The future of fast food may include surge pricing

Back in 2017, I wrote a post about the future of supermarket pricing, concluding that:

...surge pricing is coming. When you see the traditional price sticker replaced by a small LCD or LED display, you'll know it has probably arrived.

So, I was not surprised to read this USA Today story from a couple of weeks ago:

More fast-food joints, restaurant chains and brick-and-mortar retailers are taking advantage of technological advances to tap into real-time trends and swiftly adjust prices, sometimes in seconds.

It’s a tempting proposition for big businesses that can dramatically increase revenue with slight pricing changes.

Wendy’s was the latest to say it will fluctuate prices of chicken nuggets or a classic chocolate Frosty based on demand.

In a conference call earlier this month, Wendy’s CEO Kirk Tanner said the fast-food chain would experiment with dynamic pricing as early as next year...

“Beginning as early as 2025, we will begin testing more enhanced features like dynamic pricing and daypart offerings, along with AI-enabled menu changes and suggestive selling,” he said. “As we continue to show the benefit of this technology in our company-operated restaurants, franchisee interest in digital menu boards should increase, further supporting sales and profit growth across the system.”

So, how does this dynamic pricing work? When demand is high, or when consumers have fewer alternatives (so that demand is less elastic), the profit-maximising price is higher. So, in those periods of high or inelastic demand, the firm can increase profits by raising the price. On the other hand, when demand is low, or when consumers have more alternatives (so that demand is more elastic), the profit-maximising price is lower. In those periods of low or elastic demand, the firm can increase profits by lowering the price. Changing the price to better match demand conditions offers a way for the firm to increase profits both when demand is high, and when demand is low. This is essentially how Uber's surge pricing works (as I noted here).

Of course, constantly changing prices comes with problems. There are menu costs for the firm, which are the direct costs of changing prices (they are called menu costs because, when a restaurant changes prices, it needs to print new menus). But there are also more strategic problems for the firm. Second, changing prices creates uncertainty for consumers, and if they are uncertain what the price will be on a given day, perhaps they choose not to purchase (in other words, the cost of price discovery for consumers makes it not worth their while to find out the price). Third, consumers may see such price changes as unfair. This came out in research by Nobel Prize winner Daniel Kahneman and others (and described in his book Thinking, Fast and Slow). That research showed that consumers are willing to pay higher prices when sellers face higher costs (consumers are willing to share the burden), but consumers are unwilling to pay higher prices when they result from higher demand - they see those price increases as unfair.

All of that might explain why Wendy's almost immediately changed its plans after customer outcry. They issued a statement that said:

We have no plans to do that and would not raise prices when our customers are visiting us most.

Maybe not now, but perhaps sometime in the future. Dynamic pricing is coming to fast food. Watch this space.

[HT: Marginal Revolution]