The New World of Capacity-Constrained Demand



A few weeks ago, one of my friends asked me why Revenue Management (RM) mattered anymore since there was no revenue to manage. That got me thinking and as an RM person, of course it sort of rankled me. Does RM still have relevance in the post-Covid world?


I wrote the article, ‘Yield Management: A Tool for Capacity-Constrained Service Firms’, almost 30 years ago. The capacity constraints then, and up to a few months ago, were physical in nature whether they be the number of hotel rooms, the number of airline seats, the number of square meters of space or the number of restaurant seats. But, as we emerge into the post-Covid world, our capacity constraints have changed and are now driven by government distancing and safety policies. The question becomes one of how to practice revenue management in this new capacity-constrained world.

Dan Skodol (one of my former students by the way!) wrote a great article on ‘Managing Capacity Constraints in a Covid-19 World’ in May 2020 that really caught my attention. He presented the concept of effective capacity (the amount of capacity available after considering policy constraints) and discussed how hotels can best manage their effective capacity.

Dan’s article got me thinking about constraints and their impact on revenue generation. Think about the various government policies that are constraining capacity right now. Whether it be a restaurant that can operate at a maximum of 50% capacity and maintain certain distances between parties, golf courses that have to increase their tee time interval from 8 to 18 minutes or meetings that can have a maximum of 50 people, these constraints all have an impact on revenue generation. The question becomes one of how to generate sufficient revenue to maintain profitability.

The list of constraints goes on. Think about casinos having to operate with a maximum of 25% capacity, hotels with a maximum of 50% occupancy and 24 hours between customers or elevators with a maximum of 4 people. While the elevators are obviously not revenue-generating (at least yet!), casinos and hotels face the same problem as above. How can they maintain profitability given their reduced capacity?

This got me thinking some more and brought me back to my favorite business book of all time, The Goal. The Goal (and if you haven’t read it, you should!) is a novel that illustrates the Theory of Constraints. To put it in perspective, it’s the only book that students have ever thanked me for making them read. Yes, you read that right!

The Theory of Constraints consists of 5 steps: (1) identify your bottleneck, (2) exploit your bottleneck, (3) subordinate everything else to that bottleneck, (4) elevate the bottleneck and (5) repeat the process. I’ll talk a bit about each of the steps below.

The bottleneck is simply put, our capacity constraint. In revenue management, we are used to dealing with physical constraints. We still have those same physical capacities, but our effective capacity is now limited by policy constraints set by various government agencies. Once we identify our constraint, our goals are to maximize its use so that we can generate profit.

The second step of the Theory of Constraints is to exploit the bottleneck. This means maximizing our use of our constrained capacity. To put this in perspective, consider a restaurant that can operate at a maximum of 50% capacity. On high demand evenings (and yes, there are some), it better make sure that it’s both maximizing its revenue potential by actively managing its reservations policies, providing adequate staffing levels, eliminating discount packages and considering its menu pricing policies. Or, consider a casino that can operate at a maximum of 25% capacity. What can it do to maximize its revenue potential from that effective capacity? If it has a loyalty program, it can restrict admittance to certain tiers of customers (as in customers who are more avid gamblers).

The second step is where RM becomes essential. As Dan Skodol mentions, hotels need to carefully manage and track their ‘out-of-order and off the market rooms and to not lose sight of the importance of forecasting demands.’ Essentially, it is crucial to actively manage your reduced capacity and try to generate as much profit as possible from it. If you’ve got the demand, make sure you take full advantage of it. I don’t mean that in a negative way—just don’t waste the opportunity!

The third step is to subordinate everything to the bottleneck operation. There are a few ways to do this including spreading demand to off-peak periods and building demand during off-peak periods. This is where good marketing comes in. How do we build demand during off-peak periods? It could be discounts; it could be special promotional packages, or it could be letting customers know about when the low demand periods are. But, there are many other things that can be done. The question is how to generate revenue from the capacity that you have.

Think of the sorts of things that restaurants did when they were not allowed to have dine-in business. Their physical capacity of seats simply disappeared, so they had to look at their new capacity, the production capacity of their kitchen. What could they do to generate revenue from that? Many restaurants turned to takeout, delivery, meal packages and other creative promotions. Yes, they didn’t generate as much revenue as when they had their physical capacity available, but they were able to stay afloat. And, at the same time, many discovered a new possible revenue stream.

The four step is to elevate the constraint. This usually entails spending money to add capacity. Given that most companies can’t add capacity right now, this may seem like a moot point, but think about hotels that are using their meeting space for virtual events or pop-up restaurant concepts or think about restaurants that are adding outdoor dining areas. These are but a few of the many creative examples out there (for some great examples, please see covidinnovation.com).

The final step is to repeat the process. Yes, I know, most of these 5-step process things always end like this, but think about it. Policy restrictions will eventually begin to loosen. What impact will that have on your effective capacity? How will you manage it? The process begins again…..

Back to the original question. Does RM even matter any more? The answer is a resounding YES!!! Yes, your physical capacity has been reduced by various governmental policies. What we need to be focusing on is managing that effective capacity as profitably as we can and at the same time be generating other revenue streams to help offset the loss of our full physical capacity.


Would love to hear your thoughts and examples!

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