How Revenue Management Works (and How to Use It) (2024)

When you travel by plane, have you ever noticed that almost every flight is full? If an airline can fill a plane without turning away customers, they have successfully optimized their pricing strategy. This is part of a process called Revenue Management. Learn more about Revenue Management and how you can use it in your business.

What is Revenue Management?

Revenue management, also known as revenue optimization, refers to a variety of techniques that businesses use to maximize revenue, primarily through variable pricing. It collects data about customer buying behavior and overall economic conditions to forecast demand.

Revenue managers analyze economic and customer data to set prices that meet customer demand for seats or rooms while maximizing supply or capacity, such as seats on a flight or hotel rooms.

Yield management, an important part of revenue management, refers to revenue from core resources or capacity. A 200-room hotel with all rooms booked derives most revenue from its rooms, but this measurement excludes revenue from other hotel services. Additional revenues such as room service meals and spa treatments add to the hotel’s total revenue but are not included in yield management.

Revenue Management Features

Revenue management techniques are widely used in service industries such as airlines, hotels, car rental companies, and cruise lines because they have the following characteristics:

• Supply constraints. The airline and hotel industries are made up of businesses with limited supply to sell, and there are strict caps on the number of seats airlines can sell on a plane carrying 200 passengers.

• Fresh produce stock. A seller’s supply has a short lifespan, sometimes only a few hours. If a 200-room hotel only sells 150 rooms per night, those 50 vacant rooms 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 might only pay $200.

• Predictable demand. These companies carefully forecast changes in customer demand: if a hotel knows when big events are taking place, they can price rooms accordingly.

Why is revenue management important?

The revenue management process helps companies increase profitability and maximize revenue by getting the most out of what they sell, identifying the customers who value their services most, and capitalizing on demand opportunities in ways that a single pricing strategy cannot. Companies can take a data-driven approach to determining what to sell, when to sell, who to sell to, and at what price.

Revenue Management Process

1. Data collection and analysis
2. Market evaluation
3. Establishing segments
4. Demand forecasting
5. Executing the plan
6. Adaptations and Revisions

Businesses implement revenue management to determine how to maximize revenue from their services or products. Revenue management software makes the process easy. Here are the steps:

1. Data collection and analysis

Revenue managers typically analyze data about a company’s resources, management, staff, and current and potential customers, including studying consumer spending habits and preferences, household income, and geographic location. Set your price What is accepted by customers and contributes most to profits.

2. Market Assessment

Airlines, hotels and other industries want to know market trends and what their competitors are doing. Knowing your competitors’ strengths and weaknesses helps you set your own prices. Feedback from customers and social media influencers is also important, as is the latest industry research and news.

3. Setting up segments

This includes categorizing customers by type or calendar period. For example, a hotel’s primary customer segments are business travelers and leisure travelers. Leisure travelers are further divided into singles, couples, and families. Furthermore, there are calendar segments (such as days and weeks, weekdays and weekends), which are further subdivided by seasons, holiday periods, or specific events (such as business conventions or the Super Bowl).

4. Demand forecast

Companies use historical data, general economic forecasts, consumer spending projections, and even weather forecasts to create calendars of expected peaks and valleys in demand. Airlines, hotels, and other travel-related industries attempt to create demand forecasts for each day throughout the year when pricing their services.

5. Execute the plan

Companies then use their demand forecasts to plan how to maximize revenue. For example, Friday evening flights are typically filled with business travelers returning from business trips and leisure travelers heading out for the weekend. Airlines price their flights accordingly, charging higher fares and using higher-capacity planes on Fridays. In contrast, fares tend to be lower on Sundays.

6. Adaptations and Modifications

Revenue management plans are not fixed, and companies must adapt and adjust to continually optimize their approach. For example, many airlines and hotels increased prices following the COVID-19 pandemic to capitalize on pent-up demand for travel and leisure.

Revenue Management Strategy

There are many tools available to businesses when creating a revenue management strategy. Here are some of the most popular:

Pricing Strategy

The main types of pricing models are:

• Open price. 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.

• Predict the price. Companies using this strategy set prices in advance for dates or periods when they expect demand to increase or decrease, a standard practice for hotels in seasonal resort locations.

• Segmented pricing. Companies set different prices for different types of guests and time periods based on their customers’ willingness to pay. For example, a weekday business traveler will typically pay more for a hotel room than a weekend leisure traveler.

• Period pricing. Also known as length-of-stay pricing, this strategy mandates or encourages longer stays or longer use of services such as car rentals. For example, a hotel might require a three-night minimum stay during busy holiday weekends.

• Competitive pricing. Businesses may match competitors’ prices, differentiate by offering lower prices to attract customers on a budget, or charge higher prices to highlight the quality of their services and amenities.

Inventory control

Inventory is the amount of hotel rooms that have not yet been booked, airplane seats that have not yet been reserved, or cars that have not yet been rented. The right mix of inventory is important to meet the demand of customer segments; for example, economy, economy plus, and business class seats on an airline, or hotel rooms for business and leisure travelers. Companies manage inventory by monitoring capacity, such as the total number of passenger seats on an airplane or the total number of hotel rooms. The goal is to maximize capacity while avoiding overbooking.

Booking Incentives

Companies such as the hotel industry sometimes offer booking incentives, such as “pay now” options that allow customers to receive a discount if they pay in full at the time of booking rather than at the time of use. Airlines, hotels, and other travel industries also often use third-party booking services such as Expedia or Kayak, and typically pay based on the sales price. To encourage customers to book directly and save on third-party costs, suppliers may offer discounts, loyalty rewards, and other booking incentives.

Revenue Management KPIs and Metrics

Industries that practice revenue management focus on a few key business metrics. Key Performance Indicators (KPIs)These include:

Revenue per seat mile

The airline industry uses Passenger Revenue Per Available Seat Mile (PRASM) to measure how much revenue each seat on an airplane generates per mile flown. Airlines compare this to their Cost Per Available Seat Mile (CASM) to measure the total operating profit for a flight.

Utilization rate

Hotels, cruise lines, and car rental companies care about occupancy, expressed as a percentage of capacity used. For example, if a hotel has 85 of 100 rooms booked for a particular period, then the occupancy rate is 85%. In revenue management, we ideally aim for 100% occupancy.

Average accommodation price

Hotels and cruise lines use this metric to track how much a room generates in daily rate revenue. For example, a hotel with 100 rooms might charge a daily rate of $200 for 50 rooms for leisure travelers and $300 for the remaining 50 rooms for business travelers. The average daily rate for the 100 rooms, discounted by the difference between the two rates, is $250. Revenue Per Room (REVPAR) and Revenue Per Room (REVPOR) also include other guest expenses such as room service meals and laundry charges.

Revenue per vehicle

Rental car companies use this to measure how much revenue each vehicle generates. Let’s say a company with 100 vehicles rents out an average of 50 vehicles over a 30 day period, making an average of $100 in revenue per day. Then:

50 x $100 x 30 = $150,000 ($3,000 per rental vehicle)

Because only half of the vehicles were rented that month, the average daily revenue for the entire fleet was only $50. The rental company could increase this number by offering more vehicles for rental. They might also decide to change the mix of vehicles they offer and add more expensive SUVs.

Profit per unit

Every industry must somehow measure the profitability per unit of product or service after costs are subtracted from revenue. Airlines measure average profit per seat, per plane, or per route. Hotels measure average profit per room, and car rentals measure average profit per vehicle.