Optimal Pricing Considering Customer Categories:
Case on Car Rental Industries
N.A. Masruroh, V.P. Tjakra, R.R. Ratinghayu
Department of Mechanical and Industrial Engineering, Gadjah Mada University, Yogyakarta, Indonesia
(aini@ugm.ac.id)
Abstract – Segmentation of the customer provides an
opportunity to offer more than one class with the different
price. However, the most occurring problem is the loss of
demand for lower class due to its high demand but limited
capacity, while the utility of the higher class is low due to its
high price. Thus, setting the right price becomes critical.
This paper proposed optimal pricing models considering the
customer segments. Car rental business is used as a case
study. The capacity of car rental business is dynamic since
the number of cars available might dynamically change due
to the dynamic return time of the customers. Two scenarios
are proposed, without substitution and with substitution.
Since the models are non-linear programming with
constraints, KKT procedure is applied to get the optimal
solution. Results from the case study show that the proposed
model enables to increase revenue significantly.
Furthermore, substitution scenario has the opportunity to
obtain higher revenue.
Keywords - car rental industry, non-linear optimization,
substitution, third-degree price discrimination
I. INTRODUCTION
Competition among business is getting tenser
recently. To win the competition, there are some
strategies that can be applied. One of them is Revenue
Management (RM) that is defined as the strategy of
selling the right product for the right price at the right
time to the right customer [1]. Following the success of its
application in airline industries, RM becomes widely used
in other industries especially when the products are
characterized as perishable, such as hotel, retail, sport and
entertainment ticket, cargo, car rental, etc.
Car rental business has similar characteristics with
airline and hotel industry. The product can be categorized
as perishable and it can be booked earlier. The customers
also can be segmented into some classes and also the
products can be differentiated into some groups. The main
difference between car rental business and airline or hotel
industries is that the capacity in the car rental business is
dynamic since the number of cars available might
dynamically changing due to the dynamic return time of
the customers.
Based on the decision variable, two RM strategies can
be applied; quantity based RM and pricing based RM.
Both strategies use maximize revenue as objective
function. Quantity based RM concerns on how to
optimally allocate limited resources to different demand
classes. It can be said that quantity based RM reduces
sales by limiting supply. However, if a company has
price flexibility, instead of reducing sales through limiting
978-1-5386-0948-4/17/$31.00 ©2017 IEEE
supply, the company might reduce sale by increasing
price. In this case pricing based RM can be used. Pricing
based RM use price as control variable. Thus the problem
in pricing based RM is how to make such price
adjustment in order to maximize revenue [2]. However
the distinction between the two is not sharp. Also, some
previous works conclude that car rental business can be
used either quantity based RM or pricing based RM.
If the application of RM in airline industry starts in
1975, the use of RM in the car rental industries starts
about 1994. One of the pioneers for this implementation is
National Car Rental. They applied the concept RM to
control the capacity, manage the price, and determine the
overbooking policy. It was reported that they could
improve revenue by $56 million in the first year [3].
An example of work that uses quantity based RM for
car rental business is done by Guerriero and Olivito [4].
They developed deterministic linear programming to
determine the decision of accepting or rejecting the
booking request. The possibility for substitution is
accommodated. In this case, the demand for a class can be
substituted with superior class using an upgrade
mechanism. Another approach was proposed by [5]. In
their work, flexible capacity is considered. For this
purpose, dynamic booking control problem is formulated
as discrete-time stochastic dynamic programming under
the infinite time horizon. Heuristic algorithms were
proposed to solve the model.
Pricing based RM or dynamic pricing assumes that
price has impact on demand. Customers can be
categorized into myopic and strategic customers based on
their purchasing behavior. Customers who buy as soon as
the offered price is less than their willingness to pay is
categorized as myopic customers. In contrast, strategic
customers will optimize their purchasing behavior in
response to the pricing strategies of the firms [2]. While
most work is done with the assumption that customers
have myopic behavior, Ref [6] developed two pricing
schemes for the strategic customers called posted and
contingent pricing. They concluded that the optimum
strategy is posted pricing with two to three times of price
changing over a finite time horizon. Ref [7] developed
pricing model that considered substitution scenario. Static
deterministic optimization was used to manage multi-
product and determine the pricing strategy to optimize
profit.
The main problem in the car rental business is
determining the most appropriate cost and structure
pricing. This is based on the fact that the purchasing cost
for a car is relatively much higher in comparison with the
rental fee [8]. Customers of car rental can be grouped into
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 Proceedings of the 2017 IEEE IEEM
several segments based on their valuation. This
segmentation provides an opportunity to offer more than
one fleet class with the different price. The differences
between classes are usually in the additional features or
vehicle types. Customers for the higher class mostly come
from business traveler and leisure traveler usually prefers
the lower class. The problem arises when the demand for
a certain class is higher than the capacity while the
demand for another class is lower than the capacity. If the
excess demand comes from the class I, it will not create
any problem since it is assumed that the purchasing power
of customer class I is the highest thus whenever the
capacity is not available they are willing to downgrade to
class II. The problem is when the excess demand is the
class II customers. These customers cannot afford the
price for class I. Based on that condition, this paper tries
to develop mathematical model to obtain the optimum
pricing with two scenarios; (i) without considering the
possibility of substitution, and (ii) considering the
possibility that class I may fleet substitute class II fleet
and not vice versa (one-way substitution). The concept of
third-degree price discrimination is adopted with the
assumption capacity is solely expended upfront before
demand is realized and the length of rent is affected by its
price.
II. METHODOLOGY
The model development starts with developing
demand and duration model. The demand function is
developed as a function of price variance for both fleet
classes. While the duration function is obtained from the
relationship between rental duration and the price
variance. Historical data is used to set the parameter
values. The capacity is expressed as the availability of
vehicle and in this case, is dynamic, depends on the return
rate of the vehicles and the possibility of substitution.
As previously mentioned, the revenue model is
developed under two scenarios; without substitution and
with substitution (one-way substitution). Revenue is a
function of duration and price. Also, the duration is a
function of price. The minimum number of vehicle and
vehicle availability becomes constraints. Thus, the model
is a constrained NLP model. In order to get the optimum
price, Karush-Kuhn-Tucker algorithm is applied.
III. RESULTS
This research focuses on middle-class car rental
business. In this segment, the customers are price
sensitive and the demand is time dependent. In general,
customers in car rental industry may rent a car without
any time limit at a specified price as long as the capacity
is available. Since there is a capacity constraint, the
company has to be careful in determining the right rental
fee, in order to maximize profit within limited resources
(fleet) without losing any potential customer. In the case
that the effect of seasonality is significant, the model will
be developed for both peak and off peak season.
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A. Seasonality effects
The effect of seasonality will be assessed to see if
there is any peak or off-peak periods within a week. For
this purpose, we apply ANOVA to the daily revenue for
each class of fleet. The results show that the first class
fleet doesn’t have any peak period, while second class
fleet does have peak and off-peak period. The result from
post hoc test using Tukey’s test for the second class fleet
revenue shows that peak season happens on Friday and
Saturday, while off-peak season happens on Sunday to
Thursday. Thus for the second class fleet, the model will
be developed for both peak season and off-peak season.
B. Pricing Model I: Without Substitution
Fig 1. presents the visualization on how the
parameters used in this model interact each other. Initial
inventory, Vi(t-1), refers to the number of fleet i in the
previous period and di(t-1)) represents the number of
demand realized before period t which will reduce initial
inventory.
Fig. 1. Parameters Visualization without Substitution Model
Basic assumption used in this scenario is second class
customer can only be served by second class fleet, and
first class customer can only be served by first class fleet.
In period t, initial i class fleet which is not used remain in
the station and denoted by i( − )− i( − ). The number of i
class fleet increases as i class fleet from previous period
or period t ends its trip in period t with the rate of i( ). Let
Pi be the rental fee for class i and , , is the rental
duration of class i, customer k, at time t. then the objective
function becomes:
= , , ∗ ( ) + , , ∗( )
(1)
Subject to:
, ≤ ( , − , + ) (2)
, ≤ ( , − , + ) (3)
The decision variables in this scenario are the rental
fee per 24 hours for first class fleet (P1) and the 24-hour
rental fee for second class fleet (P2).
The stages of optimization process are as follows; (i)
company determines the rental price for both types of
fleet, then (ii) given the price, the customer determines the
demand and duration for the desired fleet. Since
customers are price sensitive, the cheaper its price, the
longer duration will be taken. The customer's demand on
 Proceedings of the 2017 IEEE IEEM

a fleet can only be realized after ensuring that the fleet is contains second class fleet which available at time t plus
indeed available at the rental location. portion of first class fleet which is allocated to fulfill the
Equation (2) and (3) describe that customers will get second class fleet demand, ψ1(t).
their demand realized if demand of the required fleet does
not exceed the minimum number of the required class
fleet available at time t.
It is assumed that the rental duration of class i, Δi, is a
function of price. And so does the demand of class i in
period t, di,t. Thus,

∆ = − (4) ; ∆ = − (5)
. = − (6) ; . = − (7)
Fig. 2. Parameters Visualization with Substitution Model
Where d, e, a, b, i, j, k, l, are constants in both duration
and demand function for both class. To make the The demand and duration function become:
optimization process easier, d2,t in equation (2) is
substituted by equation (7) and d1,t in equation (3) is ∆ = − + (15) ;∆ = − + (16)
substituted by equation (6). Then we obtain the following = − + (17) ; = − + (18)
, ,
equations:

0 ≤ , + 2 − 2 + (8) Where B, E, J, L, are constants. Equation (16) – (18)

shows that duration and demand function in with
0 ≤ , + 2 − 2 + (9) substitution scenario affected not only by its price but also
by the price of the substitute product.
Thus the objective function in the forms of Lagrange is The substitution scenario is expected to reduce the
denoted as follows: loss of the second class fleet demand and increase the
utility of first class fleet. The objective function is
= − + − + + , + 2 − 2 + developed by multiplying the rental fee by the duration of
+ ( , + 2 − 2 + ) the rent for each fleet minus the penalty cost (Pcost) as
(10) consequence for substituting second class by first class
Then the optimum price are: fleet. It can be formulated as follows.

∗
= /2 (11) Max = ∑ ∑ , , ∗ ( ) + , , ∗( ) −
∗
, , =( 2 − , − + ± , − , + ∗ (19)
2 − , − + − 2 ( ) 2 − , − ) /(4 )
Subject to:
(12)
∗
= /2 (13) ≤ ( − + )+ ( − +
, , , , ,
∗
, , =( 2 − , − + ± ) (20)
, ≤ (1 − )( , − , + ) (21)
2 − , − + − 2 ( ) 2 − , − ) /(4 )
(14) Equation (20) and (21) represents the availability
constraints. The minimum number of available rental fleet
C. Pricing Model II: With Substitution is influenced by previous demand, return rate, initial
average inventory and portion of first class fleet to
In this scenario, the first class fleet is allowed to serve fulfilled second class demand (ψ).
second class fleet demand but not vice versa (one-way Substituting equation (17) to equation (21) and
substitution). This is the solution to the problem of losing equation (18) to equation (20), the constraints become:
the second class fleet demand due to its limited capacity,
while the first class fleet has low utility due to its low 0 ≤ (2 −2 −2 ) + , + + ψ( − − )+
demand.
Fig 2. represents the visualization on how the ( , + ) (22)
parameters used in this model interact each other in the 0 ≤ (2 − )( − − ) + (1 − ) , + (23)
model. Initial inventory, V(t-1), represents the number of
fleet in previous period (period t-1) and d(t-1) denotes the The Lagrange function for the objective function can be
number of demand realized at period t-1 that will reduce formulated as follows.
the initial inventory. In the substitution model, the
available fleet to meet second class demand, V2(t),

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 Proceedings of the 2017 IEEE IEEM

= [ (− + + ) + (− + + )− rental fee during the peak season is expected to decrease

((ψ( − − )+ ,+ )∗ ) + ( (2 + ) − demand, while the decreasing price in first class fleet and
(2L + ψJ) − (2 + ) + , + + + ) +
,
second class fleet rental fee at off-peak season is expected
((2 − )( − − ) + (1 − ) , + )]
to increase the demand in that period. The results of
paired t-test show that after optimization, there is a
(24)
significant increase in revenue for both conditions. It also
We address three possible scenarios based on the can be seen in Fig. 3. In addition, the utility of first class
possibility of the Lagrange multipliers. fleet is improved.
Scenario A: when Lagrange multipliers and
both equal to zero. Thus partial derivative of (24) to TABLE I
PARAMETERS FOR WITHOUT SUBSTITUTION SCENARIO
and denoted as follows:
No Parameter Value
∗ ( ) ( ( ))
= ( )
(25)
1 Length periode 24 hours
∗ ( ) ( ( ))
= ( )
(26) 2 First class fleet demand function per period 8,58 – 1,218E-05 *P1

3 First class fleet duration function per customer 3,371- 3,7E-06 *P1
Scenario B: when Lagrange multipliers equal to
Second class fleet demand function per period
zero, while not equals to nol. Thus partial derivative 4
(peak)
14,45 – 1,723E-05 *P2
of (24) to and denoted as follows: Second class fleet duration function per
5 2,789 – 3,83E-06 *P2
customer (peak)
( ) , (( ) ) Second class fleet demand function per period
( ) 6 21,6 – 3,78E-05*P2off
(off-peak)
∗
= ( )
(27) Second class fleet duration function per
7 2,863 – 3,91E-06 *P2off
customer (off-peak)

( ) (( ) ) 8 Initial inventory first class fleet 5 unit/24 hours

,
( )
∗
= ( )
+ 9 Initial inventory second class fleet (peak) 10 unit/24 hours

( ) , 10 Initial inventory second class fleet (off-peak) 18 unit/24 hours

− ( )
(28)
11 Return rate first class fleet 2 unit/24 hours

Scenario C: when Lagrange multipliers is not 12 Return rate second class fleet (peak season) 7 unit/24 hours
equals to zero, while is equal to zero. Thus partial 13 Return rate second class fleet (off-peak season) 5 unit/24 hours
derivative of (24) to and denoted as follows:
∗
TABLE II
− ( − )( − ) +( + )( − )( + )
= BEFORE-AFTER OPTIMIZATION PRICE WITHOUT SUBSTITUTION
[− ( + ) +( + )( + )( + )] + [ − ( − ) +( + )( + )( + ) ] SCENARIO
( + ) ( + )− ( + ))(−(2 + ) + , + + ( , +
−
[− ( + ) +( + )( + )( + )] + [ − ( − ) +( + )( + )( + ) ]
Second Class Fleet Rent Fee/24 hr First Class Fleet
Optimization
∗ peak off-peak Rent Fee/24 hr
(2 + )∗ ∗
− (2 + ) + 2, −1 + 2 + ( 1, −1 + 1 After Rp 365.000 Rp 266.000 Rp 417.000
=
(2L + ψJ) Before Rp 300.000 Rp 450.000
(29)
IV. DISCUSSION 14,000,000
Revenue

A. Without Substitution Scenario 9,000,000

4,000,000
It is assumed that the demand for each period is
1
8
15
22
29
36
43
50
57
64
71
78
85
92
99

constant. With the aim of testing the model performance, Day

data of a car rental company is used with the parameter as
real model
in Table I. Table II shows the comparison between initial
condition and after optimization condition. Fig. 3. Total Revenue Model-Real Comparison Simulation
It can be seen from Table II that price changes occur
to balancing disparity demand between both classes of B. With Substitution Scenario
fleet. First class fleet has lower demand than the second
class fleet and demand at peak season is much higher than The case study for substitution scenarios is conducted
off-peak season. The increasing price in second class flee by using hypothetical data since no real data is available.

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 Proceedings of the 2017 IEEE IEEM

Table III shows the parameter used for the substitution opportunity to get higher revenue. For further research,
scenario. After determining parameters, optimal price can the model can be developed by also anticipate the change
be obtained by implementing KKT procedure. of demand within one period, since the optimal pricing
Comparison of price with variation of ψ and Pcost can be model in this study has not accommodate the change of
seen in Table IV and Table V respectively. Table V shows demand within a period of time.
that substitution scenario has opportunity to obtain greater
revenue than no substitution scenario. The more portion TABLE V
of first class fleet to serve second class demand (ψ), the COMPARISON OF REVENUE WITH SUBSTITUTION SCENARIO
more revenue can be obtained.
Substitution Condition TOTAL
TABLE III
Pcost Rp 30.000
PARAMETER FOR WITH SUBSTITUTION SCENARIO
Yes (ψ 20%) Rp 11.706.000
No Parameter Value Yes (ψ 40%) Rp 13.975.000
1 Length periode 24 hours Pcost Rp 50.000
First class fleet demand function 4,19– 1,6E-05 *P1 +
2 Yes (ψ 20%) Rp 11.538.000
per period 1,41E-05*P2
First class fleet duration function 3,98– 1,42E-05 *P1 + Yes (ψ 40%) Rp 13.950.000
3
per customer 1,2E-05*P2
4 Second class fleet demand function 8,87– 4,92E-05 *P2 + No Rp 12.938.000
per period 5,78E-05*P1
Second class fleet duration function 4,165– 1,85E-05 *P2 +
5
per customer 1,01E-05*P1 REFERENCES
6 Initial inventory first class fleet 4 unit/24 hours
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are segmented into two classes. The model is developed Helia, University of Applied Sciences, 2013.
based on third-degree price discrimination concept. The
dynamic changing of capacity is explicitly included in the
models. Two scenarios are considered; (i) without
possibility of substitution and (ii) with possibility of
substitution. Since the resulted models are NLP with
constraints, KKT procedure is applied to get the optimum
price. Based on the numerical studies it can be concluded
that both scenarios enable to increase revenue
significantly. Further, substitution scenario provides

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