MGO 304 1st Edition Exam#2 Study GuideREVENUE MANAGEMENTRevenue Management: the strategy and tactics that manage the allocation of a fixed capacity to differentiate fare classes over time in order to maximize revenue. Used by: airlines, hotels, rental cars, transportation, sporting events, restaurants etc. Can be applied when: The seller is selling a fixed stock (ex num of seats), customers book prior to consumption, the seller manages a set of fare classes (each have a fixed price ex. students & senior citizens/ LF & HF) , & the seller can change the availability of fare classes over time. Remember: Its NOT based on setting and updating prices. It’s based on changing the AVAILABILITY OF FARE CLASSES where each fare price remains the SAME through the booking period. This SHAPES demand. ItsCAPACITY control, not direct PRICE control. 1st: Strategy identifies customer segments and establishes products targeted at them. (ex. the difference between Low Fare (price sensitive, date flexible, accepting restrictions) and High Fare (price insensitive, books late, and less flexible)2nd: Tactical RM the “brains” of the process. Involves Forecasting demand, running optimization algorithms, and setting & updating booking limits. 3rd: Booking control checking whether a booking can be accepted given the booking limits currently in place. (ex. a person asks for 3 seats in b class and the booking limit is 2, the request gets rejected). By Nesting and using Protection LevelsAmerican Airlines vs. People Express Ex.  People Express: charged for flight operations (ie. bagging, and meals) and offered seats that were 70% lower in price than its major competitors, and every passenger paid the low fare. So for the competitors to compete they : offered seats to leisure and business travelers (low fare & high fare tickets) and enforced booking limits and protection levels for these customers, respectively, to cover their operational costs. They then became the industry leaders. Booking limit: The max number of seats you will allow to be sold to low fare customers.Booking restrictions: Setting qualifications for passengers to even be considered aslow fare. (ie. must book at least 2 weeks before departure.)Protection Level: The number of seats that will be reserved for High fare customers.TACTICAL REVENUE MANEGEMENTCapacity Allocation: determining the number of “seats” to allow low fare customersto book when there is a possibility of future high fare demand. Particularly important for airlines. Problems: When you set the booking limit too low  SPOILAGE (not enough HF seats are purchased thus leaving empty seats that could’ve been purchased by LF customers)When you set the booking limit too high  DILUTION (the revenue was diluted by LF customers that were taking potential HF seats)ie…..The booking limit tradeoffSO to find the OPTIMAL booking limit….we use LITTLEWOOD’S RULEb* = max{C – (mean of full fare) – (full fare SD) x z-score of (1-pd/pf)- Note: if pd/pf is <0, first find the z-score of (1-pd/pf), then make that z value negative. And that's the new z-score to put in the equation!IF:pd/pf= ½ ; The z-score will equal 0 and the full fare demand variation has no influence on the booking limit. pd/pf> ½ ; The z score will be less than 0 and increasing the full fare demand variation will cause in increase in the booking limit. pd/pf< ½ ;The z-score will be greater than 0 and increasing the full fare demand variation decreases the booking limits. Sensitivity analysis: IFWE INCREASED….The average full fare demand  Booking limit decreasesThe average discount demand  No change in BLThe discount demand variation  No change in BLThe full fare price  Booking limit decreasesThe discount price  Booking limit increasesThe plane capacity Booking limit increasesOverbooking:occurs when a seller with constrained capacity sells more units than he has available to protect themselves against unanticipated no-shows and cancellations.- when a flight is oversold the passengers that bought tickets but exceededcapacity were denied boarding and bumped to another flight. This is calledinvoluntary denied boarding. Overbooking Policies:- Deterministic heuristic : b = C/p (where p = historic show rate)- Risk Based Policy: estimating the cost of denied service and weighing thosecosts against the potential revenue to determine the booking levels thatmaximize expected total revenue minus expected overbooking costs. - Service Level Policy: involves managing to a specific target Ex. denying nomore than 5000 LF seats. - Hybrid Policy: one in which risk- based policy are considered butconstrained by service- level constraints.- Other ways to reduce cancellations and no shows include: non-refundable deposits, higher prices and non- refundable tickets. Network Management:practice of maximizing profit through controlling a set ofconstrained and perishable resources and selling products that consist ofcombinations of those resources. Is important in industries that sell more than oneresource. Ex. airline industry’s hub- and- spoke networks where they have flightsthat accommodate people who have varying destinations. Most important in hotelsand rental car companies.- The seller must consider the interactions among the various products he sellsand their effect on his ability to sell other products. - Here you must determine which booking requests to accept for everypossible combination of product and fare class at every time. Which are theODFs of every possible combination.Solution approaches:-Strict Fare- class Approach  products are first allocated to high farecustomers. But here they would turn away somebody who wanted 3 nights ofdiscount tickets and except the person who wants only 1 full fare ticket. Evenin the overall revenue for the 3-night stay is greater! Allocating products inorder of class. -Greedy Heuristic Approach Serving customers based on their overallrevenue generation. Allocating products in the order of fare amount.-Linear Programming Approach Can be an optimal solution when there iscertain demand. But, it provides a good starting point to find an optimalsolution & generates “marginal values” of capacity.o