Monday 26 July 2021

A novel pricing strategy for a stock-market-themed restaurant

In ECONS101, we include an entire topic on pricing strategy (although it also includes some elements of non-pricing strategy). This is something that sets ECONS101 aside as a business economics paper rather than an economics principles paper.

The purpose of pricing strategy is simple - the firm is trying to maximise profits, and by undertaking some more 'exotic' pricing strategies, they may be able to increase profits beyond the profit that is achievable by selling at a simple single price-per-unit. Examples of alternative pricing strategies include price discrimination, block pricing, or two-part pricing. The underlying principle is that the firm wants consumers who are willing to pay more for the good or service, to pay more for it - that is how they extract additional profits from their consumers.

This stock market themed restaurant has stretched pricing strategy beyond what we normally see. They change prices every fifteen minutes, "based on supply and demand". Drinks that are more popular on the night go up in price, and those that are less popular go down in price. There are even period "market crashes", where the price of all drinks falls. And I looked it up - it's a real restaurant in Michigan called The Beer Exchange, with locations in Kalamazoo and Detroit. I'm not so sure that their pricing is based on supply and demand, because their explanation focuses purely on the demand side. However, that point aside, could this unique pricing strategy be effective in increasing profits?

As a gimmicky restaurant, The Beer Exchange probably attracts many tourists. That's an important point, because tourists' preferences (and their willingness to pay for different drinks on the menu) will be less known to the restaurant than the preferences of regular customers. The restaurant wants to charge more for drinks that their customers are willing to pay more for, so the restaurant wants to know a bit about the consumers' preferences.

One way to work out consumers' preferences experimentally is to set the prices initially at a moderate level, and gradually adjust prices as you learn more about customers' preferences. What the restaurant should recognise from the experimental exercise is that, if customers are buying a lot of something, then the price is probably too low. And, if they're avoiding buying something, then the price is probably too high. However, this sort of experiment takes a lot of time and effort to set up, and isn't going to be quick enough to pick up the preferences of a group of consumers who are only at the restaurant on a single night.

That's because most restaurants can't dynamically adjust their prices in response to the consumers that are already on the premises. The menu and prices are reasonably fixed, and consumers would probably frown on prices that adjusted constantly (this is one reason why tickets to sports games are priced much the same over an entire season, regardless of differences in demand between games). However, The Beer Exchange has built the dynamic adjustment of pricing explicitly into their business model. Because the theme of the restaurant is a stock market, their customers expect these dynamically adjusting prices. There is going to be little backlash to raising prices over the course of a night. That means that The Beer Exchange can hone in on the profit-maximising drink prices for the consumers that are there on a particular night. Very smart.

Finally, the market crashes are probably included simply as a mechanism to avoid prices becoming too high. I expect that whatever algorithm The Beer Exchange uses to adjust prices tends to push prices up more often than down. That is probably intentional, because the after-dinner crowd is likely to be willing to pay more for drinks than the dinner crowd is. So, the restaurant will want prices later in the evening to be higher than prices earlier in the evening. However, they don't want prices to go too high, because consumers would stop buying drinks and profits would fall.

Overall, this is a smart and novel use of pricing strategy to extract some additional profits from consumers.

[HT: Sarah Cameron]

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