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Lesson 5Lesson 5Lesson 5Lesson 5

Managing Supply Capacity and Demand Managing Supply Capacity and Demand in Servicesin Services

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Production and Operations Management - 5.2

Demand ManagementDemand Management Supply Management Supply Management Yield Management ProcessYield Management Process

OverviewOverviewOverviewOverview

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Readings:Readings: W.Earl Sasser: Match Supply and Demand in W.Earl Sasser: Match Supply and Demand in

Service IndustriesService Industries Case:Case:

River City National BankRiver City National Bank Homeworks:Homeworks:

Problems: see attached pageProblems: see attached page Discussion QuestionsDiscussion Questions

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Discussion QuestionsDiscussion QuestionsDiscussion QuestionsDiscussion Questions

1. It has been suggested that the price of 1. It has been suggested that the price of airline tickets should be variable,with the airline tickets should be variable,with the cost becoming higher as the time of cost becoming higher as the time of departure approaches. Comment.departure approaches. Comment.

2. What organizational problems can arise 2. What organizational problems can arise from the use of part-time employees?from the use of part-time employees?

3. Illustrate how a particular service has 3. Illustrate how a particular service has implemented successful strategies for implemented successful strategies for managing both demand and supply.managing both demand and supply.

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After completing this chapter, you should be able to:After completing this chapter, you should be able to:

- describe the strategies for matching supply and - describe the strategies for matching supply and demand for servicesdemand for services

- determine the overbooking strategy for a service - determine the overbooking strategy for a service that minimizes expected lossthat minimizes expected loss

- explain major concepts of yield management - explain major concepts of yield management approachapproach

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

Maximum availableMaximum availablecapacitycapacity

Optimum capacity Optimum capacity utilization (demand utilization (demand and supply are well and supply are well

balancedbalanced

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Cyclical variations in demand relative to capacityCyclical variations in demand relative to capacityCyclical variations in demand relative to capacityCyclical variations in demand relative to capacity

At any given time, a service organization may be At any given time, a service organization may be faced with one of the four situations:faced with one of the four situations: Excess demand: demand exceeds Excess demand: demand exceeds

maximum available capacity , some maximum available capacity , some customers are denied and business is lostcustomers are denied and business is lost

Demand exceeds the optimum Demand exceeds the optimum capacity: no one is turned away, but all capacity: no one is turned away, but all customers likely to perceive a deterioration in customers likely to perceive a deterioration in service qualityservice quality

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Cyclical variations in demand relative to Cyclical variations in demand relative to capacitycapacity

Cyclical variations in demand relative to Cyclical variations in demand relative to capacitycapacity

Demand and capacity are balancedDemand and capacity are balanced Excess capacity: demand is below optimum Excess capacity: demand is below optimum

capacity and productive resources ar under-capacity and productive resources ar under-utilized, customers may have doubts about utilized, customers may have doubts about the viability of the servicethe viability of the service

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Cyclical variations in demand relative to capacityCyclical variations in demand relative to capacityCyclical variations in demand relative to capacityCyclical variations in demand relative to capacity

The inherent variability of demand creates a The inherent variability of demand creates a challenge for managers trying to make the best challenge for managers trying to make the best use of service capacity. The problem can be use of service capacity. The problem can be approached from two perspectives:approached from two perspectives: One strategy focuses on smoothing demand One strategy focuses on smoothing demand

which permits fuller utilization of a fixed which permits fuller utilization of a fixed service capacity. service capacity.

Another strategy considers the problem from Another strategy considers the problem from the supply side with alternatives to adjust the supply side with alternatives to adjust service capacity to match demand. service capacity to match demand.

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Demand ManagementDemand ManagementDemand ManagementDemand Management

Excessive fluctuations in demand for service need Excessive fluctuations in demand for service need not be accepted as inevitable. Service system can not be accepted as inevitable. Service system can smooth demand by using both active and passive smooth demand by using both active and passive measures: measures:

Partitioning DemandPartitioning Demand Offering Price IncentivesOffering Price Incentives Promoting off-peak demandPromoting off-peak demand Developing complementary servicesDeveloping complementary services QueuingQueuing Using reservation system and handling Using reservation system and handling

overbooking problemoverbooking problem

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Partitioning DemandPartitioning DemandPartitioning DemandPartitioning Demand

Demand for a service can be grouped into Demand for a service can be grouped into

random arrivals and planned arrivals. random arrivals and planned arrivals. Example: A health clinic has walk-in patients Example: A health clinic has walk-in patients

and patients having appointments. While and patients having appointments. While walk-in demand is uncontrollable, walk-in demand is uncontrollable, appointments are controllable. appointments are controllable.

Possibility to smooth demand : Make Possibility to smooth demand : Make appointments in the periods of low demandappointments in the periods of low demand

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Pricing and promotionPricing and promotionPricing and promotionPricing and promotion

Shifting demand from peak periods to off-peak Shifting demand from peak periods to off-peak periods using pricing differentials, advertising, periods using pricing differentials, advertising, display, etc. display, etc. Examples of differential pricing: weekend and Examples of differential pricing: weekend and

night rates for over-sea calls, off-season night rates for over-sea calls, off-season hotel rates at resort locations, peak-load hotel rates at resort locations, peak-load pricing by electricity companies.pricing by electricity companies.

Additional benefits: tap a latent demand, thus Additional benefits: tap a latent demand, thus differential pricing fills in the valleys instead of differential pricing fills in the valleys instead of re-distributing peak demand to off-peak times. re-distributing peak demand to off-peak times.

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Developing complementary servicesDeveloping complementary servicesDeveloping complementary servicesDeveloping complementary services

Adding complementary services in order toAdding complementary services in order to occupy waiting customersoccupy waiting customers expand the market expand the market achieve more uniform aggregate demandachieve more uniform aggregate demand

Example: video game in lobbies of movie Example: video game in lobbies of movie theaters, a bar in restaurant’s lounge.theaters, a bar in restaurant’s lounge.

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QueuingQueuingQueuingQueuing

The focus should be on:The focus should be on: The maximum of time that customers would The maximum of time that customers would

waitwait How to make this time pass quickly and How to make this time pass quickly and

pleasantly.pleasantly. Policy to select next customer from the queue Policy to select next customer from the queue

- referred to as Queue Discipline- referred to as Queue Discipline

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Inventory and waiting line analogy

Feature Inventory Waiting LineCosts Opportunity cost of

capitalOpportunity cost oftime

Space Warehouse Waiting areaQuality Poor quality hidden Negative impressionDecoupling Promotes

independence ofproduction stages

Allows division oflabours andspecialization

Uitilization Work in process keepsmachine busy

Waiting customerskeep servers busy

Coordination Detailed schedule notnecessary

Avoid matching supplyand demand

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Using reservation systems Using reservation systems Using reservation systems Using reservation systems

A reservation is supposed to guarantee that the A reservation is supposed to guarantee that the service will be available when the customer service will be available when the customer wants it while avoiding the need for queuing.wants it while avoiding the need for queuing.

Taking reservations serves to presell the Taking reservations serves to presell the service. service.

To cope with no-shows the strategy of To cope with no-shows the strategy of overbooking is adopted: accepting reservation overbooking is adopted: accepting reservation for more than the available service supply for more than the available service supply (seats, rooms). (seats, rooms).

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Using reservation systems Using reservation systems Using reservation systems Using reservation systems

However, firms risk turning away customers with However, firms risk turning away customers with reservation if they overbook too many. reservation if they overbook too many.

A good overbooking strategy should minimize A good overbooking strategy should minimize the expected opportunity cost (cost Cu ) of idle the expected opportunity cost (cost Cu ) of idle service capacity and the expected cost of service capacity and the expected cost of turning away reservations (cost Co ). turning away reservations (cost Co ).

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Supply ManagementSupply ManagementSupply ManagementSupply Management

Using Work-shift SchedulingUsing Work-shift Scheduling Increasing customer participationIncreasing customer participation Creating adjustable capacityCreating adjustable capacity Cross-training employeesCross-training employees Using part-time employeesUsing part-time employees

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Using Work-shift SchedulingUsing Work-shift SchedulingUsing Work-shift SchedulingUsing Work-shift Scheduling

Scheduling workshifts carefully so that the profile of Scheduling workshifts carefully so that the profile of service supply can be made to approximate demand service supply can be made to approximate demand (demand chasing). (demand chasing).

Example: Daily workshift schedulingExample: Daily workshift scheduling forecast of demand by hour, forecast of demand by hour, convert forecasted demand to hourly service convert forecasted demand to hourly service

staffing requirements, staffing requirements, develop schedule of tours or shifts to match the develop schedule of tours or shifts to match the

staffing requirements as closely as possible, staffing requirements as closely as possible, assign specific service personnel to tours or assign specific service personnel to tours or

shifts. shifts.

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Daily Demand for telephone operatorsDaily Demand for telephone operatorsExample: Schedule daily shifts to chase demandExample: Schedule daily shifts to chase demand

Daily Demand for telephone operatorsDaily Demand for telephone operatorsExample: Schedule daily shifts to chase demandExample: Schedule daily shifts to chase demand

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Schedule daily shifts to chase demandSchedule daily shifts to chase demandSchedule daily shifts to chase demandSchedule daily shifts to chase demand

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Increasing customer participationIncreasing customer participationIncreasing customer participationIncreasing customer participation

The customer will act as co-producer provides The customer will act as co-producer provides the labour just at the moment it is required. the labour just at the moment it is required. Examples: fast food restaurants, self-service Examples: fast food restaurants, self-service

gas stations.gas stations. The draw-backs: the quality of labour is not The draw-backs: the quality of labour is not

completely under the manager’s controlcompletely under the manager’s control

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Creating adjustable capacityCreating adjustable capacityCreating adjustable capacityCreating adjustable capacity

Through design, a portion of capacity can be Through design, a portion of capacity can be made variable. made variable. Example: partition between first class and Example: partition between first class and

economy can be moved to meet the changing economy can be moved to meet the changing mix of passengersmix of passengers

Adding more equipments at busy times (seats, Adding more equipments at busy times (seats, tables)tables)

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Creating adjustable capacityCreating adjustable capacityCreating adjustable capacityCreating adjustable capacity

Capacity at peak time can be expanded by the Capacity at peak time can be expanded by the effective use of slack timeseffective use of slack times Performing supportive tasks during slow Performing supportive tasks during slow

periods of demand allows employees to periods of demand allows employees to concentrate on essential tasks during rush concentrate on essential tasks during rush hours hours

Example: servers in restaurants wrap Example: servers in restaurants wrap silverware in napkins when demand is lowsilverware in napkins when demand is low

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Cross-training employeesCross-training employeesCross-training employeesCross-training employees

Some service systems are made up of several Some service systems are made up of several operations. Sometimes when one operation is operations. Sometimes when one operation is busy, another operation may be idle. Cross-busy, another operation may be idle. Cross-training employees to perform tasks in several training employees to perform tasks in several operations creates flexible capacity to meet operations creates flexible capacity to meet localized peaks in demand. localized peaks in demand.

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Using part-time employeesUsing part-time employeesUsing part-time employeesUsing part-time employees

When peaks of activity are persistent and When peaks of activity are persistent and predictable, part-time help can supplement predictable, part-time help can supplement regular employees. regular employees.

Suitable for jobs requiring low- moderate skills Suitable for jobs requiring low- moderate skills

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Yield ManagementYield Management(Perishable Asset Revenue Management-PARM)(Perishable Asset Revenue Management-PARM)

Yield ManagementYield Management(Perishable Asset Revenue Management-PARM)(Perishable Asset Revenue Management-PARM)

Yield management is the process of allocating the Yield management is the process of allocating the right type of service capacity to the right customer at right type of service capacity to the right customer at the right price so as to maximize revenue (yield).the right price so as to maximize revenue (yield).

Yield management is a mixed strategy which Yield management is a mixed strategy which integrates both supply and demand management integrates both supply and demand management options such as reservation systems, overbooking options such as reservation systems, overbooking and partitioning demand.and partitioning demand.

History:History: Late 1970’s:Late 1970’s:AirlinesAirlines Late 1980’s:Late 1980’s:HotelsHotels 1990’s1990’s : : Car rental, utilities and otherCar rental, utilities and other

service service

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Major componentsMajor componentsMajor componentsMajor components

Demand forecasting and market segmentationDemand forecasting and market segmentation Reservation system and overbooking policyReservation system and overbooking policy Appropriate pricing policy and procedures for Appropriate pricing policy and procedures for

different market segments and demand periodsdifferent market segments and demand periods

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Market SegmentationMarket SegmentationMarket SegmentationMarket Segmentation

Example: airline market segmentationExample: airline market segmentation Business travellers:Business travellers:

Short trips with multiple destinations in one Short trips with multiple destinations in one triptrip

Want to get home for the weekendWant to get home for the weekend Many changes in travel plans - last minute Many changes in travel plans - last minute

bookingbooking Willing to pay full fare / business classWilling to pay full fare / business class

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Market SegmentationMarket SegmentationMarket SegmentationMarket Segmentation

Leisure TravelersLeisure Travelers Long trips, with families but fewer destinationsLong trips, with families but fewer destinations Stay over weekendStay over weekend TravelTravel planned far in advance with rare planned far in advance with rare

changeschanges Price sensitivePrice sensitive

Group ToursGroup Tours Early reservationEarly reservation Very price sensitive with large bargaining Very price sensitive with large bargaining

powerpower

Hotel Market Segmentation

20.70% 15.50%

21.70%

12.50%

15.20%

24.50%

13%

19.80% 16%

5.10%5.20%

5.30%6.50%

7.10%

6.80%4.10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Occupancy Revenue

Others

Frequent Trav.

Full Rates

Corporate

Airline Crew

Corporate

Convention

Group Tours

Indi

vidu

Gro

up

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Yield Management PricingYield Management PricingYield Management PricingYield Management Pricing

Basic principlesBasic principles Different rates for different market segmentsDifferent rates for different market segments Differentiation is created by adding different Differentiation is created by adding different

restrictions to discountsrestrictions to discounts Types of Restriction used Types of Restriction used

Advance reservationAdvance reservation Advance purchaseAdvance purchase Advance requirement (length)Advance requirement (length)

3days/ 1-2-3 weeks / 1 month 3days/ 1-2-3 weeks / 1 month

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Yield Management PricingYield Management PricingYield Management PricingYield Management Pricing

RefundabilityRefundability None / Percentage / FullNone / Percentage / Full

Changes allowedChanges allowed None / Date only / UnlimitedNone / Date only / Unlimited

Required time of stayRequired time of stay Weekday / WeekendWeekday / Weekend

Required duration of stayRequired duration of stay

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Yield = Revenue realized

Potential Revenue 100%

Rooms Rack Rate Sold At rateStandard 400 $ 75 200

100$60$75

Suite 20 $ 200 510

$150$200

Yield CalculationsYield CalculationsYield CalculationsYield Calculations

ExampleExample

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Yield CalculationsYield CalculationsYield CalculationsYield Calculations

Potential Revenue = 400 (75) + 20 (200) Potential Revenue = 400 (75) + 20 (200) = $34,000 = $34,000

Revenue realized = 200 (60) + 100 (75) + 5 Revenue realized = 200 (60) + 100 (75) + 5 (150) + 10 (200)= $ 22, 250 (150) + 10 (200)= $ 22, 250

Yield = 65.44 %Yield = 65.44 %

Note: Occupancy rate = 75%Note: Occupancy rate = 75%

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P (d < x) C

C + Cu

u o

Yield Management techniqueYield Management techniqueYield Management techniqueYield Management technique

Yield management problem can be analyzed Yield management problem can be analyzed with the critical fractile model:with the critical fractile model:

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Where Where x = the number of rooms overbookedx = the number of rooms overbooked d = the number of no-shows based on past d = the number of no-shows based on past

experience experience Co = the loss associated with not having a Co = the loss associated with not having a

room room available for an overbooked guest available for an overbooked guest

Cu = the loss when a reservation is not Cu = the loss when a reservation is not honoured honoured

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uo C x)(d P C x)< (d P

uo C x)(d P -1 C x)< (d P


Overbook up to x th room if the expected cost of Overbook up to x th room if the expected cost of overbooking still less than or approximate to the overbooking still less than or approximate to the expected cost of vacant room due to no- show expected cost of vacant room due to no- show guest guest

oror

The number of rooms overbooked should just The number of rooms overbooked should just cover the cumulative probability of no-shows cover the cumulative probability of no-shows calculated in the above equation and no morecalculated in the above equation and no more

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Example: Surfside HotelExample: Surfside HotelExample: Surfside HotelExample: Surfside Hotel

During the past tourist season, Surfside hotel did During the past tourist season, Surfside hotel did not achieve very high occupancy in spite of a not achieve very high occupancy in spite of a reservation system designed to keep the hotel reservation system designed to keep the hotel fully booked. Prospective guests apparently fully booked. Prospective guests apparently were making reservations that, for one reason or were making reservations that, for one reason or another, they failed to honour.another, they failed to honour.

The front desk records of no-shows during the The front desk records of no-shows during the current peak period, when the hotel was fully current peak period, when the hotel was fully booked is given as followsbooked is given as follows

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No-showsd

ProbabilityP (d)

P (d<x)

0 .07 01 .19 .072 .22 .263 .16 .484 .12 .645 .10 .766 .07 .867 .04 .938 .02 .979 .01 .99


Surfside Hotel No-shows ExperienceSurfside Hotel No-shows Experience

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A room that remains vacant owning to a no-A room that remains vacant owning to a no-show results in a loss of $40. In order to avoid show results in a loss of $40. In order to avoid some of this loss, management is considering an some of this loss, management is considering an overbooking policy. However, if a guest holding overbooking policy. However, if a guest holding a reservation is turned away owing to a reservation is turned away owing to overbooking, the total loss is estimated at $100. overbooking, the total loss is estimated at $100. The best overbooking policy strategy should The best overbooking policy strategy should minimize the expected loss in the long run.minimize the expected loss in the long run.

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Overbooking loss (pay-off) tableOverbooking loss (pay-off) table

a policy of overbooking by 2 rooms will minimize a policy of overbooking by 2 rooms will minimize the expected loss in the long run. the expected loss in the long run.

Reservations overbookedNo-shows Proba-

bility0 1 2 3 4 5 6 7 8 9

0 .07 0 100 200 300 400 500 600 700 800 9001 .19 40 0 100 200 300 400 500 600 700 8002 .22 80 40 0 100 200 300 400 500 600 7003 .16 120 80 40 0 100 200 300 400 500 6004 .12 160 120 80 40 0 100 200 300 400 5005 .10 200 160 120 80 40 0 100 200 300 4006 .07 240 200 160 120 80 40 0 100 200 3007 .04 280 240 200 160 120 80 40 0 100 2008 .02 320 280 240 200 160 120 80 40 0 1009 .01 360 320 280 240 200 160 120 80 40 0Expected loss,$ 121.60 91.40 87.8 115 164.6 231 311.4 401.6 497.4 560

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Using the critical fractile model, the number of Using the critical fractile model, the number of rooms overbooked should just cover the rooms overbooked should just cover the cumulative probability of no-shows calculated cumulative probability of no-shows calculated as:as:

A strategy of overbooking by 2 rooms satisfies A strategy of overbooking by 2 rooms satisfies the critical fractile.the critical fractile.

P (d < x) $40

$40 + $100 .28

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No-showsd

ProbabilityP (d)

P (d<x)

0 .07 01 .19 .072 .22 .263 .16 .484 .12 .645 .10 .766 .07 .867 .04 .938 .02 .979 .01 .99


Surfside Hotel No-shows ExperienceSurfside Hotel No-shows Experience

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When is Yield Management appropriateWhen is Yield Management appropriateWhen is Yield Management appropriateWhen is Yield Management appropriate

Constrained capacity with high cost of Constrained capacity with high cost of increasing capacity because of the necessary increasing capacity because of the necessary lumpy facility investment (i.e. hotel addition must lumpy facility investment (i.e. hotel addition must be at least an increment of 50 rooms)be at least an increment of 50 rooms)

Ability to segment market into different customer Ability to segment market into different customer classesclasses

Perishable inventory : the revenue from an Perishable inventory : the revenue from an unsold unit of inventory is lost foreverunsold unit of inventory is lost forever

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When is Yield Management appropriateWhen is Yield Management appropriateWhen is Yield Management appropriateWhen is Yield Management appropriate

Fluctuating Demand : using demand forecasting yield management Fluctuating Demand : using demand forecasting yield management allows managers to increase utilization during periods of slow allows managers to increase utilization during periods of slow demand and to increase revenue during periods of high demand.demand and to increase revenue during periods of high demand.

Low marginal sales cost (such as the selling of a snack for an airline Low marginal sales cost (such as the selling of a snack for an airline passenger)passenger)

Product / Service sold or reserved in advance: there is the Product / Service sold or reserved in advance: there is the uncertainty of when to accept an early reservation at a discount price uncertainty of when to accept an early reservation at a discount price or when to wait and hope to sell the unit to higher-paying customer or when to wait and hope to sell the unit to higher-paying customer

Using a demand control chart to decide.Using a demand control chart to decide.

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Documents

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