INSEAD Library

Includes bibliographical references and index

Digitized

Capacity Options for Revenue Management Theory and Applications in the Air Cargo Industry Contents 1 Introduction ................................................................................................... 1 2 Capacity Agreements in the Air Cargo Industry .............................................. 5 2.1 The Air Cargo Industry .................................................................................... 5 2.1.1 Challenges in Air Cargo Transportation........................................ 7 2.1.2 Market Dynamics ................................................................................. 7 2.2 Case Study: Capacity Reservation and Dynamic Pricing at Lufthansa Cargo AG...................................................................................... 10 2.2.1 Products................................................................................................. 11 2.2.2 Competition ......................................................................................... 11 2.2.3 Revenue Management System........................................................ 14 2.2.4 Rationale and Problems of Long-Term Contracts ................... 17 2.3 Research Questions and Methods.............................................................. 18 3 Literature Review on Supply Contracting and Revenue Management.............................................................................................................. 21 3.1 Advance Sale of Capacity ............................................................................. 21 3.1.1 Economic Reasoning and Implications ...................................... 21 3.1.2 Selected Modeling Approaches....................................................... 23 3.2 Supply Contracts ............................................................................................ 24 3.2.1 Order Quantity Decisions Under Stochastic Demand: The Newsboy Model ........................................................................ 25 3.2.2 Purposes of Contracts ...................................................................... 29 3.2.3 Contract Types.................................................................................... 30 3.3 Revenue Management ................................................................................... 37 3.3.1 Background.......................................................................................... 38 3.3.2 Criteria for Successful Applications............................................. 39 3.3.3 Components of Revenue Management Systems....................... 40 3.3.4 Implementation and Impact............................................................ 46 X Contents 3.3.5 Areas of Application ........................................................................... 47 3.3.6 Air Cargo Revenue Management..................................................... 48 4 Capacity-Option Pricing Model........................................................................... 53 4.1 Model Overview and Setup ............................................................................ 53 4.2 Assumptions ...................................................................................................... 55 4.2.1 Market Structure.................................................................................. 55 4.2.2 Supply and Market Demands.......................................................... 56 4.2.3 Prices and Costs .................................................................................. 57 4.3 The Intermediary's Problem........................................................................... 59 4.4 The Asset Provider's Problem ....................................................................... 63 5 Model Results and Comparative Statics ........................................................ 5.1 Framework for the Analysis .......................................................................... 5.1.1 The Base Case....................................................................................... 5.1.2 Scenario Definition.............................................................................. 5.1.3 Numerical Solution Procedure ........................................................ 5.2 Illustration of Optimal Policies .................................................................... 5.2.1 Optimal Reservation Policy of the Intermediary ....................... 5.2.2 Optimal Pricing Policy of the Asset Provider............................... 5.3 The Benefit of the Contract Market............................................................. 5.3.1 Optimal Pricing and Reservation Policies ................................... 5.3.2 Expected Profits.................................................................................... 5.3.3 Capacity Utilization ............................................................................ 5.4 Comparative Static Analysis of Contract Types...................................... 5.4.1 Capacity Size ........................................................................................ 5.4.2 Contract Market.................................................................................... 5.4.3 Spot Market .......................................................................................... 5.4.4 Cost Structure....................................................................................... 5.5 Reduction of Double-Marginalization ........................................................ 69 69 69 70 72 72 72 74 77 77 78 79 80 81 86 98 112 119 5.6 Summary of Results ........................................................................................ 123 6 Model Extensions: Distribution of Profits, Correlations, and Overbooking ........................................................................................................... 127 6.1 Distribution of Profits....................................................................................... 127 6.2 Interdependencies Between Stochastic Variables ................................. 130 6.2.1 Correlation Between Spot Market Demand and Spot Price ...................................................................................................... 131 6.2.2 Demand Correlation Between Contract and Spot Market .................................................................................................. 132 6.3 Overbooking ....................................................................................................... 134 6.3.1 No-Shows Within the Capacity-Option Pricing Model 134 6.3.2 Conditions for Useful Application................................................... 135 Contents 6.3.3 Optimal Overbooking Policy.......................................................... 136 6.3.4 Illustration of Optimal Overbooking Policy ............................ 139 6.3.5 Joint Optimization of Tariff and Booking Level .................... 142 7 Application Case Study in the Air Cargo Industry....................................... 147 7.1 Data Sample ................................................................................................... 147 7.2 Estimation of Model Variables ................................................................. 149 7.2.1 Capacity............................................................................................... 149 7.2.2 Contract Market Demand.............................................................. 149 7.2.3 Spot Market Demand...................................................................... 151 7.2.4 Spot Price............................................................................................ 7.2.5 Other Parameters ............................................................................ 7.3 Results............................................................................................................... 7.3.1 Optimal Choice of Contract Type and Pricing Policy ........... 7.3.2 Incremental Revenue Earned by Using CapacityOption Contracts........................................................................... 152 152 152 154 157 8 Managerial Implications and Conclusion ........................................................ 161 8.1 Managerial Implications and Implementation Issues ....................... 162 8.2 Further Applications and Future Research.......................................... 164 A Mathematical Formulae ......................................................................................... 167 A.1 Normal Distribution ..................................................................................... 167 A.1.1 General Form..................................................................................... 167 A.1.2 Standard Normal Distribution .................................................... 167 A.1.3 First Partial Moment ...................................................................... 168 A.1.4 Standard Normal Loss Function................................................. 168 A.1.5 Partial Expectations ....................................................................... 169 A.1.6 Primitive of the Cumulative Distribution Function ............. 169 A.2 Leibniz' Rule .................................................................................................. 169 B Proofs and Calculations ......................................................................................... 171 B.1 Second Partial Derivatives of the Asset Provider's Expected Profit ................................................................................................................ 171 B.1.1 With Respect to the Reservation Fee ........................................ 171 B.1.2 With Respect to the Execution Fee............................................. B.2 Offload Quantity ........................................................................................... B.2.1 Expected Value................................................................................. B.2.2 Derivative with Respect to the Booking Level ........................ 172 174 174 175 References....................................................................................................................... 179 Index.................................................................................................................................. 191