Tuesday, 21 December 2010

Happy Holidays thanks to OR

At this time of the year many of my colleagues and fellow Dutchmen arrange to go ski in France or in Austria (Swiss is too expensive, you know the Dutch) or fly off to some sunny destination to enjoy the December holidays. Personally I like to stay at home and enjoy being with family and friends. It also allows me to write this blog and enter the December Blog Challenge of INFORMS.

How do Holidays and Operations Research relate? Well, a lot I would say. The obvious examples for this time of year are:

  • Given a (tight) budget which Xmas-presents to buy to maximise joy (Knapsack problem)
  • The shortest route along all the shops you want to go to for Xmas shopping or all the relatives you want to visit (Travelling salesman). Santa's route actually is that of a travelling salesman.
  • Getting all the presents you bought into your car (vehicle load optimisation)
  • Avoid gaining weight during the Xmas holidays, design a healthy Xmas menu (Diet problem)
  • And many more.
Those who don’t stay at home but book a flight, a train, a hotel room or any other holiday accommodation also come across Operations Research. It is used to determine the fee you have to pay for the flight or hotel room you book. It’s called revenue management or yield management. It explains why the person next to you paid a different fee than you and why prices for hotel rooms and flights fluctuated from day to day. The basic principle of revenue management is rather simple, try to maximise revenue given an uncertain demand. Remember selling lemonade as a child outside your house? You had to decide when to try and sell it, (it didn’t work on a rainy day) decide on a reasonable price and when/how to change the price as the day rolled on. Things are no different in selling flights or hotel rooms. There is however more to revenue management than just determine the right price.

One of my customers is in the travel industry. They offer flights, hotels and holiday accommodations or combinations thereof via the web. It is interesting to see how their planning cycle works and how Operations Research is used to support it. It all starts with having something to sell. Before you can sell, you need to have inventory (How many cans of lemonade to make?). Each year, ahead of the holiday season, it must be decided how many hotel rooms and flight seats are required to fulfil market demands or capture the market potential. This decision can have a lot of impact since, if a too small amount is bought, it is a missed opportunity for increased revenue. However if too much rooms or flights are bought, a lot of the capacity will by left unused leading to uncovered costs. Although deciding on the exact amounts is still a craftsman’s job, a lot can be learned from the past. This is where Operations Research offers a helping hand. Using advanced forecasting methods the capacity managers are able to make good esstimates for the required inventory that is than (together with strategic commercial objectives) input for the sales & booking process.

Given the above, you can imagine that the inventory risk is rather large. Huge amounts of flight seats and hotel rooms need to be bought in advance, which are perishable. If the flight seat, hotel room or accommodation isn’t sold, it expires. Also 95% of the inventory needs to be sold to have a healthy P&L, which leaves not much room to manoeuvre. This is already hard when you are selling just one product. Think about selling 18 million different products! Here is where the Operations Research comes in again. To deal with the complexity and size of the challenge, we developed a specific optimisation model that is incorporated into a revenue management system. The model is used to determine the optimal price for each of the 18 million products. On a daily basis 2-3 million product prices are updated, taking the actual bookings and updated forecasts for future demand into account.

At the introduction of the model, the mindset of the pricing managers was to set prices to sell 100% of the inventory. They achieved high occupation levels, but at the cost of many discounts. With the revenue management model this changed. First they used to model to maximise revenue by making timely price adjustments. Now they are even beyond that, using the model to find new growth opportunities. The revenue management model handles everything so they also can enjoy their holidays as well, thanks to OR. Happy Holidays to you all!

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