Yield Management in the Service Industry - Literature review Example

Title of report: Yield Management in the Service Industry. (Student name) (Presented to) (Institution) (Unit code & unit name) (Date submitted) Introduction The term yield management (YM) is a coin from the airline industry. Its main objective is to manage the product and service inventory in a manner that maximizes revenue. It is mainly used in service industries such as airlines, hotels, restaurants, car rentals, trains-operating and cruise liners as a technique to allocate limited resources. By regulating this allocation, a firm can optimize the total revenue or "yield" on its investment in capacity. It is for this reason that yield management is also known as revenue management and revenue optimization. According to (Donaghy et al, 1995) yield management is a set of demand optimization models, forecasting techniques and implementation procedures which are used together to determine which reservation requests to accept and which to decline in order to optimize revenue. From this definition, it can be seen that yield management is a fundamental economic discipline appropriate to many service industries in which market segmentation and price differentiation combined with statistical techniques to grow the market for the service hence increasing the revenue "yield" per unit of capacity (Netessine and Shumsky 2009). The concept of yield management first emerged in the service industries such as airlines and hotel industry in the late 1960s. A few reported the use of this practice in other industries; such as health care (Chapman and Carmel, 1992), golf course industry (Kimes, 2000), broadcasting (Cross 1998), Internet service provision (Nair et al, 197) and non profits sector (Metters and Vargas 1999). However, the concept of yield management has since been embraced in other sectors a part from service industries. Even manufacturers are resulting to yield management techniques in a quest to increase their profits. Notably, capacity of manufacturing is as perishable as an advertising slot or an airline seat. If it is not utilized when it is available, that opportunity to use the capacity is lost forever. Current Technologies and Techniques a.) The Yield Management Control dimensions In the hotel industry just like any other hospitality industry, harmonizing capacity with the constantly varying demand continues to be the top priority and a major challenge for all service providers. Hotels will always have either too few or too many rooms available for specific arrival and departure dates in view of market demand. When developing a yield management model for a hotel, there are three basic types of controls that come into prior to the arrival day. These include capacity management, rate inventory control and duration control. The capacity or inventory management allocates the saleable inventory of various types to different market segments in regard of expected demand, no-shows, cancellations and early departures. On the other hand, rate control aims at establishing the revenue maximizing the rate mix, which is the number of rooms to be sold for different rates, for various market segments’ demand situations. Duration control takes in account that the value of a request by a customer can only be established by multiplying the rate available by the number of time periods requested. However, it should be noted that in the area of group business, the time/date sensitivity dimension comes into consideration. This means the number of high yield customers displaced and losses in revenue determine the group availability and rates as a result of this displacement. Also, in real-life guests usually determine two or three of the parameters for making decisions thereby controlling most of the dimensions. This leaves the hotel management with only a single decision; to accept or to reject the request. b.) Methods of capacity control There are four basic methods used by operators in the service industries to control their inventory. First, bookings can only be accepted up to full capacity that is 100%. Nevertheless, not many hotels overbook and therefore, lose revenue. Secondly, a service provider is likely to ‘pool’ their clients in order to service the varying demand. Examples include services offered by shuttles to and from a dentist’s waiting room and the airport. Thirdly, many service providers lower their standards during peak times. An example is customers standing in an overcrowded train. Finally, many players in the service industry influence the behavior of their customer by providing improved information. An example is a news broadcast about traffic jams and overcrowded train stations and airplanes. c.) Yield Management decision support tools Yield management problem solutions are derived from abstract, theoretical and complex modeling techniques, which can be categorized into four major groups namely: booking curves, expert systems, neutral networks and operations research models. These models are known as the expected marginal room revenue (EMRR). EMRR values obtained are the opportunity cost of marginal room units representing the values of alternative revenue opportunities lost by selling the marginal room. Once it is established, the EMRR curve can be used to determine the optimum number of rooms to be allocated for sale through rate classes to a different class segments. i.) Booking Curves This is one of the most widely used methods to manage hotel inventory in view of fluctuating demand. The methods are relatively undemanding and past transaction data is use to develop them. Booking curves represent actual bookings together with checked-in demand and do not specifically establish reservation turnover resulting from calculations. They do not show sold out days nor do they take denials into account. Upper and lower threshold curves show deviations from mean demand and allow forecasting remarkable booking development. It is not lost on us that booking curves do not determine optimum allocation of booking limits for rate classes or revenue maximizing. In addition, where inventory allocations are by rate class and/or duration, they need to be checked and manually adjusted frequently to be able to improve revenue. Because yield management decisions occur repeatedly and are based on rules, artificial intelligence (AI), expert systems and neutral networks are often applied to provide support to the inventory making process. ii.) Expert systems Expert systems use sets of predetermined standards to propose booking limits. They are capable of handling most features of quality control. They be developed at a relatively low cost and can give better results than booking curves than booking curves used alone. A reputable expert system requires a thorough knowledge of customer behavior as it is an extremely difficult and complex task. An example illustrating the expert system method: If control day is December and If arrival day is January and If arrival day is more than 30 days out and If arrival day is less than 60 days out and If discount bookings are greater than 25% of capacity Then limit the availability of the discount rate to 40% of capacity iii.) Neural Networks They represent a distinct form of artificial intelligence which resembles an electronic circuit reacting to predefined inputs. Such react to situations, and adapt from continued repetition. However, neural network approaches are still majorly theoretical. As a result, they are yet to be successfully implemented in commercial systems (Donaghy et al. 1995). iv.) Operational research models (ORMs) These are usually mathematical formulations used to forecast future customer behavior and generating optimal booking limits. Forecasts help in describing to describe future bookings, cancellations as well as customer behavior. They are computed by using historic patterns, bookings, demand, and booking and transaction data. Booking limits are determined by use of mathematical formulations to describe the relationships between actions taken to control inventory and the resulting revenue. Though they have successfully been used by airlines, operational research models remain expensive and time-consuming to develop compared to expert systems and booking curves. Moreover, they are often difficult to understand especially for inexpert users because of their complex nature. Advantages of using Yield Management The most obvious benefit of yield management is shown in the introduction in this paper. This stands for maximization of business revenue through selling to each customer at the highest price and by trying to ensure that all of the available capacity is utilized, the total revenue can increase dramatically as demonstrated by service industries such as the hotel and airline industries. Yield management improves sales through price discrimination and/or differentiation (Larsen 1988). Through price differentiations, the services are able to develop unique products for their different market segments. This means that customers who would have not paid for services which they thought were exorbitantly priced can access such services at affordable packages. In the same regard, high end customers who prefer and can afford high-end services and products also get a choice; and so do the customers who fall in the middle segment who are the majority. Simply put, yield management ensures that there is a product available for every market segment thereby increasing sales. Also, yield management raises productivity through enticing more demand (Williams 1987). Because of product differentiation, products and services that are more specific to the target segment are developed. This means that customers are more likely to become attached to these products because they feel they are valued by companies. This results into increased demand across all product segments ultimately increasing productivity in the operations of a company. In addition, yield management (YM) increases competitive advantage in the service industries through revenue generation and capacity utilization (Larsen 1988; Williams 1987).As a result, service industries are able to ensure that they fully utilize their capacity. It is impossible or expensive to store excess resource. It is impossible for a hotel to safeguard tonight's room for occupation by tomorrow night's customer. A hotel will try ensuring that all its rooms are fully booked at the best possible prices in view of the season. Similarly, an airline will develop differentiated flight packages targeting different market segments in order to operate at full capacity. In the hotel industry, for example, the same unit of capacity can be used to offer many different services or products. Rooms are usually the same, whether used by business or leisure travelers. The problems with Yield Management One of the most persistent problems in implementation of yield management is practical oriented; especially because the implementation of a computerized yield management system can be quite difficult. It needs to be interfaced with the system that contains the actual total number of reservations and all the currently used automated distribution systems. Apart from the technical difficulties that are associated with installation of computerized system for yield management, systems in existence lack the capacity to accurately predict accurately prices for all consumer groups. This is especially so where one customer will takes large parts of the inventory that available at a certain time. An example is where a tour operator makes group bookings. In such a case, the systems are not able to provide accurate data (Varini, 2000). Another issue that has arisen from the use of yield management systems is the absence of consensus on where it should be placed. One is tempted to ask where to place the yield management system and whom to make responsible for it. Kimes (1989) argues that all departments of a hotel should be actively involved in order to implement it successfully. Also, customer perceptions about price increments hinder the smooth implementation of yield management system. According to Kimes (2002) the customer perceives it fair for the price of a product to increase if at all the costs should increase so that maximum profits are realized. They however, do not feel that increasing the products price in order to increase profits is a fair practice. This then presents the supplier with the challenge of identifying how he can raise profit without the consumers feeling that they are treated unfairly. Kimes (2002) proposes four solutions to this problem. The first one is to give the customer an exaggerated reference price and thereafter offer him discounts. The second option is to add additional services or value to the product and then increase the price. A third way is through selling the product as an inclusive in a package. The fourth and last option is to attach restrictions on the discounts in order to make the discounts to be perceived as being fair. Moreover, repeated use of price discounts might give grim picture of service provider and the quality of the service provided. Furthermore, as yield management involves differential pricing for the same customer pegged on the customer and demand (Kimes 1998), the need to introduce fences and a proper price mix arises. A rate fence can be defined as characteristics possessed by a particular customer, which allow her/him to qualify for a given rate. Such fences issue the supplier with a logic basis as to why some clients are charged certain price. On the other hand, the mix of prices should have a rationale and make the customers perceive as being treated fairly. However, the customer is not the only one a service provider should be concerned about. According to Kimes (1989) the morale of the employees might also go down because some of their responsibilities like determining the price of the product are taken away by the yield management systems. Therefore, the system should allow for some degree of independence into the setting of prices to enable employees to use their own judgment of such a situation. Training the employees further would also be necessary. Yield management systems have been blamed for opportunistic behavior on the part of the customer. This has been attributed to an increase in price awareness and sensitivity among customers. As a result, these customers are no longer willing to purchase at normal prices (Marmorstein, Rossomme, & Sarel 2003). From a customer’s perspective, the implementation of yield management systems might be perceived as a disadvantage because on average the spending by all customers increases. This is, however, not a problem assuming that customers are comfortable paying the price for every product that they are freely willing to buy and consume (Gourville & Soman 2002). The Difference between airlines and hotels The hotel industry is heterogeneous and fragmented. Unlike the airline industry, the hotel industry has many types of companies, destinations, products and market segments. Airlines have centralized pricing and sales. Airlines product differentiations are usually targeted at a small market segment that is mainly constituted by travelers. The hotel industry is yet to embrace the concept of fencing compared to the airline industry. A fence is a set of characteristics of a customer that allow them to qualify for a given rates of price. These fences enable the supplier to use logical basis as to why a specific customer must pay a specific price. In the hotel industry, the negotiation skills of guests and hotel personnel often prove often make the difference. Airlines are more flexible than hotel industry in terms of adjusting capacity. Unlike hotels, airlines can fly to where the customers are waiting. Recommendations Though the yield management system continues to be adopted across service industries, it also has disadvantages. One of them is the poor perception customers that develop towards suppliers over what they consider as unfair increase of product and service prices. One way of improving this perception is to adopt fair practice strategy when increasing the products price. This can be done in several ways including offering discounts where price increases have been introduced, or including additional services or value to the product and then increasing the price. One can also sell the merchandise as a component of a package or even attach restrictions on the discounts in order to make the discounts to be perceived as being fair. Though a lot of benefits continue arising from yield management systems continue to be enjoyed in the service industries, numerous benefits would be enjoyed if full stakeholder participation was encouraged. This will help in full implementation of these systems including all hotel departments for better performance. Also, the systems must to be formed in such a way that they allow employees to make their own judgment of the situation. In this regard, additional training should be provided to employees. Conclusion Yield management (YM) remains a critical tool in the service industry. In fact, not only does the implementation of an appreciable yield management system increase revenue but it also maximizes it while fully utilizing the capacity. However, proper care and consideration has to be taken when implementing for all the different aspects. The issues raised in the section discussing the problems associated with yield management should be fully addressed before trying to implement them. Finally, care has to be taken with both customers and employees. An attempt should always be made to ensure the employee does not feel sidelined when the supplier concentrates on fair practice and changing the perception of the customers. Yield management should not be used to replace a superior product or service and can not be used to substitute marketing. REFERENCES Chapman, S N & Carmel, J I, 1992. Demand /Capacity Management in Health Care: An Application of Yield Management, Health Care Management Review, 17(4):45-53 Cross, SA, 1995. An Introduction to Revenue Management, in The Handbook of Airline Economics, D. Jenkins (ed), NY; New York, The Aviation Weekly Group of the McGraw-Hill Companies Donaghy, K, McMahon-Beattie, U & McDowell, D, 1995. Implementing yield management: lessons from the hotel sector, International journal of contemporary Hospitality Management 1997 Vol 9 No 2 pp 50-54 Gourville, J & Soman, D,2002. Pricing and the psychology of the Consumption Harvard Business Review September 2002 Kimes, S E, 1989. The basics of Yield Management Cornell Hotel and Restaurant Administration Quarterly, November 1989 Kimes, S E & Chase, R B, 1998. The Strategic Levers of Yield Management JournalOf service research, November 1998 Vol 1 No 2 pp 156-166 Kimes, S E, 2000. Revenue Management on the Links, the Cornell Hotel and Restaurant Administration Quarterly: 120-127 Kimes, S E, 2002. Perceived Fairness of Yield Management Cornell Hotel and Restaurant Administration Quarterly, February 2002 [First published in: Cornell Hotel and Restaurant Administration Quarterly, February 1994, Vol 35 No 1 pp 22-29] Larsen, T, 1988. Yield Management and Your Passengers, Asia Agency Management, June, 46-48. Marmorstein, H, Rossomme, J, & Sarel, D,2003. Unleashing the Power of Yield Management in the Internet Era: Opportunities and Challenges, California Management Review, 45(3):147-167. Metters, R, & Vargas, V, 1999. Yield Management for Nonprofit Sector, Journal of Service Research, 1:215-226. Netessine & Shumsky, 2009. Introduction to the Theory and Practice of Yield Management Nair, SK, Bapna R, and Brine, I, 1997. An Application of Yield Management for Internet Service Providers, Working Paper, Department of Operations and Information Management, School of Business Administration, University of Connecticut, Storrs, CT Varini, K, 2000. Thinking of installing a computerized yield management system? The hospitality review April 2000 pp 41- 45 Williams, I,1987. Dark Science Brings Boost to Airline Profits, the Sunday Times, 27 November, 94. Read More