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Conditions for Revenue Management

Markets where revenue management can be found possess specific features. Let’s review them here in detail.

Producers should have the ability to choose their prices

This is the reason why often we find a single producer or just a few producers of a particular good or service. If producers are limited in number, they will be able to set their own prices. Economists say that they benefit from market power.
Conversely, if there were many producers of an indistinguishable good, the price would be set by the market and no individual producer would be able to have an impact on this price. Producers would have no market power, and no price discrimination or revenue management would be possible. To benefit from market power producers need to differentiate their product enough to create a new market.

For example, Apple, when they introduced the iPhone, created a new market all by itself, and could therefore charge whatever price they thought people were willing to pay.

This type of situation can last for as long as consumers perceive that the product has no valid substitutes in the market. So, fewer producers implies that they have pricing power in the market and, therefore, the ability to implement price discrimination.

The product should be perishable

Not all markets where there are a limited number of producers can use revenue management.
Let’s consider the good or service itself. It is usually perishable. If it isn’t sold, it cannot be stored and is wasted. In other word, it has a consumption date.
Think about a plane ticket, for example: if it isn’t sold before the flight takes off, its value drops to zero, because what you are buying is not the seat on the aircraft, but the usage of that seat on a particular flight on a particular date. The same applies to a hotel room (or a berth at a camp site). The room itself doesn’t disappear if it isn’t used, but the usage of the room on a particular date has a clear time constraint. Again, the transaction is for the use of the room at a specific date, not the room itself.

In Apple’s case, if products are not sold in one particular period of time, they can be stored and sold the following day, week or month. Conversely, if demand is too high at any given time, people might be willing to wait in order to obtain the product.

It is somewhat easier to adapt supply to demand by having fewer temporal constraints. In the case of perishable products, the time of production has to match the time of consumption. This is somewhat more constraining for the producer, but might constitute an advantage, if demand is high enough. After all, what is in short supply has a high value!

The capacity should be limited

Time constraints would have no importance if capacity were unlimited, but this is usually not the case. All producers face some capacity limits unless they are producing much more than they are selling, which is also not a good situation for them. Capacity limits mean that the producer or the producers cannot increase production above a certain level at any given time.

Airlines or the hotel industry are good examples, but so is a hair salon, where there is a limited space or number of employees at any given time.

To sum up

It is the combination of the previous three features that makes revenue management possible in some markets:

  • a limited number of producers,
  • producing a perishable good or providing a perishable service,
  • with strong capacity limits.

Of course, even in some markets that share those features, revenue management could be impossible because of price regulations.

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This article is from the free online course:

Manage Your Prices: an Introduction to Pricing Strategy and Revenue Management

École Nationale de l'Aviation Civile

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