Room at the Revenue Inn.

IT'S AN AGE-OLD RETAIL MAXIM: WHEN DEMAND FALTERS, LOWER PRICES AND TAKE THE HIT IN YOUR MARGINS. BUT IN AN ENVIRONMENT CHARACTERIZED BY FICKLE CONSUMERS AND VICIOUS COMPETITORS, GAUGING DEMAND BY INTUITION ALONE CAN BE A RISKY BUSINESS. REVENUE MANAGEMENT CAN HELP YOU PLAY THE SUPPLY CURVE - AND MAXIMIZE REVENUE FROM EACH AND EVERY SALE.

Traditionally, companies have achieved growth through a wide variety of strategies: capital outlays such as expansion; mergers and acquisitions; product development that taps new market segments; and aggressive sales positioning. While effective, these well-known growth strategies incur substantial cost and are associated with substantial risk.

With demanding investors pressuring management to produce more from less, the emphasis in recent years has been on cutting costs and squeezing more from the workplace. But real growth comes from the marketplace, not the workplace. While the potential productivity gains derived from improving internal processes has a ceiling, the growth potential of the marketplace does not. Yet many companies overlook a growth strategy that hones in on generating more revenue from current assets through better management of supply and demand Revenue Management (RM).

Defined as the application of disciplined tactics that predict consumer behavior and optimize product availability and price to maximize profitable revenue growth, revenue management helps companies capture revenues they have been leaving on the table. In essence, the strategy lets companies use their knowledge of consumers' wants and needs to sell the right product to the right customer at the right time for the right price.

Companies that adopt sophisticated RM report top-line revenue increases of between 3 percent and 7 percent. Since RM doesn't require proportionate capital outlays, this growth translates into hefty bottom-line profit increases of between 50 percent and 100 percent.

IN THE BEGINNING...

While today's sophisticated RM is supported by redesigned business processes and large computer systems that analyze massive databases, some of the strategy's core concepts are simple to apply. Marriott International actually pioneered a rudimentary form of RM at its first hotel, the Twin Bridges Marriott in Arlington, VA, back in 1957.

The hotel charged different rates for its rooms according to how many people occupied them - $9 for one person, $10 for two, $11 for three, and $12 for four people - and an extra $1 for use of a rollaway cot or crib. Accordingly, a fully occupied room could bring in a maximum of $13.

When a slacking off of demand prompted creative means of improving revenues, the hotel, which had a drive-up registration window, began to evaluate the revenue potential of each carload by counting the number of people in each car. When it looked as if a particular night would be sold out, cars with fewer than four occupants were turned away to maximize the revenue brought in by the remaining rooms - a strategy that generated up to 44 percent more revenue at no additional cost.

Today's RM is just a much more sophisticated application of this fundamental business practice - saving inventory for high-value customers. This concept was developed into a highly evolved science by the airline industry when post-deregulation fare wars produced record numbers of passengers and, with them, record losses. The intense competition following deregulation spurred the airlines to discount many seats unnecessarily. As a result, they began to differentiate between customers according to willingness to pay and save the scarce seats on high-demand flights for full-fare passengers - a strategy known as "yield management."

By capturing passenger booking data and analyzing the demand patterns on flights, the airlines would decide how many seats to sell on each future flight at restricted discount fares, how many seats to allocate to groups, and how many seats to save for late-booking business travelers who are more time sensitive than price sensitive. Without sophisticated decision systems, the risk of getting the passenger mix wrong would be high. If the airline held back too many seats for last-minute business customers, it would kill the opportunity to sell those seats earlier at advance-purchase discounted fares. If the anticipated last-minute hookers didn't materialize or if they booked seats and then didn't show up, airplanes would take off with empty seats, resulting in lost revenue.

Marriott had many of the same problems balancing room demand. Just as empty seats on an airplane represent lost revenue opportunity, so do empty room nights. After talking to various airlines about their practices, Marriott was sure that once significant differences in its business were addressed, these advanced concepts would work in the hotel business.

Marriott now uses automated RM systems that provide daily forecasts of future guest demand for each Marriott, Courtyard, and Residence Inn around the world. By analyzing historical seasonality and trends to forecast future demand by customer segment, the systems enable Marriott to better manage both the occupancy and rate of more than 160,000 rooms. Predictions of peak occupancy days, cancellations, no-shows, and stay-throughs enable managers to adjust room rates and manage both lengths of stay and discount business.

The result? A substantial increase in Marriott's primary revenue productivity measurement - revenue per available room. Marriott pioneered innovative "weekend products" in the hotel business - a low-tech form of revenue management that uses price rather than capital to balance supply and demand. To bolster weekend revenues at locations that serve primarily business travelers and tend to be emptier on weekends, the chain offered discount package programs designed to attract customers from the local market.

When a senior executive theorized that accepting a guest who planned a one-night stay on the hotel's peak night - Wednesday - often meant turning away guests who might have stayed longer, the company ran a simulation study that showed it was possible to forecast guest demand by both price and length of stay with a fair degree of accuracy. The demand forecasting system (DFS) concept was met with skepticism, especially from "old-timers" who felt that either guest behavior could not be predicted or, if it could be, that they could do it better than a machine. But testing proved them wrong. In an early test phase, conventional wisdom held that no discount rates whatsoever be given at the Munich Marriott during Oktoberfest because of the tremendous demand. Yet, the DFS recommended that the hotels offer some rooms at a discount, but only for those guests who would stay for an extended period either before or after the peak celebration days. Although counter to what the general manager felt was common sense, he applied the DFS recommendation and was pleasantly surprised with the results at the end of Oktoberfest. Although the average daily rate was down 11.7 percent for the period, occupancy was up more than 20 percent and overall revenues were up 12.3 percent.

RM has since enabled Marriott International to use technology to manage its business more effectively and become a pricing leader in its industry. Successful execution adds between $150 million and $200 million in annual revenue to Marriott's $10 billion-plus top-line. The company continues to refine its RM techniques and is now implementing RM at the Marriott-owned Ritz-Carlton hotels and plans to make it available to the company's recently acquired Renaissance hotels as well.

Applicable by virtually all companies, an RM concept such as that implemented by Marriott goes beyond installing a computer system. It is an integrated set of business processes that brings together people and systems with the goal of understanding the market, anticipating customer behavior at the micromarket level, and responding quickly to exploit opportunities.

Installing RM processes and systems requires a relatively small investment, but the return on the investment can be astronomical. Generally, the average gross return on information systems is around 81 percent, according to a study conducted by Erik Brynjolfsson of MIT. By giving companies specific knowledge about future customer behavior, RM systems routinely generate annual returns in excess of 200 percent. In many companies, the systems pay for themselves within months.

Originally conceived as an inventory management tool, the process is now used by RM professionals in decisions involving product mix, capacity expansion plans, operational efficiency, and resource allocation. An emerging growth strategy The Wall Street Journal says is "poised to explode," RM may well be the most effective key to profitable growth for many companies. Alfred Kahn, former chairman of the Civil Aeronautics Board and the father of airline deregulation, seconds the endorsement, terming RM a "devastatingly effective competitive weapon."

Furthermore, recent studies by Mercer Management have demonstrated that the market value of growth companies can increase twice as fast as the value of companies focused on cost-cutting. In fact, each $1 of profit generated through revenue growth can be worth three times as much to shareholders as $1 of profit generated by cost reduction.

There is no doubt that to be successful in business today, companies must grow. And top-line growth that drives bottomline profits is what RM is all about.

THE CORE CONCEPTS OF REVENUE MANAGEMENT

While RM systems can be complex, many of the core concepts can be expressed in simple terms:

FOCUS ON PRICE RATHER THAN COSTS WHEN BALANCING SUPPLY AND DEMAND

Virtually every company has to deal with supply/demand imbalances, and the natural tendency is to remedy such imbalances by using capital. Manufacturers expand production capabilities when demand increases and close plants when demand is down and profit pressure intensifies. RM principles suggest adjusting prices, not necessarily costs, as a first response to changes in demand. After all, the issue is typically market-related; therefore, the first response should be market-related, as well. Discounts can be used to stimulate certain submarkets to consume excess capacity or production. Marriott, for example, often provides a rate incentive for business guests who have booked rooms for peak Monday and Tuesday nights to check into the hotels on Sunday nights, providing business for one of Marriott's slowest nights and generating increased revenue.

REPLACE COST-BASED PRICING WITH MARKET-BASED PRICING

Most companies price products based on the cost of producing, selling, and delivering them. But consumers aren't concerned with costs - they place a value on goods and services based on their own needs and desires. A company's job is to find the market's acceptable price. While the perceived value may be enhanced by improving the product or repositioning it, the consumer will either buy or not buy at the price placed on the product. Intimate knowledge of the market helps determine the prices that are acceptable to consumers and which will give you a suitable return.

SELL TO SEGMENTED MICROMARKETS, NOT MASS MARKETS

Most companies strive to deliver what the consumer wants faster, better, and cheaper than anyone else. But unfortunately, not all consumers want the same thing. In today's increasingly chaotic marketplace, the consumer's buying decision is often dictated by particular circumstances at a specific moment of time. Effective market segmentation is now determined by a customer's willingness to pay at a specific moment in time, not by the traditional demographics and psychographics. For example, someone on a business trip is more likely to pay a higher price for a convenient downtown location than someone with the same demographic and psychographic profile who is on vacation. The vacationer is willing to shift venues to save money. Both market segments must be addressed simultaneously.

SAVE YOUR PRODUCTS FOR YOUR MOST VALUABLE CUSTOMERS

In many cases, different market segments will compete for the same product, which may be in short supply. As a general rule, people least likely to pay the highest price often seek to purchase early, shutting out later customers who would have paid more. This results in a consumer surplus for the customer who bought the product at a below-market price, and creates poor customer service when you cannot produce for those who are willing to pay more, but cannot or have not planned in advance. Predicting which segments will pay the most is critical in order to save those products for them. This is how airlines serve late-booking business travelers willing to pay full fare in order to have seats available to them at the last minute.

MAKE DECISIONS BASED ON KNOWLEDGE, NOT SUPPOSITION

As markets become more complex, decisions about product availability and price are more difficult. Simple assumptions about consumer behavior that may have been adequate in the past no longer assure optimal decisions. The larger a company is and the more complex its markets, the more critical it is to ensure that decisions are based on actual market knowledge, not supposition. RM's sophisticated forecasting tools convert uncertainty about customer demand into probability, enabling better business decisions. Computer systems review every day's sales activity, the consumer response to changes in product or price, and other relevant data. Forecasts are run overnight to give decision makers fresh knowledge about the market each morning. Companies that experience tremendous market activity during the course of a day may require re-forecasting hourly, or even more frequently. Some may even re-forecast after every transaction - and for good reason. Studies indicate the improvements in decision-making from such dynamic re-forecasting can increase revenues from 1 percent to 2 percent. For a $1 billion company, that translates to $10 million to $20 million annually.

EXPLOIT EACH PRODUCT'S VALUE CYCLE

Once customer behavior is forecasted, how do you maximize the value of your product in the market over time? RM systems use mathematical models to optimize the revenue stream from a given product. After forecasting demand in the various micromarkets, the system calculates the timing and price point combinations that will result in the optimal revenue. While no computer model can completely account for all the variances of consumer reactions in a complex marketplace, tests of this type of computer model achieve increases of 5 percent to 10 percent.

J. Willard Marriott, Jr. is chairman and chief executive of Marriott International. Robert G. Cross is chairman and chief executive of Aeronomics Inc., and author of Revenue Management: Hard-Core Tactics for Market Domination (Broadway Books, a division of Bantam Doubleday Dell).