CH 10 Customer Value and Supply Chain Management

Customer Value and
Supply Chain
Management
David
Phil Simchi-Levi
Kaminsky
kaminsky@ieor.berkeley.edu
Philip Kaminsky
Edith Simchi-Levi
Outline
 Customer Value
 The Fundamentals of Pricing Strategies
– Revenue Management & Customized Pricing

 Mail-in-Rebate strategies
 Dynamic Pricing in SCM
– Delayed Pricing vs. Delayed Production
McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Customer Value
 How should a company measure the value of its products or services?
 The emphasis has moved from internal measures such as quality to
customer satisfaction measures.
 The supply chain has a huge impact on perceived customer value:
– Prices vs. service?
– Delivery speed vs. price?
– Specialization or one-stop shopping?
 Recall that responding to customer requirements is a basic part of
supply chain management.
 Customer value drives changes in the supply chain, and is a critical
input in determining the type of supply chain for a particular product
– Large inventories
– High level of customization

The Dimensions of
Customer Value
 Conformance to requirements
– Offer what the customer wants
– Demand impacts the supply chain
 Product Selection
– A proliferation of options makes the supply chain difficult to manage
– Three trends
 Specialty stores (Starbucks, Subway)
 Megastores (Wal-Mart, Target)
 Specialized Megastores (Home Depot, OfficeMax)
– Dealing with the proliferation:
 Build-to-order
 Centralized inventories
 A fixed set of options

The Dimensions of
Customer Value
 Price and Brand
– Pricing is a key part of the customer experience
 The correct supply chain supports the correct price
 Wal-mart
– Brand works hand in hand with price
 As the number of salespeople decreases, the value of brand increases
 This is particularly true on the internet
 Value Added Services
– It is hard to compete on price alone
– Value added services are on the rise due to
 Commoditization of products
 The need to get closer to the customer
 Improving information technology
 Relationships and Experiences
– An increased connection between the firm and its customers
 Dell manages the PC’s of large customers
 3PL
 The Sony store

Smart Pricing?
 Dell:
– Same product is sold at a different price to different consumers
(private/small or large business/government/academia/health care)
– Price of the same product for the same industry varies
 Amazon
– Books.com had a lower price than Amazon 99% of the time, yet
Amazon had 80% of the market in 2000 while Books.com only 2%
 Nikon, Sharp…
– Mail-In-Rebate
 Boise Cascade office
– Prices of 12,000 items sold on-line may change as often as daily

Revenue Management
 Example:
– A cruise ship with C=400 identical cabins
– The Price-Quantity relationship

Revenue Management
2000
Price P=2000-2Q
1000
No. seats
Revenue Management
 Example:
– A cruise ship with C=400 identical cabins
– The Price-Quantity relationship
 What is the price that the company should
charge to maximize revenue?

Revenue Management
Price
Revenue=480,000
P0=1200
C=400 No. seats

Revenue Management
Price
Money on the Table=160,000
P0=1200
C=400 No. seats

Revenue Management
Price
P2=1600
Q2=200 No. seats

Revenue Management
Price
P1=1200
C=400 No. seats

Revenue Management
Price
Revenue=1600(200) + 1200(400-200)=560,000
P2=1600
P1=1200
Q2=200 Q1 =400 No. seats

Revenue Management
 Can we increase revenue more?

Revenue Management
Price
P3=1800 Revenue=1800(100) + 1600(200-100)
+ 1200(400-200)=580,000
P2=1600
P1=1200
Q3=100 Q2=200 Q1 =400 No. seats

How can the firm prevent customers
from moving from one class to another?
Sensitivity to Duration
Sensitivity to Flexibility
Low
Leisure No
Travelers Demand
No Business
Travelers
Offer
High Sensitivity
to
Price
High Low
Revenue Management
 “Allocating the right type of capacity to the right

kind of customer at the right price so as to
maximize revenue or yield”
 Traditional Industries:
– Airlines
– Hotels
– Rental Car Agencies
– Retail Industry

Traditional Requirements
 Perishable inventory
 Limited capacity
 Ability to segment markets
– early-bird booking
– over the weekend
 Product sold in advance
 Fluctuating demand

Airline Revenue
Management
 Two components of airline revenue
maximization:
– Customized Pricing:
 Various “fare products” offered at different prices for
travel in the same O-D market
– Yield Management (YM):
 Determines the number of seats available to each
“fare class” on a flight, by setting booking limits on
low fare seats

Revenue Management:
Yield Management
 There are only two price classes
– Leisure: (f2) $100 per ticket
– Business: (f1) $250 per ticket
 Total available capacity= 80 seats
 Distribution of demand for business class is
known

Business Class: Demand
Distribution
Probability
0.3
0.25
0.2
0.15
0.1
0.05
0
0 5 10 15 20 25 30
Demand for Business Class

Revenue Management:
Capacity Allocation
 There are only two price classes
– Leisure: (f2) $100 per ticket
– Business: (f1) $250 per ticket
 Total available capacity= 80 seats
 Distribution of demand for business class is
known
 Enough demand for the leisure class

Revenue Management:
Capacity Allocation
 Objective: How many seats to allocate to
the business class to maximize expected
revenue

Expected Revenue
Expected Revenue
10000
9500
9000
8500
8000
7500
0 5 10 15 20 25 30 35
Business Class

Expected Revenue
Expected Revenue
10000
9500
9000
8500
8000
7500
0 5 10 15 20 25 30 35
Business Class

Revenue Management:
Capacity Allocation
 Optimality Condition: Choose the number
of seats for the business class such that
marginal revenue from each class is the
same

Optimality Condition
Margina Revenue Business
300
250
200
150
100
50
0
0 5 10 15 20 25 30 35

300
250
200
150
Marginal Revenue Leisure
100
50
0
0 5 10 15 20 25 30 35

300
250
200
150
Marginal Revenue Leisure
100
50
0
0 5 10 15 20 25 30 35

Benefits of Revenue Management
in the Airline Industry
 Evidence of airline revenue increases of 4 to 6

percent:
– With effectively no increase in flight operating costs
 RM allows for tactical matching of demand vs.
supply:
– Booking limits can help channel low-fare demand to
empty flights
– Protect seats for highest fare passengers on forecast
full flights

Mail-in-Rebate
 What is the manufacturer trying to achieve

with the rebate?
– Why the manufacturer and not the retailer?
 Should the manufacturer reduce the
wholesale price instead of the rebate?
 Are there other strategies that can be used
to achieve the same effect?

Mail-in-Rebate
A Retailer and a manufacturer.
– Retailer faces customer demand.
– Retailer orders from manufacturer.
Variable Production Cost=$200
Selling Price=?
Retailer Manufacturer
Wholesale Price=$900

Demand-Price
Relationship
10000
Demand P=2000-0.2Q
2000
Price
Retailer Expected Profit
(No Rebate)
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
500 1,000 1,500 2,000 2,500 3,000 3,500 3,654 4,110 4,567 4,547
Order

(No Rebate)
1,600,000
1,400,000
$1,370,096
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
500 1,000 1,500 2,000 2,500 3,000 3,500 3,654 4,110 4,567 4,547
Order

Manufacturer Profit
(No Rebate)
6,000,000
5,000,000
Manufacturer Profit
4,000,000
3,000,000
2,000,000
1,000,000
0
0
00
00
00
10
61
74
14
28
55
50
50
00
50
65
56
54
78
20
44
0
8
1,
2,
2,
3,
3,
3,
4,
4,
4,
4,
5,
5,
6,
6,
7,
7,
7,
1,
Order

Manufacturer Profit
(No Rebate)
6,000,000
5,000,000
Manufacturer Profit
4,000,000
3,000,000
2,000,000 $1,750,000
1,000,000
0
0
00
00
00
10
61
74
14
28
55
50
50
00
50
65
56
54
78
20
44
0
8
1,
2,
2,
3,
3,
3,
4,
4,
4,
4,
5,
5,
6,
6,
7,
7,
7,
1,
Order

($100 Rebate)
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 4,547 4,961
Order
($100 Rebate)
1,800,000
$1,644,115
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 4,547 4,961
Order
Manufacturer Profit
($100 Rebate)
6,000,000
5,000,000
Manufacturer Profit
4,000,000
3,000,000
2,000,000
1,000,000
0
0
5
0
8
54
78
00
50
00
50
00
50
00
11
56
96
37
20
61
02
44
85
26
4,
4,
5,
7,
1,
1,
2,
2,
3,
3,
4,
4,
4,
5,
6,
6,
7,
7,
8,
Order
Manufacturer Profit
($100 Rebate)
6,000,000
5,000,000
Manufacturer Profit
4,000,000
3,000,000
2,000,000 $1,810,392
1,000,000
0
0
5
0
8
54
78
00
50
00
50
00
50
00
11
56
96
37
20
61
02
44
85
26
4,
4,
5,
7,
1,
1,
2,
2,
3,
3,
4,
4,
4,
5,
6,
6,
7,
7,
8,
Order
(Reduced Wholesale Price $100 )
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024
Order

(Reduced Wholesale Price $100 )
1,800,000
$1,654,508
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024
Order

Manufacturer Profit
(Reduced Wholesale Price $100)
5,000,000
4,500,000
4,000,000
Manufacturer Profit
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
0
500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 4,961 5,374 5,788 6,201 6,614 7,028 7,441 7,855
Order

Manufacturer Profit
(Reduced Wholesale Price $100)
5,000,000
4,500,000
4,000,000
Manufacturer Profit
3,500,000
3,000,000
$1,800,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
0
500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 4,961 5,374 5,788 6,201 6,614 7,028 7,441 7,855
Order

Mail-in-Rebate
Strategy Retailer Manufacturer Total

No Rebate 1,370,096 1,750,000 3,120,096
With Rebate ($100) 1,644,115 1,810,392 3,454,507
Reduce Wholesale P ($100) 1,654,508 1,800,000 3,454,508

Mail-in-Rebate
Strategy Retailer Manufacturer Total

No Rebate 1,370,096 1,750,000 3,120,096
With Rebate ($100) 1,644,115 1,810,392 3,454,507
Reduce Wholesale P ($100) 1,654,508 1,800,000 3,454,508
Global Optimization 3,929,189

Managerial Insights
 Mail in Rebate allows supply chain partners
to move away from sequential strategies
toward global optimization
– Provides retailers with upside incentive
 Mail in Rebate outperforms wholesale
price discount for manufacturer
 Other advantages of rebates:
– Not all customers will remember to mail them in

– Gives manufacturer better control of pricing
Smart Pricing
 Customized Pricing
– Revenue Management Techniques
 Distinguish between customers according to their
price sensitivity
– Influence retailer pricing strategies
– Move supply chain partners toward global
optimization

Smart Pricing
 Dynamic Pricing
– Changing prices over time without necessarily
distinguishing between different customers
– Find the optimal trade-off between high price
and low demand versus low price and high
demand

When does Dynamic Pricing
Provide Significant Profit Benefit?
 Limited Capacity
 Demand Variability
 Seasonality in Demand Pattern
 Short Planning Horizon

The Internet makes
Smart Pricing Possible
 Low Menu Cost
 Low Buyer Search Cost
 Visibility
– To the back-end of the supply chain allows to coordinate
pricing, production and distribution
 Customer Segmentation
– Difficult in conventional stores and easier on the Internet
 Testing Capability

A Word of Caution
 Amazon.com experimented with dynamic

pricing – customers responded negatively
 Coca-Cola distributors rebelled against a
seasonal pricing scheme

 Opaque fares (priceline.com, hotwire.com)
– Determining the correct mix of opaque and

regular fares is difficult.

CH 10 Customer Value and Supply Chain Management

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CH 10 Customer Value and Supply Chain Management

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Customer Value and

– Revenue Management & Customized Pricing

– Delayed Pricing vs. Delayed Production

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

C=400 No. seats

Money on the Table=160,000

C=400 No. seats

Q2=200 No. seats

C=400 No. seats

Q2=200 Q1 =400 No. seats

 Can we increase revenue more?

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Q3=100 Q2=200 Q1 =400 No. seats

 “Allocating the right type of capacity to the right

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

 Ability to segment markets

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Margina Revenue Business

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Margina Revenue Business

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Margina Revenue Business

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

 Evidence of airline revenue increases of 4 to 6

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

 What is the manufacturer trying to achieve

to achieve the same effect?

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Strategy Retailer Manufacturer Total

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

Strategy Retailer Manufacturer Total

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

– Not all customers will remember to mail them in

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

 Seasonality in Demand Pattern

 Short Planning Horizon

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

McGraw-Hill/Irwin © 2003 Simchi-Levi, Kaminsky, Simchi-Levi

 Amazon.com experimented with dynamic