Revenue Management in 3 Steps

The mechanics of revenue management can get complicated - dip a few inches into it and you may find yourself flooded with mathy jargon and little direction on how to make it work.

However, the basic process is actually rather simple: it's about setting the right controls to maximize revenue based on your market segments, products, and services.

In this article, we'll break down the revenue management process into three steps that you can use to get started with it in your business.

Step 1: Segment Your Market

A large group of revenue management strategies rely on the fact that groups of customers have different preferences.

The classic example of this is in the airline industry, where customers are segmented into business and leisure travelers. Business travelers are willing to pay more for a ticket because they need to travel on short notice, while leisure travelers are more price-sensitive because they often plan their trips in advance. By segmenting in this way, airlines increase revenue by making flight offers designed for each segment instead of assuming that one price fits all.

When segmenting your market, it's particularly helpful to consider both observable and more human factors. Observable factors like geography, age, or purchase history are certainly valuable, but intangible factors like customer lifestyle, values, and reasons for buying can be just as important.

As we'll see in the next step, having a clear persona representing each segment establishes the dimensions along which we can design products and services that target some mix of customer demand.

Step 2: Differentiate Your Products Or Services

The goal of differentiating your products or services is to target a mix of your segments in a way that maximizes revenue.

For example, if your market breaks out into three segments based on low, medium, and high usage of your product, then it may be tempting to create three different products that target each segment. However, if enough of the low-usage and high-usage customers will still buy a medium-usage product, then it may be more profitable to offer only a medium-usage version instead of versions for all three.

How you differentiate really involves mixing features and benefits in a way where you can control how much of which type of customer buys each product.

In our usage segmentation example, we knew that customers were different based on how often they use the product. We then used that segmentation knowledge to create a product that selects customers based on their usage. Because we can control customer purchase decisions through the levers of product, the differentiation process provides a mechanism for controlling both who buys and how much revenue that generates.

You can get creative with how you make your product or service strategically select for customer segments - in fact, you probably already have many ideas off the top of your head.

In our usage segmentation example, if you're a hotel chain it may make sense to offer lounge access, premium wifi, or free breakfast for longer stays. If you're a software company, then it may make sense to bundle 24/7 support or convenient workflow features for higher-usage customers.

The key is to think about these features as falling on a spectrum that you can use to tune the kind of demand you want to see coming into your business.

Step 3: Optimize Based on The State of Demand

You've segmented your market, you've differentiated your products - now you're ready to maximize revenue based on the demand you see on a monthly, weekly, or even hourly level.

Similarly to how a sailor adjusts the boat's sails and ropes based on sea conditions ahead, the central idea of maximizing revenue at this stage is to set the right controls to navigate future patterns of demand.

Which controls you use depends on whether it's easier to change the prices of your products or the quantities produced.

For example, a retailer must commit to buying a certain number of goods from their suppliers, but they can change prices rather easily once the goods are in inventory. In contrast, an ocean freight shipping company can easily adjust the number of shipping containers allocated to high-revenue vs low-revenue goods, but long-term contracts with customers make it more difficult to change prices.

For the retailer, the best revenue management approach would be to apply dynamic pricing strategies like discounts, promotions, and markdowns to maximize revenue. For the shipping company, the best approach would be to implement quantity-based strategies such as booking limits for high-value vs low-value goods. This would make sure that the carrier's high-volume, low-revenue product doesn't crowd out space for their low-volume, high-revenue product.

In both cases, we can mathematically determine the optimal price or quantity controls by working backward from the expected demand for each product or service across each customer segment.

Conclusion

Although the mechanics of revenue management can get complicated, the basic process is actually rather simple. By segmenting your market, differentiating your products, and optimizing based on the state of demand, you can set the right controls to maximize revenue based on your market segments, products, and services. Instead of getting bogged down in technical details, maybe you'll even find some ways to make revenue management strategies work for you without any rocket science at all.