The psychology of dynamic pricing in restaurants
Updated: Aug 12, 2019
Dynamic pricing is well established in some industries. Changes in airline prices for a specific date change over time. There was once (and may still be) a discount for flying over a Saturday night that allowed airlines to differentiate between business travellers and leisure travellers who are more price sensitive. Sports teams have started to price games based on opponent, day of the week, ticket sales, and in some cases, even the weather. Although revenue management is tricky and needs to be done strategically, it can be a very effective tool in improving revenue. It is interesting to see other industries begin to explore the possibility of dynamic pricing.
So what exactly is revenue management or dynamic pricing?
It is the strategic management of inventory or capacity to maximize revenue. Selling the right product, to the right customer, at the right price. Some would argue that revenue management is unethical. How can you charge different people different prices for essentially the same product? The truth is that we all value things differently. If dynamic pricing is established in a way that customers can understand and perceive as fair, then it can be very effective.
I have long argued that the restaurant industry is perfectly suited to execute dynamic pricing. A recent article highlights some restaurants that have have started doing it. I have also spoken to some restaurants that have begun experimenting with the concept. In truth, many have done it for a long time now. Offering discounts on slow nights or early before the dinner rush is essentially dynamic pricing. Restauranteurs are using a discount to incentivize customers to move to lower demand times in order to manage their capacity more effectively.
One of the keys to revenue management is perishable inventory. Restaurants effectively rent you a seat and seats are perishable. If my 30 seat restaurant is empty from 4pm-6pm, I don't then have 60 seats from 6pm-8pm to make up for it. However, if I can get people into those seats between 4pm-6pm (and out by 6pm) I will be better off as long as I can cover my variable costs of serving that customer. This phenomenon drove happy hour or early bird specials. This is hardly new. Even grocery stores have done it by offering student or senior discounts to encourage shopping on slower days.
Where we are seeing a change now is in prime time offerings. Demand on Friday or Saturday at 6pm is higher than the same day at 4pm, or Tuesday at 6pm. If we can't move people from those high demand times with price discounts and we must instead turn people away at peak times, we are missing potential revenue. Perhaps dinner should be more expensive on Saturday night. As a potentially contentious concept, this would require careful management. I know a restaurant that only uses a blackboard menu so price changes are easy to manage. If you have day or time specific menus then care needs to be taken to ensure the right ones are given to customers at the right time.
The key is to motivate the price differences in a way that customers can understand. A Tuesday senior or student special is easily understood. However, will customers be as understanding if they are told there is a premium for Saturday relative to Thursday, even for the same customer? The truth is that there will undoubtedly be some grumbling about this approach, but it can be rationalized. Urban hotel rooms are more expensive during the week when business demand is higher. The challenge will be in the way the dynamic pricing is presented.
Psychology tells us that people are "loss averse". This means that if the price is higher than we expect (measured against a benchmark called a reference price), we have a more negative reaction than if the price was better than we expected by the same amount. Framing the price as a discount is better than saying you're charging a premium for specific time periods or days. This is more important for restaurants with regular clientele. Regulars form reference prices and will react more strongly to the premium pricing if it is not correctly framed. If the clientele is more transient, there is less likely to be awareness of a dynamic pricing strategy.
Some businesses (although I've not seen it much in restaurants) use loyalty or membership programs to shield regulars form premiums driven by dynamic pricing.
Overall, dynamic pricing is a viable strategy for restaurants and even grocers. They do, however, need to take care to execute it carefully in order to avoid negative reactions that may negate the potential benefits.
Recommended citation format: von Massow, M. “The psychology of dynamic pricing in restaurants”. Food Focus Guelph (29), Department of Food, Agricultural and Resource Economics, University of Guelph, May 24th, 2019.