Editor’s note: This is part one of a five-part series on practical pricing pointers. In the next story, we’ll focus on how to handle pricing when your costs increase.
How often have you heard these statements?
“My costs are going up, but if I raise my prices, my customers will go ballistic”
“I’m do busy during lunch and on some weekend nights. I’d like to charge more then, but how will my customers react?”
“The delivery commissions are just killing me. I’d like to charge more for delivery orders, but what would people say?”
If you’re worried about these sorts of things, you’re not alone. The challenge operators are facing is to maintain profitability while not negatively affecting customer satisfaction. There’s some really interesting (and useful) research that can help us answer these questions. In this first part of a five-part series on practical pricing pointers, I’ll discuss the implications of this research and talk about how you can use it to make better pricing decisions.
What I find particularly interesting about pricing is that it’s a mix of science (think price elasticities and such) and art. One of my favorite statements about pricing is that it’s 50 percent science and 90 percent art. Our focus will be on the “art” of pricing.
The key issue to consider is customer reaction to your increased prices. If your customers believe that your increased prices are unfair, you may risk losing their business. But, at the same time, you need to increase your prices so that you can stay in business. This dilemma is exactly what Daniel Kahneman, Jack Knetsch and Dick Thaler addressed in their award-winning studies on perceived fairness.
They studied perceived fairness in many industries and found that fair behavior is instrumental to long-term profit. Basically, if customers feel like a company is behaving in an unfair fashion, they will not patronize that business again in the future. They also found that customers are quite okay with companies making a profit, but that in return, customers feel that they deserve a reasonable price. OK, you might be saying, but how in the world do you do that?
Customers base their fairness perceptions on the reference price and the reference transaction. The reference price is how much people think something will cost and consists of things like the last price someone paid, prices seen in advertisements or perhaps on what friends have paid. If the actual price is different than the reference price, customers may feel that it is unfair.
The reference transaction is how people think a transaction should occur. For example, some customers may think that they can get cheaper prices for delivery if they contact the restaurant directly. If that’s not true, customers may feel like the practice is unfair. Basically, any time you “violate” a reference price or reference transaction, you risk causing customers to believe that you’re behaving in an unfair fashion.
The researchers found that customers believe three basic things: One, raising price to maintain profit is considered to be fair, two, raising price to increase profits is considered to be unfair and(three, maintaining prices when costs decrease is considered to be fair. Let’s talk about each of these.
Raising price to maintain profits is considered to be fair. Given that labor and food costs have been increasing, this is a good for restaurateurs, but how should you go about raising your prices? We’ll talk about this in the next part of this Practical Pricing Pointer series.
Raising price to increase profits when costs stay the same is considered to be unfair. Given that this is exactly what industries in the airline and hotel industries have been doing for years, what lessons can be learned? They’ve obviously figured out how to do this without affecting customer satisfaction, but just how? We’ll talk about this in parts 3–5 of this series.
Maintaining price when costs decrease is considered to be fair. While it’s possible that labor and food costs will go down in the future, we have to prepare ourselves for the possibility that they don’t. Even if these costs decrease, some operators may choose to maintain price since customers will have become accustomed to paying the higher price (back to the reference price concept). From a competitive standpoint, this could potentially cause some issues since you might set yourselves up for some undercutting from your competitors.
In summary, it is possible to increase prices without negatively affecting your customer satisfaction. The key thing to think about is the perceived fairness of these price increases.
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.