Yield management

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YM is a management tool or technique that is currently being utilized by an increasing number of group and independently owned hotels in order to maximize the effective use of their available capacity and ensure financial success. YM is not an entirely new innovation and most hoteliers practice some form of YM such as the adjusting of room rates to temper fluctuations between peak and off peak seasons, mid week and weekend rates. This chapter, therefore, examines the use and application of YM in the hotel industry and hopes to demonstrate its ability to effectively maximize revenue and profit generation in this highly competitive and capital intensive industry.

Historical development of YM from airlines to hotels

The airline industry has been credited with the development and refinement of YM following deregulation of the US airline industry in the late 1970s. The resulting heavy competition led to a price cutting war with some airlines going out of business. Kimes (1997) cites the example of People’s Express, which emerged briefly as a low price, no frills airline. In response large carriers, such as American and United, began to offer a small number of seats at even lower fares whilst maintaining the higher priced fares on the remainder of the seats. This strategy allowed American and United to attract the price sensitive customers and still retain their high paying passengers. As a result, People’s Express went into bankruptcy. Consequently, YM was introduced as a method of utilizing capacity and maximizing revenue or ‘yield’ where airline companies sought to fill their planes with the optimum mix of passengers.

In similar highly competitive circumstances, YM began to be adopted in the hotel industry around the middle of the 1980s. At this time the industry was being confronted with excess capacity, severe short term liquidity problems and increasing business failure rates. Major hotel chains, such as Hyatt, Marriott, Quality Inn, and Radisson, endeavored to redress these difficulties by adopting YM. Opportunities for applying YM in small to medium sized hotels are actively being developed following the report for the European Union (Arthur, 1996).

Definition

In general terms, Kimes (1997) has described YM as the process of allocating the right type of capacity or inventory unit to the right type of customer at the right price so as to maximize revenue or ‘yield’. Applying this to airlines, YM can be considered to be the revenue or yield per passenger mile, with yield being a function of both the price the airline charges for differentiated service options (pricing) and the number of seats sold at each price (seat inventory control). Larsen (1988) further crystallizes the meaning of YM in the airline contest by dividing it into two distinct functions: overbooking and managing discounts.

In hotels, YM is concerned with the market sensitive pricing of fixed room capacity relative to a hotel’s specific market segments. Kimes (1997) states therefore that YM in hotels consists of two functions: rooms inventory management and pricing. The goal of YM is the formulation and profitable alignment of price, product, and buyer. As such, Donaghy, McMahon and McDowell (1995:140) define YM in hotels as a ‘revenue maximization technique which aims to increase net yield through the predicted allocation of available bedroom capacity to predetermined market segments at optimum price.’ It is the predicted nature of YM that is the key to its ongoing successful financial management of hotels in today’s increasingly competitive market. On a strategic level, Jones and Kewin (1997) have extended the definition of YM as ‘a decision making tool based on an analysis of past performance and forecast of future demand that enables the goal of revenue maximization to be achieved through the strategic management of a hotel’s market positioning and the operational management of the hotel’s room sales.’ This definition further highlights the differentiation between the strategic and tactical role that yield management plays in managing capacity.

Preconditions and ingredients of YM

YM suits the hotel industry where capacity is fixed, where the demand is unstable, and where the market can be segmented (Kimes, 1997). As with many service organizations, a feature of hotels is that they have low marginal costs and usually sell their perishable product to their customers well in advance of consumption. Developing these ideas further, Kimes (1997) has out lined a number of preconditions for the success of YM and suggested a number of factors or ingredients that are prerequisites for the implementation of YM as a functioning, workable system.

Preconditions

Fixed capacity

Hotels tend to be capacity constrained with no opportunity to inventory their products or goods. Simply put, many hotel services and products are perishable. Capacity can be changed by, for example, adding a number of new bedrooms or a new function suite but this usually involves a large financial investment in terms of equipment and plant.

High fixed costs

The industry is characterized by high fixed costs and, as explained above, the cost of adding incremental capacity can be very high and is not quickly adjusted. Adding new bedrooms to a hotel not only entails a large capital outlay but may also involve a long planning and construction period.

Low variable costs

The costs incurred by, for example, selling a bedroom to a customer in otherwise unused capacity is relatively inexpensive and incurs only minor servicing costs.

Time-varied demand

Since hotel capacity is fixed, organizations cannot easily adjust their capacity to meet peaks and troughs in demand. Kimes (1997) explains that when demand varies, hotels can benefit from controlling capacity when demand is high and relaxing that control when demand is low. As with airlines, utilization of reservation systems can assist in managing demand since they log requests for rooms in advance.

Similarity of inventory units

As a general rule, YM systems operate in a situation where inventory units are similar. However, it should be noted that service firms like hotels can differentiate their units by, for example, offering add on luxury features or the possibility of upgrades.

Ingredients

Market segmentation

Hotels normally have the ability to divide their customer base into distinct market segments such as leisure, business, and long and short stay. Business or corporate clients who are usually time sensitive are willing to pay higher rates whilst leisure travelers who tend to book longer in advance are price sensitive.

Historical demand and booking patterns

Detailed knowledge of a hotel’s sales and booking data per market segment should help managers predict peaks and troughs in demand and assist the hotelier in more effectively aligning demand with supply.

Pricing knowledge

Kimes (1997) describes YM as a form of price discrimination. In practice, hotels operate YM systems that depend on opening and closing rate bands. In order to stimulate demand in periods of low demand, hotels can offer dis counted prices whilst during periods of high demand low rates can be closed off. Additionally, by offering a number of rates in the hotel the manager will, ideally, profitably align price, product, and buyer and increase net yield.

Overbooking policy

Overbooking is an essential YM technique. Over booking levels are not set by chance but are determined by a detailed analysis of what has happened in the past and a prediction of what is likely to happen in the future. Predicted no shows, cancellations, denials all form part of a complex calculation carried out in advance. In this way the risk of disappointing a customer who has booked in advance is minimized.

Information systems

Effective management information is essential for successful YM whether the hotelier is operating a manual or computerized system. However, information technology can assist greatly in the sorting and manipulation of required data. The use of Artificial Intelligence (AI) has enormous potential for handling the complexities of YM because of its abilities in complex problem solving, reasoning, perception, planning, and analysis of extensive data (Russell and Johns, 1997). Expert Systems (ES) are ‘knowledge based’ software packages that reflect the expertise in the area of the application and these types of systems have extensive capacity in dealing with non numeric, qualitative data.

Measuring yield

Traditional methods of performance measurement in hotels, such as occupancy rate and average room rate, have tended to focus on the volume or value aspects of accommodation sales. However, high occupancy rates are no indication of financial success since the rate per room charged to the customer may be a highly dis counted rate well below the rack rate. While the average room rate gives an indication of the level of revenue generated per sold room, it gives no indication of the actual number of rooms sold. Indeed, as the hotelier increases one he/she tends to decrease the other. Furthermore, where room night productivity becomes a valuation technique for sales and reservation staff, lower paying group business will increase while higher paying transient business is turned away (Orkin, 1988; Jones and Hamilton, 1992). YM, on the other hand, aims to optimize both occupancy and average room rate simultaneously and this can easily be seen in Orkin’s (1988) Yield Efficiency Statistic:

Yield management decision variables

Yeoman & Watson (1997) identify the variables that hotel managers use to make YM decisions. These variables are based upon the principles of forecasting, systems, procedures, strategies, and tactics.

Forecasting

Forecasting is the foundation of yield management. This forecasting must be done on a daily basis, with 30 day, 60 day, 180 day, and 365 day projections. A continuous examination of demand and supply variables is required in order to take effective YM decisions. The factors that may affect demand and supply include past business forecasts, sales mix, special events, weather, and competitor’s behavior.

Systems & procedures

A computerized system manages all the variable decisions in order to recommend appropriate pricing decisions. Appropriate systems and procedures enable the hotel manager to store, track, and make appropriate decisions.

Strategies and tactics

Decisions are made in relation to pricing policy and market demand. Therefore on high demand days, management concentrates on decisions regarding average room rate. This will involve restricting access to accommodation from groups and low spending customers. Whereas on low demand days, management is concerned with market mix in order to maximize occupancy. In both scenarios, hotel management will have to design a policy that relates to overbooking. Overbooking occurs when customers cancel accommodation, checkout early or don’t show up on the day of arrival. As accommodation can only be sold once in the hotel industry, the hotel manager needs to set a level, i.e., a number of rooms, at which they are prepared to overbook. This level will depend on the forecast for the given period, anticipated no shows, cancellations, and early checkouts.

Conclusions

Yield management offers hotels an opportunity for a focused methodology for improving revenue that integrates the characteristics of the hotel industry. The hotel sector is both distinct and diverse in the characteristics of the unit of inventory compared to the manufacturing sector. The benefits of YM have been drawn from the airline industry but tailored to suit the hotels. Many hotels are facing financial pressures, that is, focusing hotel manager to come up with imaginative and new ways of managing accommodation. YM provides that edge as a means of helping the hotel manager to take decisions on how much accommodation to sell, to which customer, and at what price.

References

Arthur, A. (1996). Yield management in small to medium sized enterprises in the tourism industry. European Commission, DGXXIII, Tourism Unit. Frankfurt am Main.

Andersen, A. (1996). Yield management in small and medium-sized enterprises in the tourist industry. European Commission, DGXXXIII, Tourism Unit. Brussels.

Donaghy, K., McMahon, U., & McDowell, D. (1995). Yield management an overview. International Journal of Hospitality Management, 14(2), 139 150.

Donaghy, K., McMahon Beattie, U., & McDowell (1997b). Implementing yield management: lessons from the hotel sector. International Journal of Contemporary Hospitality Management, 9(2 3), 50 54.

Jones, P., & Hamilton, D. (1992). Yield management: putting people in the big picture. Cornell Hotel and Restaurant Administration Quarterly, 33(1), 88 95.

Jones P., & Kewin, E. (1997). Yield management in UK hotels: principles and practice, Paper presented at 2nd International Yield Management Conference, University of Bath, 9 11 September, England.

Kimes, S. E. (1997). Yield management: an over view. In I. Yeoman & A. Ingold (Eds.), Yield management: strategies for the service industries. London (UK): Cassell.

Larsen, T. D. (1988). Yield management and your passengers. Asta Agency Management. pp. 46 48 June.

Orkin, E. B. (1988). Boosting our bottom line with yield management. Cornell Hotel and Restaurant Administration Quarterly, 28(4), 52 56.

Russell, K. A., & Johns, M. (1997). Computerized yield management systems: lessons learned from the airline industry. In I. Yeoman & A. Ingold (Eds.), Yield management: strategies for the service industries. London (UK): Cassell.

Yeoman, I., & Watson, S. (1997). Yield management: a human activity system. International Journal of Contemporary Hospitality Management, 9(2), 80 83.

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