A Welfare Assessment of Revenue Management Systems

Abstract

We study the welfare impact of revenue management, i.e. intertemporal price discrimination when the product availability is limited both in time and quantity, and consumers' arrival is random. This practice is particularly relevant, and widely spread, in the transport industry, but little is known about its implications on profits and consumer surplus. We develop a theoretical model of revenue management allowing for heterogeneity in product characteristics, capacity constraints, consumer preferences, and probabilities of arrival. We also introduce dynamic competition between revenue managers. We solve this model computationally and recover the optimal pricing strategies. We find that revenue management is welfare enhancing. Revenue managers face two types of constraints: a limited booking period and fixed capacities. Previous sales affect the relative slackness of these two constraints, explaining price variations. Profits increase as the practice offers more leeway to the seller compared to posting a fixed price throughout the booking period. Total consumer surplus also increases for a wide range of specifications, as revenue management raises the number of sales. In the presence of heterogeneous consumers, consumers with low price sensitivity subsidize ones with high price sensitivity when demand is low but both types benefit from the practice when demand is high. This sheds some light on the impact of revenue management on the surplus of business and leisure passengers.

Keywords: dynamic computational models, intertemporal price discrimination, revenue management, transport fares

JEL Classification: C63, R41