Ford Heeds the Profits
Profits are back in vogue. Even in the dot-com world, which seemed to regard black ink as hopelessly passé, positive cash flow is no longer deemed irrelevant to success. While profitability hinges on many factors, new software that tackles the thorny area of “revenue management” may prove a boon to companies built on bricks, clicks, or any combination thereof.
The term “yield management” may be more familiar, but the concept is the same: get the most money for what you have to offer, through higher prices or simply by ensuring that less of your product or service goes to waste. Pioneered in the airline and hotel industries, where the specter of empty seats and rooms has inspired baroque systems of discounts and pricing policies, revenue management can apply to almost any business, its proponents claim. They argue that while companies have devoted vast resources to driving down costs, too often they have neglected the other side of the coin, missing opportunities to increase revenue and profits through smarter pricing.
It’s a compelling argument, particularly as manifested at Ford Motor Co. While Ford has been much in the news for its E-commerce efforts, the carmaker has quietly been enjoying a huge surge in profitability, one which rival General Motors must surely envy. Between 1995 and 1999, U.S. vehicle sales rose just 6 percent, from 3.9 million units to 4.1 million units. But revenue was up 25 percent, and pretax profits (including financing profits at Ford Credit) soared 250 percent, from about $3 billion to $7.5 billion. Of that $4.5 billion growth, Ford’s Lloyd Hansen, controller for global marketing and sales, estimates that about $3 billion came from a series of revenue management initiatives.
Ford’s ability to make so much more money without making many more vehicles is, as Donaldson, Lufkin & Jenrette analyst Wendy Needham notes, “stunning.” Much of it can be attributed to product-mix improvement. Low- margin vehicles have been phased out, and customers have been enticed to move up to option-laden models that pack a bigger profit punch.
That’s where revenue management comes in: understanding the profit potential of each model and how much to spend to market it requires lots of data and analysis. Which combinations of features do consumers most want? How much will it cost to produce them? How much should they cost? What are the vehicle preferences of buyers in different regions? How would rebates, low-interest financing, and volume discounts affect sales versus profits?
This is where software can help. So far, Ford has relied on various applications, including databases and a Web-based tool, to help managers from product development to sales understand the fine art of profitability.
Starting with a pilot program in the first quarter of 2000 and a wider rollout in July, Ford has also been using revenue management software from Talus Solutions Inc. (www.talussolutions.com). Talus is an Atlanta- based company that made its name in the airline and hotel businesses, but which is expanding into many other industries. Talus originally handled client engagements on a pure consulting basis, creating systems from scratch for each particular company. With years of experience under its belt, it is now in the midst of “productizing” its expertise, offering software (albeit that still requires some serious customization from one client to another) that can help companies assess all the variables that go into pricing and, thus, profits.
“The software makes recommendations, as opposed to automatically setting prices,” says Dr. Robert L. Phillips, the company’s chief technology officer. At least so far. In the airline industry the software does set prices, and Phillips believes that as companies become more comfortable with the technology, a certain amount of automatic price setting will take hold.
Talus works by gathering and analyzing a wide range of data, and incorporating human expertise. For example, in the airline industry it would look at historical, year- over-year booking trends, recent trends, special circumstances (are the Olympics in town?), costs, capacities, and other factors, and recommend (or set) prices so that each flight leaves the ground having earned the maximum revenue possible. In autos it might look at the cost of a rebate, trying to find the sweet spot between big, profit-killing incentives and no rebate at all, which maximizes profit-per-unit but undoubtedly weakens sales.
Hansen says that the principles embedded in the software have guided Ford’s actions for about two years, and by capturing them in a software package they can more easily be made part of the daily routine at Ford. But he adds that key changes in business processes, such as rewarding sales teams for focusing on profits rather than number of units sold, and analyzing customers’ preferences (Ford has managed to boost sales of vehicles ranging from pickup trucks to police cars by offering a more appealing mix of features, at prices within a customer’s reach but with plenty of profit built in for Ford), have played a vital role.
How much of this can ultimately find its way into software is an open question, but Hansen points out that given Ford’s $9 billion marketing budget in North America, an automated approach that saves even 10 percent of that is a huge win. Phillips claims that Talus software can boost the bottom lines of most companies 4 percent to 8 percent, justifying its not inconsiderable price: $1 million for every $1 billion under management, plus implementation and installation costs that can double or even triple that. An ASP (application service provider) option is also offered, starting at $100,000 a month.
The Price You Pay
Another Talus customer, Tickets.com Inc., uses the software to fill empty seats, in much the same way airlines do, by fine-tuning prices so that demand equals supply. “Ticket prices for a play can vary tremendously,” says Brian Peunic, Tickets.com’s senior vice president of sales. “You’ve got orchestra versus balcony, adult versus child, Wednesday night versus Saturday night. Add in all kinds of group discounts, and what you have is a system requiring lots of analysis, which is what Talus is good at.”
To date, Tickets.com has used the software for clients ranging from the Playhouse Square theater group in Cleveland to the Buffalo Sabres hockey team, mostly to set prices on group discounts. But going forward, Peunic sees the potential to derive maximum revenue from individual ticket sales, for example by charging more for front-row concert seats than 10th-row seats. “Dynamic pricing is the next level,” he says, “and there’s not much preventing it now. We have the data and the systems. The market just needs to embrace the technology.”
Analysts agree that revenue management is just beginning to reveal its potential. “It’s like clickstream analysis [of Web-site traffic],” says Mark Smith of Meta Group Inc. “One day it’s an obscure niche product, the next day it’s hot.” Talus is, by most rights, the market leader, although Technology Strategy Inc. (www.grossprofit.com), of Cambridge, Mass., is big in the retail space and Maxager Technology Inc. (www.maxager.com), of San Rafael, Calif., is a force in manufacturing.
Even as these and other companies gear up for battle, however, new players threaten to change the rules of engagement. Austin, Tex.- based Zilliant Inc. (www.zilliant.com), for example, concentrates on “E-pricing,” helping online retailers decide how much to charge. CEO Marvin Newell promises that his company will “make revenue management per se obsolete.” He argues that by concentrating on how much to charge for perishable inventory such as airline seats or cars, companies miss the bigger picture, which requires a focus on customer behavior, preferably in real time. With Zilliant’s technology, he says, companies can adjust Web prices instantly based on consumer response, competitors’ prices, and other factors. In theory, he says, the prices of goods and services could vary moment to moment, like stock prices.
“We won’t see that kind of perfect market in our lifetime,” says Newell, “but one thing is clear: the way companies think about price is changing.”
THE PROFIT GAP: FORD VS. GM
Ford earns nearly twice what General Motors does on a unit basis.*
A Value Deal
To get a better idea of the power of revenue management, consider the Ford Ranger Super Cab. This high-end, four-door pickup truck accounted for about 37 percent of all Ranger sales in 1997. When Ford knocked $700 off the price, sales shot up, and the Super Cab now accounts for 70 percent of all Rangers sold. “We still make thousands more on a Super Cab than on a more basic model,” says Lloyd Hansen, Ford’s controller for global marketing and sales. “It’s like a [McDonald’s] Value Meal: combine the things people want most and even at a discount you still do well.” The company did the same thing on other models, including Mustang convertibles, cutting the price and offering fewer packages and options, but featuring those people wanted most. Software is not essential to such efforts, but it can capture sales data and crunch through the implications of various pricing and configuration scenarios. As strategies go, it’s proven far more lucrative than simply asking, “Want fries with that?”