is intended to be the basis for a business analysis and
class discussion rather than to illustrate either effective or
ineffective handling of a business situation. Companies and
characters are fictitious and are not intended to represent actual
companies or people.
Copyright 1997 by Joseph Martinich. All rights reserved. No part
of this publication may be reproduced, stored in a retrieval system,
or transmitted in any form or by any means without the permission of
Joseph Martinich or the distributor, John Wiley & Sons, 605 Third
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Copyright 1997 by Joseph Martinich. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means without the permission of Joseph Martinich or the distributor, John Wiley & Sons, 605 Third Ave., New York, NY 10158. Printed in the U.S.A.
Alexandra Shephard, the President of Royalty, was greatly concerned about this, and so she decided to form a team of her top managers to study the problem. Because Royalty had above average room prices and above average occupancy rates, the team members assumed revenues were not the problem, so they initially focused on the company's costs. They studied staffing, advertising, supplies, training, taxes, and every other major cost component. Although they were able to identify some cost-reducing improvements, they found that Royalty's staffing and other costs were generally in line with its competitors. This caused the team to look at revenues more carefully.
Differential Pricing and Yield Management
The same situation and considerations apply to hotels. They have a fixed number of rooms each night. They want to earn as much revenue as possible from the rooms, but filling a room at a low price is better than leaving it empty. The key question is how do you fill all the rooms at the highest prices possible? There are many conflicting forces that must be considered, and all of the pricing and reservation decisions are made within an environment of uncertainty - we don't know how many customers there will be and how the customers will behave.
Hotels have always used differential pricing, charging higher prices (at or near the posted rack rate) during times of high demand (e.g. mid-week and when major conventions or other special events are in town), and lower prices during periods of low demand (e.g., weekends and holidays). The hotel also typically charged lower rates to those who reserved their rooms several weeks or months in advance. This pricing strategy has been used in the airline and car-rental industries as well. In recent years these two industries have made pricing strategies more scientific by adjusting prices for future flights or car rentals on a continuous basis according to how many seats or cars had been reserved and the predicted future demand. This approach is called yield management because it attempts to maximize the revenue yield from a given inventory of airline seats and cars. The Royalty management team had read and heard quite a bit about the effectiveness of yield management in the airline and auto rental industries, and they had even heard that some hotel chains were considering it. Royalty itself had even instituted a yield management approach in an informal way by suggesting to individual hotel managers that they review the reservation status of their sites regularly and adjust the number of rooms available at different prices accordingly. Royalty, however, did not provide specific guidelines for adjusting prices, nor did it provide any special computer software to assist with this effort. Hotel managers were expected to use data provided by the current reservation information system to make their decisions.
Considerations and Tradeoffs in Yield Management
In industries with fixed service inventories (airlines, auto rental, hotels) most companies try to use what is called discriminatory pricing, whereby they charge different prices to different customers and try to obtain as high a price from each customer as possible. For example, airlines charge very high prices for unrestricted tickets purchased close to the time or day of departure. The reason is that the type of person buying such a ticket at the last minute is likely to have a compelling need to make the trip (typically a business trip), and may require speed or flexibility in travel times (e.g., he/she cannot to stay over a Saturday night). Therefore, this customer is often willing to pay a high price for this convenience, especially if alternative flights are full. Likewise, people making reservations for discretionary travel many weeks or months in advance are able to search for the best prices and are flexible in their travel plans, so they tend to be very price sensitive, and will choose the airline that provides the lowest price. To fill the seats of the airplane, the airlines must set the prices for these passengers low. As the day of the flight approaches, if the flight is heavily booked (and if the airline perceives that competing flights are heavily booked), the customers' options are more limited and the airline is in a stronger pricing position. Therefore, the airline can increase the prices it charges (or not discount seat prices as much) to additional customers. Similarly, if the flight is not heavily booked, the airline can benefit by reducing prices further or making available more discounted tickets in order to fill the plane. (Filling a seat at almost any price is better than flying with it empty.)
Based on the experiences of the airline, car rental, and hotel industries, the following observations and factors have been identified as important in developing good yield management tactics for hotels.
Copyright 1997, John Wiley & Sons, Inc.