When you travel by plane, have you ever noticed that nearly all flights end up full? If the airline manages to fill the plane without turning away customers, it has successfully optimized its pricing strategy, part of a process called revenue management. Learn more about revenue management and how to use it in your business.
What is revenue management?
Revenue management, also known as revenue optimization, refers to the various techniques businesses use to maximize revenue, mainly through variable pricing. It relies on forecasting demand by collecting data on customers’ purchasing behavior and overall economic conditions.
Revenue managers analyze economic and customer data to set prices that will make best use of their supply or capacity, such as the number of seats available on a flight or rooms in a hotel, while meeting customer demand for seats and rooms.
Yield management, a key part of revenue management, refers to revenue from core resources, or capacity. A 200-room hotel with all rooms booked is getting maximum revenue yield from its rooms, but this measure excludes any revenue from any other hotel services. Additional income, such as from room-service meals or spa treatments, adds to total hotel revenue but isn’t included in yield management.
Characteristics of revenue management
Revenue management techniques are widely used by service industries such as airlines, hotels, car-rental fleets, and cruise ships because their businesses have the following characteristics:
- Supply constraint. The airline industry and hotel industry are made up of businesses that have a limited supply to sell; there’s a hard ceiling on how many seats an airline can sell on a plane that holds 200 passengers.
- Perishable inventory. The seller’s supply has a short life span, in some cases only a matter of hours; if a hotel with 200 rooms only sells 150 one night, those 50 vacancies are a lost opportunity.
- Variable pricing. Different customers are willing to pay different prices for the same service; a business traveler might pay $300 a night for a hotel room, while a leisure traveler is willing to pay only $200.
- Foreseeable demand. These businesses carefully forecast changes in customer demand; if a hotel knows when a big event is happening, it can price rooms accordingly.
Why is revenue management important?
The revenue management process helps businesses boost profitability and maximize revenue by getting the most from what they have to sell, identifying customers who most value their service, and exploiting demand opportunities in a way that one-price strategies can’t. It allows businesses to take a data-driven approach in deciding what to sell, when to sell, whom to sell to, and at what price to sell.
Revenue management process
- Collecting and analyzing data
- Assessing the market
- Establishing segments
- Forecasting demand
- Executing a plan
- Adapting and revise
Businesses undertake revenue management to determine how to maximize revenue from services or products. Revenue management software can make the process easier. The steps include:
1. Collecting and analyzing data
Revenue managers typically analyze data about the business’s resources, its management, and its staff, as well as current and potential customers. This includes researching consumer spending habits and preferences, household income, and geographic location to help set prices that customers will accept and that will contribute the most to revenue.
2. Assessing the market
Airlines, hotels, and other industries want to understand market trends and what competitors are doing. Knowing the competition’s strengths and weaknesses can help in setting your own prices. Feedback from customers and social media influencers also is important, as are the latest industry research and news.
3. Establishing segments
This involves classifying customers by type or by calendar period. For example, a hotel’s primary customer segments could be business travelers and leisure travelers. It may then further segment leisure travelers into singles, couples, and families. Additionally, it may have calendar segments, which could be days or weeks, or weekdays versus weekends, further segmented by seasons, holiday periods, or particular events—a business convention or the Super Bowl, for instance.
4. Forecasting demand
Businesses use historical data, as well as general economic and consumer-spending forecasts—even weather forecasts—to build a calendar of expected peaks and troughs in demand. Airlines, hotels and other travel-related industries try to create a demand forecast for each day of the year when they price their services.
5. Executing a plan
The business then proceeds with the plan to maximize revenue based on the demand forecasts. For example, Friday evening flights typically carry lots of business people returning from work travel, and leisure travelers going away for the weekend. An airline will set its prices accordingly, charging more on Fridays, and use planes with higher capacity. By contrast, prices tend to be lower on Sundays.
6. Adapting and revise
A revenue management plan isn’t set in stone, and businesses should adapt and adjust to continuously optimize their approach. For example, many airlines and hotels raised prices after the COVID-19 pandemic to take advantage of the pent-up demand for travel and leisure.
Revenue management strategies
Businesses have a number of tools at their disposal when creating a revenue management strategy. Here are some of the most popular:
Pricing strategies
The main types of pricing models include:
- Open pricing. Also known as dynamic pricing, prices change in real time based on the latest supply-and-demand data. Airlines typically use open pricing to fill seats on flights.
- Forecast pricing. Businesses using this strategy set prices in advance for dates or periods of expected higher or lower demand. This is standard practice for hotels in seasonal resort locations.
- Segmented pricing. A business sets different prices for different types of guests or time periods, based on customer willingness to pay. For example, weekday business travelers typically pay more for hotel rooms than weekend leisure travelers.
- Duration pricing. Also known as length-of-stay pricing, this is a strategy to require or encourage longer hotel stays or longer use of services, such as car rentals. A hotel, for instance, might require a minimum three-night stay for a busy holiday weekend.
- Competition pricing. A business might match competitor prices, or differentiate itself by offering lower prices to attract customers on a budget. Alternatively, it might set prices higher, touting quality of service or amenities.
Inventory control
Inventory is the amount of hotel rooms not yet booked, airline seats not yet reserved, or cars not yet rented. A proper inventory mix is important to satisfy customer-segmented demand—for example, economy, economy-plus, and business-class seats for airlines, or hotel rooms for business travelers versus leisure travelers. Businesses control their inventory by monitoring capacity, such as a plane’s total passenger seats, or a hotel’s total number of rooms. The goal is to achieve maximum capacity utilization while avoiding overbooking.
Booking incentives
Businesses such as those in the hotel industry sometimes offer booking incentives, such as a pay-now option that gives customers a discount if they pay in full upon booking rather than when the service is used. Additionally, airlines, hotels, and other travel industries often use third-party booking services such as Expedia or Kayak, paying a fee usually based on the selling price. To encourage customers to book directly, thus saving on third-party costs, the supplier may sometimes offer discounts, loyalty rewards, and other booking incentives.
Revenue management KPIs and metrics
Industries that practice revenue management keep an eye on some essential business metrics, called key performance indicators, or KPIs. These include:
Revenue per seat-mile
The airline industry uses passenger revenue per available seat-mile, or PRASM, to measure how much revenue is generated from each seat in a plane for each mile flown. Airlines compare this against the cost per available seat mile, or CASM, to gauge a flight’s gross operating profit.
Occupancy rate
Hotels, cruise lines, and car-rental companies focus on occupancy rate, expressed as percentage of capacity used. For example, if a hotel has 85 out of a 100 rooms booked in a particular period, the occupancy rate is 85%. Revenue management ideally seeks a 100% rate.
Average daily room rate
The hotel industry and cruise lines use this indicator to track how much rooms generate in daily rate revenue. For example, a 100-room hotel sets a $200 daily rate for 50 rooms for leisure guests, and a $300 rate for the other 50 rooms for business guests. The average daily rate for the 100 rooms, splitting the difference between the two rates, is then $250. Revenue per available room, or REVPAR, and revenue per occupied room, or REVPOR, include any other guest spending, such as charges for room-service meals or laundry.
Revenue per vehicle
Car rental services use this to gauge how much each car in the fleet generates. Let’s say a business with a 100-car fleet has an average of 50 cars rented during a 30-day period, at an average $100 a day. That’s:
50 x $100 x 30 = $150,000 ($3,000 per rented vehicle)
Because only half the fleet was rented during the month, the average daily revenue per vehicle for the entire fleet was only $50. The rental business can boost this figure by increasing the number of cars rented. It might also decide to change the mix of vehicles it offers, adding SUVs that go for higher rates.
Per-unit profit
All industries want some measure of profitability per product or service unit, after costs are subtracted from revenue. For airlines, it can be average profit per seat, per plane, or per route. Hotels measure average profit per room, and car rentals measure average profit per vehicle.
Revenue management FAQ
What are the benefits of revenue management?
The benefits of a revenue management system include maximizing revenue, minimizing losses, improving a business’s ability to predict customer demand, gaining an edge over competitors, and opportunities to expand in new markets or offer new services.
What is the main purpose of revenue management?
Revenue management techniques are meant to maximize revenue from a business’s main resources: airline seats, hotel and cruise-ship rooms, or rental cars. It also includes maximizing revenue from related services, such as charging for amenities for airline passengers and hotel guests, or insurance for a rental car.
What is the difference between revenue management and yield management?
Revenue management focuses on generating the most possible revenue from all resources and services, such as room service and spa treatments, as well as the daily room rate at a hotel. Yield management, a part of revenue management, focuses on maximizing revenue from a business’s main resource, whether plane seats, hotel rooms, or rental cars.
