Research Note: Overselling with Opportunistic Cancellations

Abstract

In many business sectors such as airlines, hotels, trucking, and media advertising, customers' arrivals and willingness to pay are uncertain. Managers must decide whether to quote a price low enough to guarantee early sales, or to quote a higher price and risk that some units remain unsold. In allocating capacity, they face a trade-off between two types of potential losses; (1) —selling at a low price, and losing a better price later, and (2) —waiting in vain to sell at a high price, and losing the opportunity of an earlier low price offer. Yield loss means that consumers who value the product most do not get to use it, and spoilage loss means that valuable products are wasted because no consumers get to use them. Sellers typically hedge against the risk of spoilage loss by selling some units early at low prices, and against the risk of yield loss by blocking some units in hope of selling them later at a high price. In this paper we show that the use of overselling with opportunistic cancellations can increase expected profits and improve allocation efficiency. Under this strategy, the seller deliberately oversells capacity if high-paying consumers show up, even when capacity is already fully booked. The seller then cancels the sale to some low-paying customers while providing them with appropriate compensation. We derive a new rule to optimally allocate capacity to consumers when overselling is used, and show that overselling helps limit the potential yield and spoilage losses. Yield loss is reduced because the seller can capture more high-paying customers by compensating low-paying customers who give up their right to the product. Spoilage loss is reduced because the compensation decreases the price spread perceived by the seller, and as a result, the seller is less anxious to speculate and “block” units. Overselling with opportunistic cancellations assures that the product will be sold to consumers who value it most. This means that “everybody wins”, and resources are allocated more efficiently than in conventional selling.Overselling, Overbooking, Yield Management, Yield and Spoilage Losses, Capacity Management

Market structure and the value of overselling under stochastic demands

“…First, we enrich the extant literature by focusing on the value of overselling as market structure shifts between monopoly and duopoly. In absence of competition, we strengthen the main result of Biyalogorsky et al (1999) by showing that overselling continues to shine as the optimal selling strategy even when early arrival can be limited. Second, we show that overselling by both firms as a (weakly) dominant strategy may fail to hold in a competitive setting.…”

“…7 This assumption is consistent with Biyalogorsky et al (1999) and Lim (2009). In addition, when v2 is sufficiently larger than v1, the price in Period 2 is higher than that in Period 1 so there is no incentive for early consumers to delay their purchase till Period 2.…”

“…Even if consumers do not skip reservations, Biyalogorsky et al (1999) showed that overselling with opportunistic cancellation is always profitable for a monopolist, as long as the late-arriving consumers value the ticket more than early-arriving ones. With the same model setup, Lim (2009) extended it to a duopoly and showed that overselling is a weakly dominant strategy although the outcome where both firms oversell may not always be Pareto-dominant.…”

“…Inspired by travel and lodging industries, we examine a two-period model in which each seller may also adopt the overselling strategy to customers whose valuations are differentiated by timing of arrivals.Widely seen as a popular hedge against consumers' skipping reservations, we extend the stylized approaches of Biyalogorsky et al (1999) and Lim (2009) to understand the value of overselling under various market structures. We find that contrary to existing literature, the impact of period-two pricing competition from overselling spills over to period-one such that overselling may not always be a (weakly) dominant strategy once unlimited early demand ceases to hold in a duopoly regime.…”

Electronic Tickets, Smart Cards, and Online Prepayments: When and How to Advance Sell

“…These tools include overbooking capacity, reserving capacity, and estimating available capacity. Overbooking with opportunistic cancellations can significantly improve firm profits (Biyalogorski et al 1999).…”