The results from my recent survey are in and in this series of articles we’ll be talking about some of the findings. We now have a total of 142 respondents who shared their definitions of dynamic pricing, their thoughts on where dynamic pricing had the most potential, the potential challenges they foresaw and talked about the likelihood that dynamic pricing would be adopted in the industry.
In my last article, I talked about how the definition of dynamic pricing varies, but that in general dynamic pricing is all about prices varying based on demand.
OK, this is nice, but why would a restaurant adopt dynamic pricing? Given my experience in the hotel and other industries, I can think of many reasons, but decided to ask the survey respondents what they thought. Not surprisingly, the top reason (92 percent of respondents) was to increase revenue. But reasons No. 2 and No. 3 might surprise you. The second most chosen response (82 percent) was to spread demand to slower periods, while the third was to better manage capacity (70 percent). To me, this indicates a good understanding of the fact that dynamic pricing is NOT just about increasing prices during busy periods. Let’s dive in and talk about the these benefits.
Reason No. 1: Increase Revenue
The hotel and airline industries typically achieve 3–5 percent revenue gains with revenue management and dynamic pricing. Dolan and Simon, in their cross-industry study on pricing, found that a 1 percent increase in price led to a 12 percent increase in profit. If you can maintain your current sales volume, the profit potential is even higher.
Let’s take a look at the revenue gains that some of the pricing companies have been able to achieve. Koti Pizza has achieved 6 percent increase in revenue by using Priceff’s dynamic pricing for delivery. DynamEat, in their work with a multi-unit restaurant chain, was able to increase the margin for dinner by about 15 percent without reducing volume. Similarly, Piada was able to double delivery margins by using Sauce Pricing.
Given the experience of the airline, hotel, cruise line and multiple other industries, I am confident that appropriate use of dynamic pricing will lead to increased revenue and profit. Please note my use the term “appropriate.” Appropriate entails increasing profit without affecting customer satisfaction. As Carl Orsbourn of Juicer states, “ surge pricing is not the best way to describe how dynamic pricing can help restaurants. Setting guard-rails on upper and lower thresholds for prices is important so that the guest experience isn’t impacted negatively through the introduction of this functionality.”
Reasons No. 3 and 3: Use Price to Help Spread Demand
I’ve lumped reasons No. 2 (spread demand to slow periods) and 3 (better capacity management) together, since they are essentially the same thing. For example, as one respondent stated, “Dynamic pricing changes based on a range of factors selected by management to take advantage of high demand and also generate increased interest in low demand. This could relate to times of day, menu items, seating locations or more.” Similarly, another respondent said,“‘Pricing that fluctuates according to demand. Lower prices when demand is low. Higher pricing when demand is high.”
Restaurant demand varies wildly throughout the day and by day of week. At times, demand is so high that the kitchen can’t keep up. Rather than taking the risk of dissatisfying customers whose orders can’t be fulfilled in a timely fashion, some operators turn off (throttle) some of their distribution channels (i.e. online orders, takeout orders) to reduce demand to a manageable level. Throttling has become so widespread that it’s even offered by providers such as Olo, Toast, and QSR Automations.
Think about it. By throttling, we’re turning away customers who obviously want to patronize our business. As Orsbourn told me, “Most restaurants don’t know their optimal capacity. It is left to throttling switches which may not be as informed in their level setting as they should be. Even more concerning, is when throttling switches don’t get switched back on. There has to be a better way to curtail orders than to just switch off entire sales channels—we believe dynamic price changes are one such approach.”
I agree, as do the survey respondents, that this is an area where dynamic pricing can help with.
What can we do to get them to dine with us during slower periods? Isn’t that exactly what restaurants have been doing with happy hour and early bird specials for years? Dynamic pricing is just adding a twist to this—think of it as “happy hour on steroids.”
Happy hours and early bird specials work, but what about other slow periods; would dynamic pricing work? The answer is a resounding yes. For example, in a 2004 study, Alex Susskind and his colleagues found that 75 percent of customers were willing to switch to an off-peak demand if given an incentive to do so. The question then becomes one of what that incentive should be. That’s where dynamic pricing can help.
Another question that arises is whether dynamic pricing can actually help spread out demand. At Koti Pizza, a Harvard study has shown that they were able to reduce within-week demand variation by 10 percent while achieving a 6 percent revenue increase along with a 10 percent increase in transaction orders. Based on this, again, the answer is a resounding yes!
This sounds great, how can you make sure that you don’t cannibalize your business during busy periods?
One of the concerns that operators often have with dynamic pricing is whether offering lower prices to certain customers or at certain times will cause customers who would normally be willing to dine at full price to avail themselves of the discounts.
The hotel and airline industries have faced a similar issue and use rate fences to help distinguish which customers can get the lower prices. For example, with Marriott, customers have to either “do” something or ‘be’ something in order to get a lower rate. Examples of “doing” something might be things like booking for a slow night or opting for a non-refundable reservation. On the other hand, “being” something might include things like being a member of the loyalty program, being over 60 or working for a certain company. By using these rate fences, they have been able to effectively reduce cannibalization. Rate fences can not only help to reduce cannibalization, but can also answer the second fundamental pricing question: how should you determine which customers pay which price?
Restaurants can adopt a similar strategy. “Doing” something might be placing an order ahead of time or choosing to dine during a slow period. “Being” something could be being a member of the restaurant’s loyalty program or be using a targeted promotion.
Back to the Why?
So, why should restaurants adopt dynamic pricing? The survey respondents have spoken: one, so you can increase revenue and two, so you can better spread demand to your off-peak periods. By doing so, you will be able to increase revenue and profit for your restaurant.
In the next article, I’ll be reviewing the ordering and revenue streams that respondents think have the most potential for dynamic pricing. After that, I’ll be analyzing the potential challenges facing operators, providing an overview of what people have tried and discussing the likelihood of the industry adopting dynamic pricing practices.
Sherri Kimes is an Emeritus Professor at Hotel School at Cornell and specializes in pricing and revenue management. She is passionate about helping restaurants increase profitability. She can be reached at firstname.lastname@example.org.