Demystifying Price Optimization
By Kelly McGuire Vice President, Advanced Analytics, Wyndham Destination Network | July 06, 2014
Most revenue management experts agree that in order to continue to drive revenue and profits in a changing marketplace, the hotel revenue management discipline must evolve from revenue management to price optimization. As hotels make this important shift, it is crucial that executives understand what price optimization is, how it relates to revenue management, and what advantages will be gained from this approach. In this article, I'll briefly describe how pricing in hospitality and travel has evolved over the past few decades, then I'll define price optimization and describe why it is important for hotels to leverage this approach.
A History Lesson: Yield Management in the Airlines
Yield management, as a discipline, started after deregulation in the airline industry, as a method for airlines to control the number of discounted fares they sold. They forecasted demand by fare class and "protected" a certain number of seats for higher paying fares. Fences (rules to qualify for purchase) were created around the discounted fares, such as advanced purchase or Saturday night stay, which discouraged those that would pay a higher fare from booking the lower fares. As this business process evolved, and more discounted fares were developed, mathematicians began to model the problem to find the mathematically optimal protection levels that would maximize revenue. The output was the number of each discounted product to sell in order to maximize revenue. The early systems developed for this purpose were known as yield management systems.
After the carriers began to move towards "hub-and-spoke" itineraries, where a significant percentage of passenger itineraries involved a stop at the carrier's hub, yield management systems needed to account for the large numbers of connecting passengers produced by the hub and spoke approach. This involved managing demand for a specific segment (known as a "leg") of an itinerary when many different kinds of itineraries (all with different values to the airline) also flowed over it, and optimizing the availability of different fares on these connecting itineraries. This is called the "network effect". (In hotels, length of stay creates a similar issue.)
This practice was highly successful for the airlines, generating interest outside of the airline industry. Yield management, or revenue management as it came to be known, was specifically designed for industries that met certain necessary conditions: fixed capacity (only 75 seats on the plane or 300 rooms in the hotel), perishable produce (once the plane takes off, you can't sell the empty seat), time-variable and segment-able demand, advanced reservations (requiring inventory to be "protected" for more valuable business), and low cost of sale. Hotel companies began to adapt the airline methodologies to their business problem, as did some cruise lines, retail, and media companies.
Then Things Changed...