Pricing

Why Yield Management Doesn’t Fly in B2B Pricing

By Colin Carroll
August 7, 2012

Over the last 10-20 years numerous B2B companies have attempted to improve business results with Yield Management techniques. Executives who spend hundreds of hours a year at 35,000 feet naturally start thinking, “wow, my business is really a lot like the airline business.” But it’s becoming increasingly clear that Yield Management hopes in B2B fallshort of the expectations of executives and the promises of vendors.

Where does Yield Management fall short for B2B?

 Four principles of sound price management practices have been “mis-handled” in the approach to apply Yield Management in B2B settings:

A focus on operational metrics over profit metrics

Price inelasticity in B2B

A net increase of customer sensitivity to price

Cost allocation practices which hide the true impact on profits

Yield Management has its origins in airline and hotel reservation pricing systems. Its basic premise is that a middle seat, or hotel room, left unsold represents a lost business opportunity and selling it adds pure profit.,,At the heart of the yield management failures in B2B is that business customers have very different purchasing behavior than consumers, and the effect of price promotions for business customers produces very different results – all of which are bad in the context of B2B.

What Can You Learn from Yield Management?

Airline operators use an operational metric called “revenue per mile per seat.” But, the airline does not want to optimize the revenue per seat mile flown on a specific flight, rather on all flights over an extended time period. Their aim is maximize revenue, not profit.

Many consumer markets have elastic pricing. In B2B sectors, demand is effectively “derived.” Lowering the price of paper to the Chicago Tribune will not help the Tribune sell more Sunday papers. It might induce the Chicago Tribune to buy ahead, accumulating inventory, but it won’t change the absolute demand for their product. As a B2B supplier, you may increase your share of the market by lowering your prices, at least in the short term, but your competitors will react. They will lower their prices to retain sales volume and you will be left with the same share but lower revenues and increased pressure to turn a profit.

Providing a special price on a middle seat can induce more passengers to buy. The low price for that customer establishes a “reference price,” which does not have a significant impact on your future sales to other customers. Special pricing in B2B markets however, where price information is actively sought and managed by professional buyers, has a negative effect on overall market pricing and increases aggressive buyer behavior.

Cost allocation ultimately determines the profitability of “selling the middle seat.” Yield Management practitioners have a vested interest in framing the sale of the “walk up customer who buys an empty middle seat” as pure profit. But, don’t fall into this trap. In industrial sectors, rapid swings in raw materials and energy are difficult to pass on to customers and have an added complication – high fuel and input costs have made many “high fixed” cost industries look more like high variable costs industries, and reduce or eliminate the margin on marginal sales. There are very few business left that don’t have incremental costs associated with a sale.

As an executive or business manager, your role and responsibility is to maximize value for your firm. Any of the mistakes above puts you at odds with that responsibility. While Yield Management techniques may have created value for airlines and hotel operators, these techniques do not have the same application in B2B industries and transactions where the evidence indicates they are a poor fit and contribute to destructive business practices.

– Colin Carroll

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    Colin Carroll

    Colin Carroll has over 15 years of experience helping manufacturers implement and automate price and margin management best practices. Colin is currently a Pricing Expert at McKinsey & Co. Prior to joining McKinsey, Colin was the VP of Business Consulting at Vendavo. Before joining Vendavo, Colin was a pricing strategy consultant in addition to eight years at International Paper Company in a series of sales and marketing management positions, including Marketing Manager, Catalog Segment and Marketing Director, Publication Papers. Originally from Buffalo, New York, Colin has an MSE in Operations Research and Industrial Engineering from the University of Michigan and a BA in Mathematics from Binghamton University.