Tuesday, 17 April 2018

Menu pricing in restaurants is about to become more complex

Price discrimination occurs when firms charge different prices to different customers for the same product or service. Savvy firms will charge higher prices to customers with more inelastic demand (i.e. those who are less likely to be dissuaded by higher prices), and lower prices to customers with more elastic demand. This allows firms to extract more profits from customers who are willing to pay more.

Menu pricing (also known as second-degree price discrimination) occurs when firms offer customers a menu of different options. Importantly, the firm knows that some of the menu items will appeal to customers who have relatively inelastic demand (and for those items, the firm will charge a higher mark-up over cost) and other menu items will appeal to customers who have relatively elastic demand (where the firm will charge a lower mark-up). Menu pricing is called menu pricing because it is the type of price discrimination typically employed by restaurants. Think of a restaurant wine list - would it surprise you to learn that the mark-up on a cheap bottle of wine is smaller (in percentage terms, not just in dollar terms) than the mark-up on an expensive bottle of champagne?

However, there are other forms of price discrimination as well. Airlines practice price discrimination by charging different prices for flights at different times of the day, or different days of the week. Certain time and day combinations (e.g. early mornings, and late afternoons, on weekdays) appeal more to business travellers, who have more inelastic demand (they have more inelastic demand because they really have to get to that meeting on time, and must go to a particular city on that day and at that time). Airlines charge higher prices for those flights than for flights at other times or on weekends, since those other flights will appeal to leisure travellers (who have more elastic demand, because they have more alternative options open to them).

However, demand for restaurant tables differs by time and day as well. Why don't restaurants price discriminate, by offering different prices by time and day? Of course, many do in a limited way, by offering lunch or brunch menus that differ from their dinner offering (and notice, the prices are cheaper in the lunch menu, even for the same items). Now, it turns out that restaurants might be expanding the practice, as Bloomberg reported back in January:
One of London’s leading restaurants will today start pioneering a new pricing model based on the travel industry, with different charges depending on the day of the week and time of your booking.
Bob Bob Ricard, known for a luxurious dining room where each table has a call-button for Champagne, will offer exactly the same menu, only prices are 25 percent lower for off-peak times such as Monday lunch and 15 percent off mid-peak, including dinner on Tuesdays and Sundays. Book for Saturday night and it’s full price.
“The idea just came from looking at how the rest of the world functions,” said owner and founder Leonid Shutov...
“It’s what we learn in economics 101, it calls for price differentiation. I do realize it’s a bit of a brave decision because any departure from the standard model involves risk. But I am not really worried. We are not changing the menu. We are not trying to entice customers with anything from what they know and love. We are just saying that on certain days it will cost less.”
The idea is good, Leonid, but it's called price discrimination, not price differentiation.

[HT: Marginal Revolution]

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