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Date
28 May 2014

Callable bookings: the future of revenue management?

In recent years, the implementation of revenue management practices to sell fixed capacity, perishable products has become widespread across many industries including the airline, hotel and car rental sectors. Being used to maximise revenue from a fixed level of capacity, revenue management is the art and science of varying price depending on the level of demand and price sensitivity of consumers. However, the commonly implemented revenue strategy of varying the price charged depending on the time of booking has been suggested as hindering revenue maximisation. Therefore, American academics have introduced the concept of “callable” products.

It is assumed that those bookings made closer to the time of consumption are less price sensitive due to a greater sense of urgency or lack of flexibility. A premium price is therefore able to be charged; dividing bookings into two distinct categories - discounted prices for those booking early and higher prices for those booking nearer to the time of consumption. However, when a limit is set for the number of bookings taken for each price category, revenue can be lost in two circumstances - when there is a higher-than-expected level of demand for later bookings, resulting in lower-priced bookings displacing higher-priced bookings (cannibalisation); or when capacity reserved for higher-value bookings is left spare and could have been sold to lower-value customers (spoilage).

As introduced by Gallego, Kou and Phillips in 2008, and more recently considered by Calder in 2014, “callable” products could be used to effectively hedge against this problem of uncertain levels of high-value demand. A callable product is a low-price booking sold to a consumer who willingly grants permission for the supplier to “call” the booking should they be able to obtain a higher price for it at some point in the future. Both parties voluntarily buy into the booking and both will gain if it is called - consumers will receive a refund plus additional compensation, and the company can re-sell the booking at a higher price. If a higher price is not able to be earned, the original booking remains. Therefore, callable products are considered to be a risk-free source of additional revenue.

Although this notion of callable products is not yet implemented by companies, other practices are used to hedge against high-value demand uncertainty, including overbooking - where a greater volume of rooms or seats are sold than are available in speculation that some consumers will not show; and stand-by bookings - which are sold to consumers at a deep-discount and will only be consumed if there is spare capacity. However, whereas these practices place a certain amount of responsibility on companies to provide an alternative to the consumer should all bookings turn up, callable products do not and instead just simply free up capacity. Consequently, callable products are believed to be more beneficial to suppliers.

Nevertheless, despite previous suggestion, callable products are not a completely riskless form of revenue management. Calls would have to be issued at a certain time before service consumption. Therefore, additional last-minute bookings after this cut-off point are not accommodated for, representing a potential loss of further high-value bookings. Also, some bookings may be called and the refund and compensation paid, but some customers may not have been going to show anyway. This again represents a loss of revenue, as the company would have bought-back capacity that was already spare.

With the overriding purpose of callable products, as well as revenue management in general, being to increase revenue from a finite supply of perishable products, it is important that the potential revenue gains from the implementation of revenue strategies outweigh the costs incurred. Involving complicated calculations and forecasts, callable products would require sophisticated technology and strict policies, both of which represent a significant cost to suppliers. However, with rate strategy becoming increasingly fierce and competitive, is it just a matter of time before this proposal of callable revenue management becomes a reality?

It must also be noted that with strategies tending to focus on the relationship between pricing and consumer demand, the important relationship between pricing and profitability is often overlooked. With profitability affecting the financial position of a company, including its cash balance and also liquidity, the impact of revenue management strategies extends well beyond the generation of total revenue. Therefore, it is important that the relationship between revenue management and the whole of the finance function is understood. Revenue managers must consider not only the short-term effect on revenue generation, but also the long-term impact on wider financial results.

Designed for individuals working in revenue management, arena4finance’s course in Finance for Revenue Managers addresses this interrelationship, and aims to improve understanding of financial accounting in the hospitality industry. Covering the profit and loss account, pricing strategies and key performance indicators, individuals learn of the impact that revenue management strategies have on a company’s bottom line and the wider effect that they have on financial performance.

For further information on the Finance for Revenue Managers course, please visit the dedicated webpage here or contact arena4finance at hello@arena4finance.co.uk.