Information Technology Editor
In truth, this is the science airline passengers love to hate. Passengers hate to have to comprehend the complexities of 50,000 fares; airlines love to watch as their revenues skyrocket with optimally priced seats on filled-to-the-brim flights. Revenue management-the mathematically based science of margin enhancement-in fact allows airlines (and other industries) to analyze a myriad of “what-if” scenarios in order to calculate the most optimal usage of seats, such as seat allocation, scheduling and pricing.
With the lion’s share-some 80 percent-of all airlines worldwide using third-party systems, PROS Revenue Management is the brain behind the brawn of the mega-complex IT systems that calculate and re-calculate millions of variables and tens of thousands of transactions every hour. Now moving into other industries, PROS’s computer systems are helping energy, hospitality, broadcast and other markets boost their revenues through smart science.
Houston-based PROS Revenue Management claims that an average client (with high fixed costs; low variable costs) gleans a 2 to 8 percent increase in gross revenue-but natural gas clients (mainly interstate pipelines) have bagged an extra-hefty 7 to 25 percent return. So, for a company with sales of $500 million, generated revenue translates into $20 million to $40 million. And with only changes in business practices, on average, PROS asserts a six-month payback on investment.
“When margins at energy marketing companies are from one-half cent to two-and-one-half cents, there’s not a lot of slop factor there anymore,” said Matthew Johnson, PROS’s vice president of energy. PROS’s senior research scientist, Theodore Valkov, Ph.D. had this to say about possible returns in electricity: “The return in energy should be substantial. They concentrate on operations and providing service no matter the cost. In energy, or any other industry, when there’s low margins, wrong decisions tend to be less forgiving and any revenue increase dramatically and directly affects the bottom line.”
But what basic principles and theories are at work behind the science of revenue management? And how do they apply to the dynamic electricity market?
The science of revenue management: Tools and framework
According to Valkov, there are five aspects of the “revenue management framework” that work in synergy: limited resources (capacity in pipeline), perishable assets (closed nom deadline, unsold capacity) variable demand (winter/summer peaks), variable asset utilization (airline no-shows, shipper doesn’t use capacity) and market segmentation (fare classes, restrictions, transportation-firm, interruptible, hourly, daily, etc.), with all five aspects being present in the natural gas and electricity.
Now considered more than a “trendy account fad,” revenue management practices and technologies are lending a helping hand to industries beset and bedeviled by the roller coaster ride of supply and demand. When demand changes by the hour, day, week or season, businesses can be befuddled on how to allocate the right amount of inventory or develop marketing strategies without solid demand estimates. Even FERC has realized the impact of revenue and yield management on the industry: “In the deregulated airline sector, the simple peak/off-peak concept has been replaced by yield management systems, basically complex price discrimination and market segmentation schemes. In unregulated markets, they are the key to profit. In regulated markets, they are also the key to greater efficiency and greater fairness.”
Some of the tools utilized in the toolbox for revenue management include: modeling, market segmentation, forecasting, pricing and valuation (risk analytics) and optimization (includes all decision variables). In Valkov’s opinion, market segmentation (who to sell and times to sell-hourly, day-ahead, etc.) and accurate forecasting in energy are especially critical. When you look at what your different types of customers need-you’ll see how much demand you can expect, and you’ll know how to price optimally and react, he said.
The biggest mistake Valkov continues to see is that when companies try to bring up their revenues, they usually look at cutting costs. How they should address maximizing revenues, he said, is by asking “How can we make more money by selling better and smarter?”
Energy is the easy part
When’s the last time you remember anyone saying electricity was the “easy part?” As much as we begrudge the complexities of dealing in the world’s most volatile commodity-we’re sorely bested by the spaghetti-bowl network of routings and connections present in the airline industry.
“In the airline industry, we rebuild the world and reanalyze it every night,” said PROS’s Johnson, “Natural gas and electricity has a fraction of the complexity of the other industries we deal with. In airlines, there are 50,000 fare changes a day. And at every five bookings, we reforecast and re-optimize the allocation of seats and pricing, which adds up to 2.5 million variables at 36,000 transactions an hour.”
According to Valkov, there are several key areas in which the electric industry can directly utilize revenue enhancement. They include:
- Exploiting price spikes: Capturing the benefit of spikes by using multi-variable forecasting and estimating the time and size of spikes.
- Optimization of portfolios: Portfolios of real options that represent physical assets and contracts.
- Fuel management: Managing the optimal choice between various types of fuels, the optimal route of procuring fuels (buy in futures or cash market, etc.) and the optimal mixing of fuel types to meet environmental regulations, etc.
- Wellhead to busbar revenue optimization: Capturing value all along the value chain; optimizing, integrating and managing its various segments.
In energy, PROS offers several solutions: the prosRM Transportation Revenue Optimization System (forecasts demand for transport of the commodity by market segment, determines optimum use of capacity and predicts customer use of existing contracts); the prosRM Storage Revenue Optimization System (captures price arbitrage opportunities present in futures marketplace within the constraints of the physical hedge); and the prosRM Capacity Management System (optimally routes the commodity from supply to market, minimizing transportation and fuel costs while maximizing buy/sell revenue opportunities at pools and interconnects).
Though the current energy products are focused on the natural gas market, PROS is working on launching a power generation system and other optimization systems designed specifically for power. Already, PROS has signed on five energy accounts-Williams Energy Marketing and Trading, and four interstate pipelines. PROS claims that energy, with its growing fluctuation in demand, is a very fertile ground for revenue management.
From after-the-fact to real time: Altra and PROS integrate
A mere five years ago, most energy professionals would have scoffed at the idea of a truly “workable” and useful revenue and yield management system. But with the continued waning of margins and waxing of market complexities (via more and more disaggregation), energy companies are fast-footing their way to any vendor who can bump up already meager revenues.
In April, Altra Energy Technologies Inc. and PROS announced a business alliance to integrate PROS’s revenue optimization tools with Altra’s transaction management software suite. Plans are afoot to integrate and offer (as an option) the prosRM Capacity Management System and the prosRM Storage Management System with the Altra Gas and Altra Pipeline products to customers. The products logically rely on and add value to the data contained in and processed by each other’s systems.
“Today, if I have 20 different supply sources, 15 transportation alternatives and 100 markets-how do I choose the best route?” said Cleve Hogarth, Altra’s senior vice president of client services. “Well, now the systems are deployed desktop and run ‘what-if’ scenarios in real-time for scheduling. This really ups the ante for the value Altra customers receive from their products. It propels Altra from an after-the-fact transaction management product to an almost real-time decision-making tool.”
As for the now seemingly passÃ© difficulties that in the past had plagued energy, Hogarth noted how times had changed: “Five, seven and 10 years ago, there was only one product for least-cost routing available. Those were the first vestiges of products to run the gamut of variables and offer the best route to choose. But it was clumsy and took overnight. And usually by then the opportunity was gone.”
Deployment on a commercial basis of the PROS and Altra integrated systems is expected in the third quarter of this year.
Capturing diversity in demand & selling smarter
In the end, Valkov best summarized the highly mathematical theories, real-time calculations, sciences and theorems behind revenue management in a rather succinct statement: “Airlines used to sell seats. Then there was this revolution through revenue management. When they stopped selling seats and started selling services, like restricted fares, business class, and so on, they captured the diversity in demand. You see, people will pay different fares for what, in effect, is the same seat. It’s about providing services, not merely selling or buying the commodity.”