Where's Herbie?

In my previous article, I talked about the theory of constraints and The Goal.   As I mentioned, there are five steps in the theory of constraints:  (1) identify your bottleneck, (2) exploit your bottleneck, (3) subordinate everything else to that bottleneck, (4) elevate the bottleneck and (5) repeat the process. In this article, I’m going to talk some more about step 1, identifying your bottleneck

In The Goal (you really need to read it!), Alex Rogo, the protagonist, is taking his son’s scout troop on a hike.  The scouts are not keeping a very good pace and Alex can’t figure out why. He tries all sorts of things to pick up their pace, but nothing works. Then he sees Herbie. Herbie keeps falling behind and is struggling to keep up.  Alex notices that Herbie has a heavy backpack that slows him down.  Alex and the scouts distribute Herbie's backpack contents (which includes a huge frying pan along with other assorted junk!) among themselves and presto, the pace picks up and they reach their destination in time.

So, why am I telling you this story? Well, Herbie is a metaphor for a bottleneck.  The key question is ‘who (or what) is Herbie?'   The bottleneck (or Herbie) is the constraint that’s keeping you from reaching your ultimate goal. 

In the case of revenue management (RM), our Herbies are typically physical capacity, whether it be rooms, seats, square meters or tee times. But, with Covid, we now have additional government Herbies (aka policies and restrictions) to contend with.

For example, hotels may be subject to a maximum occupancy percentage, use only alternate rooms or have at least 24 hours between guests. Or, restaurants may have restrictions on the maximum number of guests, a maximum capacity percentage or a maximum party size.   These policy constraints (or policy Herbies!) end up shrinking our physical capacity to what Dan Skodol calls effective capacity.

One of the ‘necessary conditions’ for RM is relatively fixed capacity. Well, that’s sort of changed in the Covid world, but everything else has stayed the same. We still have the same cost structure, variable demand, perishable inventory, varying price sensitivity etc., it’s just that our capacity isn’t the ‘fixed’ that we’re used to managing.

The big challenge is to determine what your effective capacity now is. Policy constraints vary by location and industry. While some are simple (i.e. a maximum of 20 people in a restaurant or 50 people in a meeting room), let’s take a look at a few that are a bit more complex.

Consider a golf course that normally has a 10-minute tee time interval (amount of time between successive parties of golfers) with a maximum of four golfers per party. This would mean that their effective booking capacity is 60/10 = 6 tee times/hour and 6*4 = 24 golfers/hour.  To keep things simple, let’s assume that they now must maintain a 15-minute tee time interval and can still have four golfers/party. Whoops! They’re now down to just 4 tee times/hour and 4*4 = 16 golfers/hour.  This 16 golfers/hour is now the effective capacity that they need to manage.

Or, let’s say a hotel is located in a city that requires that rooms be vacant for at least 24 hours between guests.    Essentially, this means that their length of stay has been increased by one day. While hoteliers normally like longer lengths of stay, this is a longer stay without cash flow on each day—so….but it’s the law, so we must figure out a way to work with it.   To keep things simple, let’s say that the hotel has 100 rooms with an average length of stay of one night.  With the new policy constraint, their effective capacity is now 50% since on average, half of the rooms will be empty at any given time. Conversely if their average length of stay was two nights with the same policy constraint, the effective capacity would now be 67% (2/(1+2)).   

Why do I care about effective capacity?  That’s what you have to work with given your new Herbies. Does Revenue Manage matter in a situation like this? Yes! It’s our job as Revenue Managers to figure out how to manage our new effective capacity as profitably as possible.   I’ll talk some more about that in the next article!