Revenue management as a differentiator in an on‑demand world

3/24/2017, written by Vinayak Naik

Categories: Revenue Management

In an on-demand economy, every business is a revenue-management business. As industries get disrupted by the change in consumption models, the opportunities for both the challengers as well as the incumbents lie in maximizing the ROI and optimizing their assets, which is what the principles of revenue management best provide.

The goal of any business is to maximize profits, which usually means maximizing revenues (exceptions would be industries where winner-takes-all type dynamics rule, in which case the company has an incentive to maximize revenue without consideration of profit, at least for a period of time).

Given the advances in technology and changing consumer behavior, on-demand companies are popping up and upending incumbents who had built solid businesses over a period of several years. A look at companies like Uber, Oyo, Airbnb, etc. reveals that they have all grown in an industry with one or more of the following characteristics:

  • High fixed costs: Means low profit margins to begin with, which provides a reason to look at algorithm-based pricing models to maximize revenues.
  • Use-it or lose-it goods or services: Means that the producer has to sell goods or services at a price that is at least equal to or higher than the marginal cost of producing that good or service.
  • Regulation: Makes the market less efficient. This is a reason for entrepreneurs to disrupt the existing players, on the back of other technological advances which incumbents are late to adapt to (Uber changed the paradigm of black-yellow regulated taxi services to any private car that can be called using smartphones).
  • Lack of goods substitution: Means that consumers cannot swap out their demand for one product (say, a room to stay for the night) with any other product, which means demand for the product remains, regardless of pricing.

So how does revenue management play into all this?

In any business, the easiest way to maximize profits is to generate the maximum amount of revenue per unit of cost that goes into generating that revenue. This is especially true in high fixed cost industries (like airlines, hotels, car transportation), where maximizing revenue for every unit of cost associated with that business is done by price discrimination: the philosophy that allows companies to charge different pricing based on factors like demand-supply, macro factors like weather and economic conditions, as well as the willingness to pay of the consumer.

In use-it-or-lose-it industries, by understanding the relationship between demand and supply and the levers that move the price (the intersection of the demand and supply curves), companies can use demand forecasting and customer behavior analysis to determine optimal pricing of their goods and services, thereby maximizing revenue and profits.

This is what revenue management is all about.

By applying revenue management principles, on-demand economy companies like Uber (upending the regulated taxi services) and Airbnb (upending the hotel business) have built systems that provide real-time pricing using demand forecasting and customer behavior analysis and successfully consummate that transaction by becoming the matchmaker between the buyer and the seller. This has enabled them to build leadership positions in their industries.

Ironically, this has given enough reason for the incumbents also to look at new age revenue management systems to stay competitive and to maximize their profits.

The beauty of revenue management principles is that it is applicable to any business: not just the ones that are getting disrupted. Any business that uses assets to generate revenue is fair game.

As days go by, the demand and application of revenue management systems will only go up as incumbents in disrupted industries play catch-up and new industries get disrupted. The other trend that bodes well for revenue management system adoption is the ‘on-demand-ization’ of traditional industries. Commerce fulfillment and last-mile delivery are some industries that are getting to experience the benefits of on-demand recently, and which will only continue to grow.

The airline industry has been a pioneer in introducing mathematical revenue optimization for ticket pricing. In the industry itself, Lufthansa has been a leader in this area and Nagarro has helped them develop strong revenue management capabilities. Along with established practices in design, digital and data analysis, Nagarro is able to apply agile methodologies to leverage these capabilities and maximize profitability for its clients.

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