What are the Biggest Challenges with Implementing Dynamic Pricing?

    So you've decided to try the strategy. Where should you begin?

    Menu on a restaurant table next to silverware.
    Adobe Stock
    The application of dynamic pricing has to be done with the customer in mind.

    The results from my recent survey are in and in this series of articles we’ve been 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 they talked about the likelihood that dynamic pricing would be adopted in the industry.  

    In my last article, I talked about the “where” of dynamic pricing, but in this article we’ll be talking about the “what” of dynamic pricing. Specifically, I’ll be talking about what operators foresee as the biggest challenges with implementing dynamic pricing.  

    What’s the What??

    I presented the survey respondents with 10 possible challenges associated with dynamic pricing and asked them to rank their top three. Bet you can’t guess what came out on top.

    Let me help you out a bit. I was reading through my local “Nextdoor” feed and noticed the following post.

    Last week, while dining out at a local restaurant, one of us noticed that the cost of his entree on the bill was higher than the menu price by $2. He brought the discrepancy up to the server and she at first appeared confused about it but eventually told us that there had been a price increase, but that the new menus had not yet been printed. She refused to correct the price to what had been advertised on the menu. Upon further checking, our table of 4 discovered that each entree was higher than the price which had been provided on the menus from which we placed our order for a total overage of $7 for our table. We stewed about this for a few minutes and observed others enter the restaurant and place to-go orders at the register without being told that the prices had changed and with no corrections having been made to the paper to-go menus or the regular dine-in menus. I flagged down our server and politely asked whether the manager was available and he was not. I replied that charging higher than menu prices without notifying customers of the change in advance was essentially theft and that if the management of the restaurant had made that change and the staff knows about it, then they're participating in the theft.”

    As you might expect, there were quite few comments on this post and they were not exactly on the understanding side.

    Indeed, survey respondents were most concerned about customer reaction to dynamic pricing. The top two reasons given were one, how to communicate price differences to customers and two, potential customer resistance. This concern showed up in multiple comments from respondents. Consider the following comments from the survey respondents, "customers need a certain level of predictability,” “can the price go up as I sit in the restaurant?,” “if the customer cannot count on their restaurant maintaining price stability, they will simply shop for their next meal via “Expedia”-like apps,” and “unfair.”

    What the Research Shows

    Based on my research, customers are fine with varying prices (particularly if framed as a discount), but only if they know what the prices are, and as a result, have control over whether to purchase at that price. Happy hours are a great example of this. Customers know when happy hour is and also know what prices and options are available then. They can either choose to go at that time or not.

    Customers are also fine with prices going up if your costs increase. For example, consider the following comment from the ‘nextdoor’ feed I displayed. “I don’t mind paying what they have to ask to stay in business. But make sure you post it correctly, because it makes us feel like you’re trying to pull one over us. I don’t blame you if you have to raise your prices, but let us know upfront and be honest about it.”

    If prices just change without any particular reason (in revenue management, we refer to these reasons as rate fences), customers get upset.    

    Perhaps customers don’t even notice when prices change, particularly if the changes are fairly small, but if they do notice, how will they react? And, even more importantly, how will you explain it to them? Saying that you charged more because you could won’t go over too well!

    Remember the Customer

    I’m certainly not saying that restaurants shouldn’t use dynamic pricing, but based on my research and experience in multiple industries, the application of dynamic pricing has to be done with the customer in mind. Research shows that customers are perfectly fine with prices varying by time of day, by day of week, by relative busyness and by physical location, but the key here is that the customers know about the “rules” for different prices and can choose when to purchase their meal.  Some people may worry that customers will always choose to purchase at the lowest price, but think about it—does happy hour take away from all of your peak hour business? No!

    Rate fences are called fences because their purpose is to keep customers who are willing to pay a higher price from purchasing at a discounted price. For example, you can get a cheaper flight if you choose to purchase a non-refundable ticket. Or, you can get a cheaper room if you book a room during the off-season.  If you want to learn more about rate fences, please take a look at my previous article on this topic

    The way in which varying prices are communicated to customers matters.  For example, Koti Pizza lets customers monitor how delivery prices vary. As a result, they have been able to dampen demand swings. Or Domino’s gives customers a "tip" if they order pickup rather than delivery.  Some European restaurants have higher menu prices for customers seated outside and many high-end restaurants in the US offer lower prices during lunch or at the bar. Or, Del Taco offers lower prices on Tuesdays.

    As Eli Chait, the CEO of Wholesail asked me many years ago, “How do you design the optimal happy hour?”  What a great question. It’s not just what prices to charge, but also the “when,” “who,” and “what” associated with those prices. That’s essentially what we’re trying to do with dynamic pricing.

    This takes us back to the two fundamental pricing questions that I talked about in the first article in this series: one, which prices should be charged, and two, how to determine who pays which price. As we discussed, the answer to the first question is sometimes more based on math, while the answer to the second question is more based on market segmentation and consumer psychology (i.e. rate fences).

    Moving Forward

    In the next article, I’ll be talking about the “when” of dynamic pricing. Specifically, I’ll be 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 sk@sherrikimes.com.