Thursday, November 6, 2008

Key Marketing Metric - Understanding The Difference Between Displacement And Dilution

Unwise Discounting Can Reduce Profits And Market Share

By David Miranda

Revenue optimization, once known as yield management, is relatively new to marketing. It was developed first in the travel industry. The premise is that perishable inventory (airline seats, hotel rooms, rental cars, cruises) is directly and dynamically correlated to key factors such as time, supply, and demand. It is the primary reason that the price of an airline ticket varies so dramatically among passengers on the same flight. Some passengers booked well in advance to get the best fare, while others who had to book at the last minute paid the highest price.

Of course, this is not an exact science, but a sophisticated "guessing game" by the airline, hotel, car rental firm, or cruise line. The process requires huge amounts of data to be "crunched" to determine the number of seats, rooms, etc. to be offered at any given price. When demand is low, more inventory is offered at lower prices and vice versa.

Revenue optimization has now made its way into other sectors, but caution should prevail. Many times business utilizing the practice displace or dilute revenues, so it's important to know the distinction.

Displacement refers to selling at a low price during periods of high demand. This unwisely "displaces" higher revenue to competitors after the company, who sold out its inventory at the low price, cannot meet additional demand. The result is that the competitor benefits from higher margins. Example: A company decides to offer a product at a highly discounted price and sells out. Unfulfilled demand is forced to competitors who charge more for the same product realizing higher profits.

Dilution refers to unnecessarily discounting prices to customers who either have already or would pay a higher price. Example: A company has already sold products at a higher price, but the product is moving slowly, so the company decides to sell remaining inventory at a lower price. Dilution occurs when the customers who already paid the higher price now demands the discount afforded others. The result - dilution.

The lesson is clear. A company must first analyze the potential effects of discounting - will it dilute revenue already realized or will it displace higher margin business to competitors?

Before considering discounting, do the math!