CAPACITY AND DEMAND MANAGEMENT IN LOGISTICS SERVICES – PART 2

In the previous issue, we began a series of two articles dedicated to the challenging issue of capacity management in logistics service delivery systems.

The uncertainties of demand (variability, seasonality) allied to the perishability of capacity (impossibility of stocking capacity to use it at times when it is less than demand) characterize the problem continually faced by countless service managers.

We have seen that there are two basic strategies for managing capacity in services. The first consists of “chasing” demand, that is, if demand increases, capacity increases, and if demand decreases, capacity also decreases. This is a limited application strategy in most logistics systems due to the difficulty or even impossibility of activating and deactivating resources at the same speed as demand increases or decreases.

The second strategy, called Level of Service, consists of scaling the capacity at a fixed amount equal to a percentage of the maximum expected demand. The service provider decides to size its installed capacity to meet, for example, 85% of the maximum expected demand. When the demand is lower than this value, it has idleness and when the demand is higher than the decided service level (85%), it is unable to meet all requests. The decision for a service level lower than 100% can be explained as follows: being prepared to meet the maximum demand can be more expensive than what is earned in the few moments when the demand is higher than the 85% previously defined as the service level.

Both idleness and unsatisfied customers are undesirable situations for a service manager who has set a service level. We commented, then, in the previous number, the existence of a series of mechanisms of adjustment between offer and demand that can help to reduce the difference between capacity and demand in those periods in which the offer exceeds the demand or in those in which the demand is greater than that capacity.

The first article in the series presented a set of “tricks” to act on capacity in order to bring it closer to demand. The present article is dedicated to the mechanisms that can be used to work the demand in order to adjust it to the existing capacity. As mentioned in the previous article, we repeat here that one or more mechanisms from the two sets presented can be applied simultaneously, possibly with greater effectiveness than adopted separately.

II - DEMAND MANAGEMENT

Unlike capacity, demand for services is not a variable under the direct control of the service provider. It is influenced by factors such as prices practiced by companies in the sector, advertising, level of economic activity, momentary needs of the client, accessibility of the service, etc. However, a service provider can exert some influence on demand behavior through the use of one or more mechanisms that will be presented later in this article.

The most important requirement for effectively managing demand is knowing who the customers are and understanding their needs. Such information will help the service provider to decide which mechanisms will be most effective in managing the demand for its services. Thus, for example, the practice of reduced prices is a mechanism that can shift demand from peak periods to periods of lower demand for services. However, if customers are not very price sensitive, the adoption of such a mechanism may be innocuous.

Another possibility allowed by understanding the customer and their needs is the identification and separation of different demands for different types of services offered. A company whose service is the delivery of packages, knows, for example, that the demand for its services can be divided between demand for urgent deliveries and demand for regular deliveries. By studying customer behavior, she discovers that there are customers who use her regular service but who do not use the urgent delivery service. Certainly, there are different patterns of demand for the two services. This may mean that the capacity resources allocated to one and the other service may not be adequate. Very likely, too, the mechanisms for working the demand for the two services may be different.

Knowledge of the customer and his needs is a necessary but not sufficient condition for managing demand. Service managers must also study the nature and conditions of demand behavior. A series of factors of a social, political, economic, climatic nature, etc. influence the demand for services. Some of these factors may be regular, others not. Uncovering the drivers of demand and understanding their effects requires data collection. Knowledge of these data not only helps the manager to determine which mechanisms can be most effective in influencing demand, but also helps him to verify whether his capacity should remain at the level it is.

The basic principle that guides demand management is changing its timing. The idea is that peak times are alleviated and off-peak periods, with excess capacity, are better utilized. Mechanisms to achieve this purpose can be divided into two groups, namely: direct management of demand, which presuppose contact with the customer and prior knowledge of their preferences or availability before the moment the service is provided; and indirect management, which aims to induce customer behavior in an attempt to divert them from peak hours to periods when there is idle capacity. Some of the most common mechanisms suggested by the literature will be presented below. It should be noted, however, that not all mechanisms are appropriate or feasible for all types of services.
III – MECHANISMS TO INFLUENCE DEMAND

All elements of the marketing mix can play some role in influencing demand during periods of overcapacity or undercapacity. Playing with prices is perhaps the best known mechanism; however, changes in service mix and distribution strategy, and communication efforts, can be good allies in attempts to adjust demand to existing capacity. Although each mechanism will be analyzed separately, the joint use of two or more mechanisms can be more effective in the task of influencing demand behavior.

Pricing – One procedure that managers can employ to shift demand from peak periods to those of moderate demand is to use differential pricing schemes. The efficiency of the price differentiation mechanism strongly depends on the price elasticity of demand. The lower the price elasticity, the smaller the impact on demand. The mechanism can also increase the primary demand for the service. Potential customers can start using the service at lower price periods, increasing the service utilization rate.

On the other hand, it should be noted that the price that the client is willing to pay for a service has a lot to do with the moment in which the client wants the service. Thus, in periods when demand clearly exceeds capacity, a price increase can be a wise practice, better balancing capacity and demand, increasing the margin per unit of service sold and diverting customers who do not need to use the service at that time or who are not willing to pay a premium price for periods of normal demand.

Still with regard to the use of the price variable as a mechanism for adjusting supply and demand, it is necessary to avoid pitfalls such as the one into which a North American overnight air transport company fell. This company offered next-day delivery services as well as 48- and 72-hour deliveries at prices lower than the rates charged for next-day deliveries. However, because there was excess capacity, the company always delivered the next day. When customers found out, the mix of the business shifted significantly toward lower-priced services. So, even though there was an increase in volume, the resulting lower margins raised the break-even point of the business considerably.

Yield Management (or Revenue Management) – It is a mechanism based on practicing different prices depending on the remaining stock of available seats considering the proximity of the moment of the service. Yield Management began to be used during the deregulation of the North American airline industry. With prices released, airlines started a price war that considerably eroded their profit margins. This scenario provoked a gradual evolution of demand management techniques. With Yield Management, airlines began to use historical ticket sales data for different routes, and the data began to be analyzed using a dynamic statistical process and mathematical optimization to ensure the best allocation of seats for different classes and prices that should be charged. With the results that airlines began to report (American Airlines, for example, would have attributed Yield Management profits of 1,4 billion dollars over a three-year period in the early 90s), other service systems with similar characteristics to the airline industry: relatively fixed capacity, the possibility of market segmentation and advance sales, began to take the first steps in adopting that practice. Nowadays, hotels, car rental companies, transport companies, and even Broadway theaters manage their demand with Yield Management.

There are a number of important requirements for the adoption of Yield Management. The main thing is the existence of segmentable markets, that is, the company must distinguish the segments of the market where it is operating so that it can select the segments of interest and identify opportunities for price differentiation. Within each segment it is necessary to specify the classes of service and the conditions for participating in the classes. It is also necessary, in each class, to identify the service differentiators in order to then adjust the prices for each class of service.

The logic behind the practice of various prices can be seen in the graphs in figure 1. The situation corresponds to an airline that sells seats on an airplane for a certain flight.

The graphs show the seats sold for each different price. Assuming that demand has a linear behavior with respect to prices, the straight line shows, for each price, the seats that will be demanded. Thus, as can be seen by the dashed lines in graph (a), for a very high price, few seats will be sold. On the other hand, for a low price, more seats will be sold. Total revenue will be the price of a seat multiplied by the number of seats sold. In the graph, total revenue is represented by the area of ​​the rectangle that has one vertex at the origin and the opposite vertex on the demand line. We can see that with just one price range, total revenue would be represented by the gray rectangle. We also noticed that there is a large area under the line that is not used, an area that represents lost revenue.

Observing graph (b), we see that with a high number of price subclasses, the sum of the areas of all rectangles almost completely fills the area under the demand line, obtaining much greater revenue. This logic is what explains the high number of price subclasses and this ensures revenue maximization.

Readers interested in more information about this modern demand management technique have several interesting sites to visit. The website http://www.prosrm.com, for example, features articles on the technique and news from companies in the most diverse sectors that have adopted the concept. It is interesting to note that airlines that have adopted Yield Management to optimize their revenues from ticket sales are starting to use the technique in their cargo operations. In the website http://www.abovetheweather.com, the reader can find an updated list of companies that use Yield Management, with the presence of companies operating in the logistics area such as Ryder TRS and Yellow Freight System.

Developing New Services or Complementary Services to Existing Services Many service managers constantly struggle to increase business volume during periods of low demand, especially when facilities and/or equipment have a high fixed-cost, low-variable-cost structure. The idea of ​​developing new services for other types of customers during periods of low occupancy can be attractive in terms of profitability.

Care must be taken with introducing these extra services so as not to affect the functioning of existing operations. The concern to use facilities and/or equipment that are idle for a certain period can distract the company from its focus, compromising the quality of the original services. Serving customers that the company is not used to serving can require other skills from staff, requiring more service time than anticipated, breaking the vulnerable balance found in most service delivery systems.

The introduction of complementary services to existing services can be a more harmonious way of occupying possible idleness in the system when the demand for the main services is low. Complementary services represent related activities, without requiring new competences or substantial investments. Logistics operators that offer storage and cross-docking services, for example, may eventually expand their service offering with labeling operations, small assemblies, inventory control, etc.

Creation of a Reservation System – This mechanism assumes the advance sale of service capacity. Excess demand in a certain period can be taken advantage of by moving it to another period. Reservation systems somehow reduce the randomness of demand and can be seen as builders of “customer stock”.

The biggest problem associated with reservation systems is that customers often do not honor reservations made. The solution to this inconvenience may be to charge for the reserved and unused capacity, in case the customer does not cancel the reservation within a fixed period.

Educate customers/Inform customers about workload

Communication efforts can be helpful in attempts to smooth demand behavior by adjusting to existing capacity. Letters, advertising flyers, phone calls from salespeople can remind the customer about peak periods and encourage them to use the service in periods of lower demand. It is not necessarily a question of offering discounts, but of showing them that outside the peak period the service can be provided with better quality, less haste, in short, with better conditions.

Distribute demand over planned periods

This mechanism means offering the service on days or at certain times in order to homogenize the behavior of the demand and better use the capacity. Once again, the company's communication work is required, seeking to show customers the economic advantages provided by the fact that they use the service obeying the programming made by the company.
As inventories have always been an important mechanism used by manufacturers to compensate for variations in demand, many service providers are looking for ways to use this mechanism in their problems of mismatch between supply and demand. Thus, for example, a company that expects to complete the loading of a truck to release it to carry out deliveries is “stocking demand” until it reaches a level that justifies the use of that capacity. The question is how much is compromising the level of service. Cargo consolidation can take longer than the customer is willing to wait. Evidently the company is trying to optimize transport because otherwise the cost of delivery could be very high.

Distributing demand over planned periods or any other form of “stocking demand” is an increasingly dangerous trick. Customers are increasingly demanding, they want the service when they determine it and not when the company is willing to provide it. If a competitor "disconnects" from the others, investing in flexibility to offer the service at any time, even if it is for a slightly more expensive price, it may have competitive advantages because customers sensitive to speed may prefer this new option . Today customers choose a supplier for the value they provide. Many customers include the time it takes to receive the service as a cost that must be added to the price they pay and, even if the price is low, the benefit/cost ratio (price plus waiting time), i.e. the perceived value ends up being low. On the other hand, a fast service can represent greater value because the benefits of speed (less uncertainty about the waiting time, no worries, no need for alternative plans, etc.) act as a price reducer, increasing the relationship between benefit and cost.

BIBLIOGRAPHY

FITZSIMMONS, JA; FITZSIMMONS, M. Service Management: operations, strategy and information technology. New York: Irwin McGraw Hill, 1997.

HAKSEVER, C.; RENDER, B.; RUSSEL, R.; MURDICK, RG Service Management and Operations. Upper Saddle River, NJ: Prentice Hall, 2000.

HARRIS, F.; PEACOCK, P. Hold my place, please. Marketing Management, v.4, n.2, p.34-46, fall 1995