Editor’s note: This is part three of a five-part series on menu pricing. In the next installment, we’ll talk about how best to present your different prices to your customers. Read part one here, and part two here.
Variable pricing has worked well in the airline and hotel industries for years, but could it work in the restaurant industry? Yes, we have happy hours, coupons, and day of week specials. But could we do more?
Restaurant demand varies by day of week, time of day, and time of year. So it seems like that there’s potential for variable (or dynamic) pricing. About 20 years ago, I posed just that question to several restaurant operators and to say I encountered resistance is an understatement. The basic reaction was “we’re running a restaurant, not an airline. That sort of pricing would never work for us.”
As a researcher, these are fighting words, so I wanted to study it.
Before I get into the results of my research (which by the way, show customers are fine with variable pricing policies), let’s talk a bit about pricing in general. As I mentioned in the first article of this five-part series, what I find particularly interesting about pricing is that it’s a mix of science (think price elasticities and such) and art.
I’ll talk about the “art” in a moment, but let’s get some other pricing things out of the way. Let’s say we have a restaurant that sells a hamburger for $10 regardless of the day of week, time of day, or anything else for that matter. Well, some customers would be willing to pay more than $10, but they’re certainly not going to go to the manager and ask to pay more. Conversely, some people don’t want to, or can’t pay $10. If the restaurant charged multiple prices (let’s say $12, $10, and $8), it would be able to increase revenue.
There are two major questions that need to be answered: One, how do you choose the right prices to offer and two, how do you determine who pays which price? We’re going to focus on the second question. A restaurant operator can’t exactly offer the $8, $10, and $12 to customers and ask which they prefer. Well, they could, but I can pretty much guarantee their answer. There need to be reasons why people pay different prices.
Think about pricing in the airline and hotel industries. If you want to pay a cheaper price for a fare, you must do things like book in advance or prepay. Conversely, if you want extra leg room or to board first, you may pay a premium. Similarly, in the hotel industry, if you want a room with a good view, you’ll pay more, but you can get cheaper rates if you stay on certain days of the week or if you’re a member of the loyalty club. The possible reasons why people pay different prices are called rate fences. This might seem like an academic topic but think about how the restaurant industry already uses rate fences. For example, “Taco Tuesdays” (day of week rate fence), “Happy Hours” (time of day rate fence), Restaurant Week, senior discounts, and coupons.
Why am I focusing on rate fences? Well, you need to have reasons for charging different prices and your customers have to be okay with them. The last thing you want is for your customers to feel like you’re ripping them off or that your prices are unfair. Sounds like we’re back to the perceived fairness studies of Kahneman, Knetsch and Thaler that we discussed in the first article.
Jochen Wirtz and I asked customers in three different countries to evaluate the perceived fairness of 5 different rate fences (time of day, day of week, weekend/weekday, table location and two-for-one coupons) on a 1–7 scale (1 equals Very fair, 7 Very unfair).
The results were quite interesting. Not surprisingly, people rated two-for-one coupons, as the fairest (2.2/7), followed by time-of-day pricing (2.99/7), lunch/dinner pricing (3.45/7) and weekend/weekday prices (3.94/7). The only rate fence considered to be unfair was table location pricing (4.42/7).
What does this mean for restaurant operators? Customers find most variable pricing practices studied to be fair. Given this, don’t be afraid to try some out. But, when you do this, make sure that your rate fences are transparent to your customers, are easy to explain and administer and that your customers understand your reasoning. Emphasize that variable pricing allows your customers to choose prices that best suit their needs.
Sherri Kimes (sherrikimes.com) is an Emeritus Professor at the Hotel School at Cornell and specializes in pricing and revenue management. She is passionate about helping restaurants increase profitability. She can be reached at email@example.com.