Revenue Management in the Hospitality Industry - Case Study Example

Contents Contents Revenue management in hospitality industry 2 Theoretical Concepts: 3 Yield management theory of management economics or Price Discrimination Theory: 3 Revenue Management System – An Application Aegean Airlines [Kavassalis] 9 Results of Implementation: 10 Conclusion: 11 References: 12 Revenue management in hospitality industry Hospitality industry deals with a number of businesses such as lodging, dining, travelling etc. It can be called a multi million revenue industry. Hospitality sector includes airlines, hotels, restaurants, entertainment parks etc. Three decades back, uniform payment systems were enforced everywhere. All the rooms in a hotel and all the tickets of a plane costs same. No matter whether it is the room near the pool side or at the third floor, costs the same or the ticket that was booked one month ahead of time cost the same to the customer as the ticket that was purchased one day ahead. Soon the strategic planners realized that hospitality sector is the industry which is either need based or entertainment based. It is the sort of need where most of the times people are willing to pay as much amount as demanded. Then industry adopted the revenue management system. Almost all the service industries are delivering value to the customers. Their aim is to maximize the value being delivered. They have the right to charge as much as the value they are delivering. Theoretical Concepts: Revenue management system deals with the target of revenue maximization. Revenue management which is also known as yield management is to maximize revenue by setting different prices for every segments based on their willingness to pay. Different prices are also set depending over different demand supply of the markets. The more the customer is willing to pay, the more he or she is charged. In this way business related customers are always charged much higher than customers who are on leisure trips. It is based on the following theories: Yield management theory of management economics or Price Discrimination Theory: Price discrimination theory deals with charging different amount of price to different customers at different times. In order to achieve price discrimination there are certain conditions that have to be met such as there should be customers having different elasticity of demand. Higher price can be charged if demand is inelastic because in case of inelastic demand customer is willing to pay as much as demanded such as if a person has got an important meeting which he or she cannot miss then he or she has a higher inelastic demand and would be willing to pay whatever is demanded [Riley, 2006]. In order to achieve price discrimination, there should be imperfect competition in the market that is there should be very few sellers or highly differentiated products. This condition is also true in case of hospitality industry such as there are few hotels or airlines and if they are more in numbers than they provide highly differentiated products such as special routes or packages. There are barrier to switching that compels customers to pay as much as demanded such as there are airlines that offer short or direct routes to certain cities that other airlines do not offer so one has no option but is bound to take the service and is also willing to pay higher. Price discrimination is also based on: Demand Versus supply: Price discrimination can be done the best when the price setters have the best idea of demand versus supply in the market. With the increase in demand, keeping the supply constant, higher price can be easily charged while if the demand declines then price should be kept low. Revenue Management is also important due to the following reasons [Kumar]: Limited Supply with Increasing Demand [Kumar]:Revenue Management is important because in hospitality industry there is a limited supply while demands keep on changing. Whether it may be a hotel where there are fixed numbers of rooms or an airline industry where there is limited fixed number of seats which cannot be increased in short run so there is an immense potential to maximize revenues in times of higher demand. Different Segments in Market [Kumar]: Revenue Management is also important because the target market consists of two major chunks of customers. One who are business customers who are higher inelastic that is willing to pay as much as demanded that again provide good potential to maximize revenues while another segment who are on leisure trip who are elastic that are not willing to pay high price, they need discounts to be attracted. Perishable Product [Kumar]: The inventory in hospitality industry is perishable that is if a room in a hotel or a seat in an airplane is left vacant overnight or on a trip respectively, the profit is lost forever and cannot be recovered. Varying Demand: Since in hospitality industry whether it may be airline industry or hotel industry, different demands exist at different time periods. So there is an opportunity to maximize profits by offering different rates at times of higher demands such as peak seasons, while attracting customers by giving discounts at off season timings when the demand is considerably low. Low Marginal cost [Kumar]: Since hospitality business is based on higher initial fixed cost and lower cost for each additional customer so in such case price differentiation can be applied. Booking at Different Timing [Kumar]: Since all the rooms or seats are not sold at the same time so it is not necessary to charge all the customers with the same price. A price differentiation can be applied by offering discounts to customers making reservations early than the customers who are late comers. In this way revenue maximization is possible. Steps of Revenue Management: Target Market: The first and foremost step of revenue management system in a hospitality industry is to know the target market. Who the customers are? How much are they willing to pay? What value do they expect from the industry? These are the basic price determining factor, which will help in setting the price. Segmentation: Next step in revenue management system is identifying the segments. How many target segments exist within the target market? The market is segmented on the basis of the customer profile, status, paying power etc. For knowing the customer an important step can be a good Customer Resource Management system to keep track and record of customers in order to determine their worth and willingness to pay. Determine the elasticity: Another bigger step is to determine how inelastic a customer is to the demand? Higher inelastic, more the customer is willing to pay while customers with elastic demands are not willing to pay more. Such as students would not be willing to pay more while a business executive having an important meeting or conference will be paying as much as demanded. Season: Season is an important factor in setting the price as in peak season customers are willing to pay more due to higher demand so price setters have the edge to set higher prices, while in off season price setters are bound to keep the prices low. Classify the product: Before price setting it is important for price setters to classify the products on the basis of the value it is delivering. Higher the value being delivered, more the price can be charged. Demand Forecasting: Another milestone in determining the price is demand forecasting. It is determined through keeping trends of the past years in mind. Once demand is forecasted, it facilitates the price setting as supply is constant in short run and if demands exceeds supply a higher price can be set. Demand forecast is usually low in off seasons while high at times of peak season. Price Optimization: The most important step is setting the price for every segment. All the above mentioned factors should be kept in mind while setting the price like demand versus supply, the worth of the customers in the segment to determine willingness to pay, season, and inelasticity of the customer. Higher the demand, worth and inelasticity of the customer the higher the price should be set otherwise a lower price should be set. In economic terms price should be set where the maximum revenues can be generated. Overbooking: Another aspect to revenue maximization is overbooking. In order to save loss of profits in situations where it is expected that customer will cancel at the eleventh hour, a certain figure is forecasted and overbooking is done in order to maximize revenues. But there is huge risk involved with this as in case of non cancellation by the customer as another customer who was overbooked might be dissatisfied and result in loss of customer, profit as well as reputation. Therefore very few overbooking should be done [Revenue Management, 2001]. Current Hospitality Issues and Their Implications: Certain issues faced by hospitality industry include the following: Performance Evaluation [Kumar]: The performance of the revenue management model is difficult to evaluate. It can be evaluated through comparing the model with the model of other competitors in the market. Different Pricing – Unethical [Kumar]: On finding out that two people sitting next to each other are being charged a totally different amount is often considered unethical by the customer. Therefore it is important to maintain a balance between “short term profits and customer loyalty” [Kumar]: Pay for Performance – Hurdle to Revenue Management System [Kumar]: Since staff is paid a certain portion on making a sale therefore they prefer to make huge group bookings, which is against the concept of Revenue management System thus reducing overall profits. Therefore the staff should be paid more if they bring a high price customer instead of more customers. Going Green: As time is passing people are becoming more aware about sustainability issues. The most important issue nowadays is that hospitability should go green, that is buildings as well as planes should be checked for carbon emission. If the management should take care of the planet as well as profits then the issue could be resolved [Jin Zhou, Jing, 2009]. High Labor Cost: The labor cost is considered one of highest cost incurred by the hospitality management but pleasant employee guest interaction is very important in hospitality industry therefore its importance cannot be denied so the management has to accept that although labor cost is costly but is very important [Jin Zhou, Jing, 2009]. Competition: With the passage of time new and new competitors are coming into the market and it is becoming increasingly difficult to stay in the market. Therefore the industry should come up with a good brand image and innovative and creative ideas to attract customer base and not only stay but lead the market. CRM [Higgins, 2010]: Since the information of the customers is very important in determining how much they should be charged and how much they are willing to pay, therefore the industry needs to maintain a high technologically sound and updated Customer Resource Management Information System. Now the company has to invested a allot over the MIS. Keeping in mind the importance of the system, the investment becomes high avoidable in fact worth investing in. Industry’s Heavy Dependence over the Economy: Industry’s profits are highly dependent over the economic cycle. That is if the economy if good, the travelling, tourism, hotel industry will thrive otherwise suffer. In the periods of recession, the profits of a large number of airlines as well as hotels suffered. Revenue Management Destroys Customer Loyalty [Shoemaker, 2003]: If the customer finds out that he is being charged few more hundred pounds due to increase in demand or since hotel has got only few more rooms left at the peak season, customer loyalty suffers and they become much disappointed. Solution: Relationship Management: Relationship Management is highly influential in such a scenario in order to convince the customer that they are not being cheated but this was the rate that is going on and if they want discount they should make sure to make prior bookings next time. Revenue Management System – An Application Aegean Airlines [Kavassalis] Aegean airline is the largest airline of Greece. It was established in 1993. It has recently become the member of star alliance. It is listed in Athens Stock Exchange. The airline has won several awards. In 2006 the airline adopted revenue management system. The airline soon realized that all those seats if not sold before time of departure go wasted therefore they should maximize revenue by implementing Revenue management system for their perishable seats. Apart from this they face other issues like unplanned and unestimated bookings. They could not decide the correct fare for each class. Since 1993 after its establishment till 2006 all the operations of booking, pricing, over bookings were performed manually through past records. But with the passage of time it became much more difficult to continue manually. At that time they decided to implement a revenue management system. Before implementation, they conducted a one year long market survey. Objective of RMS implementation: The major issue that Aegean airline was facing was that it was most of the time flying with empty seats due to last minute cancellation. Therefore they wanted accuracy in overbooking predictions. Another major objective to implement revenue management system was to automate freight management. Implementation: The revenue management system was implementing by SARPE revenue management system providers, while 6 people from airline were involved. One as the leader while remaining 5 as analysts. The system is based on forecasting on the basis of historical data through statistical as well as mathematical means. The analysts enter the information while the system determine optimized prices as well as predictions for overbooking. Benefits: A large segment has cheaper seats due to proper pricing mechanism. They have now got whole one year’s schedule on the system where as now the airline is enjoying better rating as well as reputation. First and the foremost step by the Aegean airline was that they conducted a survey to determine the SARPE as the best service provider based on quality as well as the cost. Flight timings, number of passengers as well as other relevant data was input into the system in order to make future predictions through historic data. System was tested in which both white as well as black box testing was performed in order to check for any bugs that could be presented into the system. All the relevant staff was trained how to operate and maintain the system. Finally after debugging, the system was integrated in to the airline’s operations. The system upon accepting the data through Reservation system, calculates optimized costs per seat. Results of Implementation: The revenue management system which is operated through File transfer protocol server has increased revenues by about almost 2%-3%. Conclusion: Initially all the hospitability industry was working on manual basis where all the predictions were mere guess by the staff or management. All the historical data was manual was hard to manage and consider. All the customers were charged the same no matter either they make their booking at the eleventh hour or many days prior. Lots of inventory used to go wasted such as rooms in hotels, seats in plane due to eleventh hour cancellation, leading to heavy losses incurred by the industry. It was difficult for the industry to survive in the times of economic decline. The business was tough to manage due to huge fixed expenses. The forecasts generated by revenue management system are accurate to a larger extent. This maximizes revenue. Revenue management system plays a very vital role in determining strategic objectives. It not only maximizes the revenue but also satisfies customers by meeting their demands. One dependency of the system is that it requires accurate past details data such as number of flights or rooms, number of customers each day, timing of the customers etc. it can only give near to accurate output only if historical data is correctly entered. The purpose of the system is to facilitate the functionality of the industry making it profitable which would in turn deliver increased value to the customers. References: Carkeek, Simon. Essential activities for today’s hotel revenue manager. [Online]. Available at: . [Accessed 5 December 2010]. Graham, Nick. Five Ways to Drive Hotel Rates over the Next 12 Months. [Online]. Available at: < http://www.htrends.com/trends-detail-sid-50520-t-Five_Ways_to_Drive_Hotel_Rates_over_the_Next____Months___By_Nick_Graham.html>. [Accessed 5 December 2010]. Gupta, Ritesh. Integrating RM and CRM in a Mutually Beneficial Relationship. [Online]. Available at: < http://www.htrends.com/trends-detail-sid-48734-t-Integrating_RM_and_CRM_in_a_Mutually_Beneficial_Relationship___By_Ritesh_Gupta.html>. [Accessed 5 December 2010]. Haley, Mark. Inge, Jon. 2004. Revenue management. [Online]. Available at: [Accessed 5 December 2010]. Higgins, John.k. 2010. CRM and the hospitality sector: it’s all about value. 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Available at: < http://www.htrends.com/trends-detail-sid-47888-t-Assessing_the_Role_of_RM_in_Ensuring_Financial_Success_of_an_Alliance_in_the_Aviation_Industry.html>. [Accessed 5 December 2010]. Salerno, Neil. Essential activities for today’s hotel revenue manager. [Online]. Available at: < http://www.htrends.com/trends-detail-sid-48604-t-Hotel_Revenue_Management_is_Now_More_Important_Than_Ever___By_Neil_Salerno.html>. [Accessed 5 December 2010]. Shoemaker, Stowe. 2003. Future of Revenue Management: The future of pricing in services. Vol 2. No. 3. [Accessed 5 December 2010]. The Effect of Yield Management on Hotel Chains. [Online]. Available at: < http://www.eventogo.com/tips/business/yield-management.php>. [Accessed 5 December 2010]. Thibodeau, Patrick. 2005. Marriott Links Two Data Streams with Revenue Management System. [Online]. Available at: . [Accessed 5 December 2010]. Read More