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RM: Supply Chain's Missing Link
By E. Andrew Boyd
Supply chain management has consistently proven its value. Focusing on planning, scheduling and operational problems arising in the manufacture of physical goods, supply chain success stories are measured in the hundreds of millions of dollars. Savings are achieved by making the entire production process work harmoniously so as to produce goods as efficiently and inexpensively as possible.
Supply chain management, however, focuses on only one side of the equation - the supply side. Equally important yet frequently neglected is the demand side, an area where the service industries have focused intensively. In particular, the travel and transportation industries have pioneered many highly successful demand management practices. Most notable among these practices is revenue management, which applies forecasting and optimization methodologies to address pricing and/or finished product inventory management. Are these demand management practices applicable in the world of physical goods and, if so, why have manufacturers been so slow to adopt them?
To better answer this question it is useful to examine how revenue management evolved in the airline industry. In the mid-1970s, the airline industry developed computer systems for maintaining supply and demand data known as Central Reservations Systems. Supply consists of seats on scheduled flight legs, demand consists of booking transactions, and products are defined by establishing fare classes, with higher-priced products having fewer restrictions. Seat inventory on each flight leg is partitioned among the fare classes and posted on the Central Reservations System. A customer can book a Q fare class ticket on flight 111 connecting to flight 222 if there is Q class availability on each flight leg. Although there are other methods of controlling inventory in use today, most carriers control all or part of their inventory in a manner very similar to this.
The flexibility to freely define products did not occur until after deregulation in the mid-1980s, but when it did airlines were faced with a glaring question: How should seat inventory be divided among different products? Simple as this question may seem, it led to over 15 years of mathematical development by academic researchers and practitioners alike. Overbooking was the first step, followed by increasingly sophisticated forecasting algorithms for determining product demand, optimization algorithms for assigning seat inventory to product types, and specialized algorithms for dealing with the sale of contracted blocks of inventory. Enhancements continue to this day, with the Reservations and Yield Management Study Group remaining the most highly subscribed subdivision under the umbrella of AGIFORS, the Airline Group of the International Federation of Operational Research Societies.
In retrospect, the outgrowth of revenue management in the airline industry was inevitable. With an electronic distribution system in place there was a need to make product availability decisions. The accessibility of historical transactions provided a rich source of data to fuel research on the best way to make these decisions. As a result, today's most advanced revenue management systems have evolved to the point where forecasting and optimization are done on an almost continuous basis, restricted only by the limitations of the hardware platform and the quantity of data. Even so, frontiers remain — that revenue management has only begun to address.
There are many contributing factors to the relatively slow acceptance of revenue management techniques in the manufacturing industry. The supply chain is complex, and in seeking to cut costs, manufacturers quite rightly turn their attention toward streamlining production processes. Moreover, the core business of manufacturers has historically focused on production, not sales. By providing a new, low-cost distribution channel, the Internet is forcing manufacturers to streamline the sales and distribution process in order to remain competitive. The net result is a growing online database of sales transactions coupled with electronic distribution systems in need of automated pricing and inventory availability decisions — with links back into the supply chain. Manufacturers thus increasingly find themselves in the same position as the travel and transportation industry was many years ago. The adoption of revenue management in the manufacturing value chain is equally inevitable; the only questions are when and in what specific form.
Pieces of the puzzle remain to be defined before revenue management can fully flourish. Standard electronic distribution mechanisms must prevail before industry-wide revenue management practices can evolve. Being based on the Internet, electronic distribution is so new to many industries that even the basics — auction, fixed price, variable price, exchange, home Web site, the use of customer information — are often in question, much less the mechanical details of the process. Providers of supply chain solutions, however, are not waiting on the sideline, as attested to by Manugistics' recent acquisition of Talus Solutions. The sale and distribution of inventory are an enormous part of the value chain, and the tools of revenue management have proven too invaluable for manufacturers to delay any longer.
E. Andrew Boyd (aboyd@prosrm.com) is vice president of Research and Design and Senior Scientist at PROS Revenue Management in Houston, Texas. He received his Ph.D. in operations research from MIT in 1987.
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