Imagine yourself as an airline owner who owns a plane with 100 seats, on a typical weekend flight you manage to find 60 customers willing to pay $500/seat. This is great, but what about those other 40 seats, as soon as the plane takes off those seats are worthless. What if instead of charging customers $500 for those remaining 40 seats we only charged them $300 ? - we could fly with a full plane !
So for a couple of months you try this and it works great, but then suddenly the number of customers buying the $500 seats drops dramatically. So you set off to speak to your customers and find out why, and they all come back with the same response: "we'd rather wait a while and get the $300 seats". By selling some of the seats at discount you've ended up devaluing all your seats. What's a poor airline owner to do ?
Welcome to Yield Management
Yield Management is the task of figuring out how to dynamically price a perishable resource (anything from fresh fruit to hotel rooms) without your discounted sales destroying your premium sales.
To quote Wikipedia:
There are three essential conditions for yield management to be applicable:
- That there is a fixed amount of resources available for sale.
- That the resources sold are perishable. This means that there is a time limit to selling the resources, after which they cease to be of value.
- That different customers are willing to pay a different price for using the same amount of resources.
Who uses it
Let's look at some industries that have sophisticated yield management systems:
- Car Rental
- Online Advertising
In every one of these cases sophisticated yield management techniques have resulted in billions of dollars of additional revenue. Figuring out how to sell off excess capacity at discount without damaging your main sales is a huge business opportunity, and one which is barely exploited in most industries.
Before we look at industries where it could be used, let's have a look at how the four industries above do it so we get an idea of how we could adapt the techniques.
Airlines and Car Rentals have both taken similar approaches in becoming real-time pricing industries, with prices constantly changing, making it almost impossible for consumers to know if a price will increase or decrease. Price confusion works. Faced with uncertainty people are willing to pay the price offered rather than wait for a better price, people don't want to take a chance on the price dropping if it could also rise. There are however very few other industries where this technique would be accepted so let's have a look at the other models.
Online advertising typically takes a dual sales route, direct, where most major sites will have a sales team which tries to sell their premium ad-space, and brokered, where the left over "remaindered" ad-space is sold via ad brokers who resell it pseudo-anonymously. One example might be a site using Google Adsense for their remaindered ad-space, the buyers have no idea which site their ads will be featured on so there's no risk in the premium ad-buyers going that route. One of the key advantages of this approach is that the site keep selling the premium ad-space up-to the very last second, until a page is actually served when a brokered ad inserted instead of an empty premium ad slot. This means that unlike the other industries listed here, sites don't have to be able to predict in advance how much spare capacity they'll have.
Hotels have one the most interesting solutions, a few years ago Priceline came up with the idea of selling hotel rooms anonymously in a similar way to what's done with online advertising. Called "Name Your Own Price" it let customers specify a criteria for a hotel (4* in Manhattan) and a price, if it could find a hotel which matched the room would be booked (you commit to the purchase before finding out which hotel it is). By taking this approach hotels could discount their empty rooms without devaluing the rest of their rooms.
Who should use it
Let's take a look at some industries that don't regularly practice yield management but could benefit from using it to monetize underused capacity/resources:
- Gigs / Music concerts
- Sports events
- Theme parks
- Fast food/lunch shops
- Sporting facilities (gyms, tennis courts, golf courses, etc)
- Equipment rental (music, sports, tools, etc.)
- Venue hire
- Band hire
- Services (Personal tutors, photographers, etc.)
A successful yield management system for any of these would easily be worth millions. However one of the reasons that they haven't adopted these techniques is they can't afford to invest in building models to predict future demand like airlines and hotels can. So a last-minute approach in a similar style to online advertising is critical.
So what would we need if we wanted to achieve the same results without being able to predict demand in advance ? - well there are two key building blocks that would allow us to build our new funky low-cost yield management system:
- Ability to target customer individually based on market segmentation. Customers get annoyed if different people see different prices. However customers (for whatever irrational reason) are unfazed at other people getting discount vouchers. The ability to push out a "voucher" to an individual is extremely valuable.
- Ability to wait until the last possible moment to offer discounts. Holding off as long as possible encourages people who already want to make a purchase to make it otherwise if they wait they risk losing out and not getting what they want. Plus the supplier gets to know exactly what their excess capacity is when discounting.
Historically achieving these two has been tricky, individual targeting is expensive and when holding off you end up with a lead time of a few days in practice (to allow time for people to see the offer, book and get to the location) which isn't late enough to avoid interfering with premium customer purchases.
In an ideal world imagine a scenario where a theatre realizes it's only 75% full an hour before a show starts. What if they could push out an offer to all students within a one mile radius offering tickets at 70% off and make immediate sales to anyone interested ?
Until recently such a concept wouldn't be practical, but with the convergence of smart-phones, social networks and pushed real-time data suddenly it's become almost trivial. Innovative just-in-time yield management pricing has become feasible for even small businesses. Something along similar lines would work for almost every one of the industries listed.
If you think the combination of these three (mobile, social and real-time) sounds familiar, it's what Fred Wilson describes as The Golden Triangle. And right bang in the middle of the triangle sits the gold mine of yield management. A huge opportunity for start-ups to ride the three megatrends of today and still be profitable from day one.