Pricing Strategy Is My Business

The Pricing Newsletter

September 2020

Hello Pricers,

Welcome to September! With backdoor bailouts, foreclosure moratoriums, and sky-high stock markets front and center, it can be difficult to make business decisions with any degree of certainty.

Be careful out there!

Pricing Question from a Reader

I run a small restaurant on a major highway. I'm literally in the middle of nowhere. Should I be dropping my prices to survive?

Introduction

It sounds like you think you're a commodity with minimal pricing power. By definition, commodity vendors must either compete on price or use differentiation to shed their commodity status. It does seem to make logical sense that an unknown brand in the middle of nowhere probably won't be a destination for the gourmet set. Foodies can likely find high status eateries within arm's reach.

However, I wouldn't start dropping your prices quite yet. We can probably tease a few interesting details from your question that may prove useful for improving your pricing strategy.

Questioning an implicit economic assumption

Economics, at its heart, is a study in models. Economists try to find patterns in the world, summarize them using math, and then research their implications. They don't, by and large, attempt to understand the world directly. The world is far too complex, with far too many variables and far too many unknowns. This simplification, though necessary, results in a form of myopia through which implicit assumptions go unnoticed by researchers and those who blindly make use of their models.

We must, therefore, consider the models that served as the underlying basis for your question.

Most people believe that there is a correlation between price and quality. Few have stopped to ask themselves, however, why this relationship holds true. Why does a meal at the Four Seasons command a higher price than one at Papa John's?

Ultimately, high quality vendors rely upon the benefits of strong reputations. Early buyers are forced to rely upon signals that can often prove misleading. As time marches on, the relative importance of signaling gives way to the effects of reputation. Previous customers and industry analysts share their opinions, and potential customers take these viewpoints into account. Once a sufficiently large customer base has been established, prices will be forced to drop, allowed to rise, or become fixed at their current levels.

The assumption doesn't apply to you

Assuming your restaurant isn't part of a chain or a franchise, a near certainty based upon your apparent pricing authority, you may have little to fear from the reputational effects on pricing power.

Whether your restaurant's offerings result in legions of happy customers is immaterial to your pricing power, because of your relative and likely permanent anonymity. Your average customer is likely a person just passing through on the way to a far-flung destination. Even if your establishment made a strong impression upon him, what are the odds that he would a) remember your establishment's name and address; b) express his views to others who are likely to pass by your restaurant; and c) make a case memorable enough for his listeners to remember while driving along the specific highway?

I've performed the calculations, and the odds are minuscule at best. For your firm's reputation to be affected by word of mouth, messaging from prior customers would have to overcome the inertia, disinterest, and traveling habits of both existing and future customers. If your reputation doesn't matter, maybe your anonymity will provide you with additional pricing flexibility.

Van Westerndorp's model

I'm not going to lie, I hate the implementation of the van Westendorp model. Nevertheless, its fundamental goal is valid. According to Peter van Westendorp, there exists a price point at which customers will believe that they're receiving a reasonable exchange of value for their hard-earned cash.

As with all economic models, van Westendorp's also includes plenty of implicit assumptions. One of them is that a customer must perceive a price point to be reasonable before a monetary exchange can take place. Clearly this is not the case. If it were, a previous issue of this newsletter wouldn't have included a news story about $30 cheese pizzas from Domino's that sold like hotcakes.

Because you have been freed from the burdens of maintaining a strong reputation, you can avoid worrying about what is reasonable and instead focus upon the point just below which customer frustration turns to anger, lawsuits, and Molotov cocktails. That is likely to be your point of profit maximization.

Weary travelers, tired from their long journeys along an unfamiliar highway, will prove especially susceptible to high pricing. Their normal levels of internal fortitude and disagreeability will have been worn down with each and every mile driven. This point is beyond dispute, as sleep deprivation is the cornerstone to modern interrogation techniques.

Raising the irritation-aggression price point

Once you've accepted the fact that your anonymity supports the potential for higher prices, the next question you must ask is how that price point can be raised further. After all, there must exist some combination of signals or offer characteristics that will cause your pricing to appear merely irritating, yet unworthy of extreme customer ire.

It pains me to say this, but one cannot simply apply the rules of premium brand creation. Much of the premium strategy is devoted to the establishment of a long-term reputation. That is not your goal. Striving for strongly positive reactions from buyers would prove counter-productive, as the associated expense would eat away at your profitability while offering little in return.

Tactics for raising your price point can be categorized in according to their methodology:

  • Altering your signals
  • Changing the nature of your offering
  • Avoiding the appearance of commodity status
  • Manipulating patrons' thought processes

Altering your signals

Signaling exists at every phase of a business cycle. For your purposes, the most important are:

  • Attraction - Convincing a traveler unfamiliar with your offerings that your establishment is worthy has little to do with your pricing power. All that is required is to convince him that your offering is suitable for his needs.
  • Decision confirmation - This is where the bulk of your attention must be focused. There is little time between the point at which a passerby decides to enter an establishment and the point at which he confirms his decision to become a paying customer. Fortunately, much of the signaling required during that sliver of time is fixed in nature, so the cost on a per-unit transaction will trend to zero. I've already graphed out some examples of how signals can affect restaurant pricing in a previous article.

The key concept is that once a person enters a place of business, the proprietor must do everything in his power to defend his pricing strategy. A potential customer will already have a built-in incentive and a very real switching cost to be borne, should he decide to spend yet more time travelling elsewhere in search of a suitable dining experience. Each sale is, in many ways, the patron's to lose.

Changing the nature of the offering

It's surprisingly uncommon for firms to attempt anything distinctive. Whether managers fear taking risks, or whether they are simply uncreative is immaterial. Adding differentiation can prove quite cheap and, for anonymous vendors who don't rely on repeat customers, easy to implement repeatedly. Why not throw things at the wall and see what sticks?

How hard would it be to brand an establishment as the home of the world-famous unlimited nacho buffet? It wouldn't require a brilliant chef to cut up an array of toppings and melt some cheese. On the contrary, kitchen backroom activities would be minimized and frontroom activities would be reduced as well; customers could simply help themselves to the available food.

The human brain, and much of modern economics, has yet to fully integrate the concept of unlimited availability. Many models quickly fall apart once the assumption of scarcity is removed. Fortunately, buffets that advertise the opportunity for unlimited feasting are actually anything but. Each patron is still limited by his own appetite as well as a sense of decorum. As a result, a restaurateur can charge high rates in exchange for the promise of unlimited portions without having to actually provide them. Given that the cost of ingredients is but a small portion of most restaurants' spending, a nacho bar with unlimited provisions could prove a gold mine.

A clever restaurateur might even find that upselling and bundling becomes easier in such situations. What nacho enthusiast wouldn't pay a bit more for fresh guacamole made at the table, or a frozen margarita to complete the dining experience?

Avoiding the appearance of commodity status

There are many methods that customers can use to evaluate the relative worth of an offering. One of the most commonly used is estimation by analogy. In essence, many customers will pursue the following process:

  1. Encounter an unfamiliar offering
  2. Recall a similar offering with a known price
  3. Consider the known price as what is fair for the unknown offering
  4. Purchase the unfamiliar offering if and only if its price is similar to the price of the analogous good

In order to maximize one's pricing power, one has two avenues of strategy. As described earlier in this article, one can attempt to match expensive items with which buyers are familiar. It is often far easier, however, to simply nullify a buyer's ability to identify any analogous offerings at all. The most obvious and most common approach to the latter is to ensure that one's offerings are perceived as both quirky and unusual.

What would you say are reasonable prices for the following?

  • Lobster ice cream with gold leaf and boysenberry syrup
  • Truffle risotto made to order by an opera singer
  • Hibachi-grilled Mexican food served by a stand up comedian

The more unusual the offering, the less able patrons will be to find fault with one's pricing. In fact, patrons will prove more likely to view such an offering as an experience worthy of greater payment than would a mere nutritional top off.

Manipulating patrons

You may not believe this, but there are some vendors who enjoy what could be referred to as a flexible sense of morality.

There are various means such individuals could employ to increase their pricing power. Here are but two examples:

  • One could hide one's pricing until customers are seated or, better yet, have begun consuming some free hors d'oeuvres. The social pressure to avoid the embarrassment associated with leaving would, at that point, prove immense and likely to push patrons to pay far more than they would feel reasonable.
  • One could attempt to convince patrons that they simply lack the ability or authority to judge the pricing and nature of an offering. A diner with an unsophisticated palate might not recognize a fine wine if he were hit over the head with it. Suitably snooty waitstaff could easily pull the wool over his eye with a bit of psychological manipulation.

There are, of course, many other methods along these lines, but I will leave it to the reader to discover them.

Conclusion

Business owners and economics wonks are far too eager to apply every economic model to every economic situation. This predilection is dangerous. Every model contains implicit assumptions, and almost no one gives a second thought as to what they are.

This fact represents both danger and opportunity.

  • A danger - Blind obedience to models leads to increasing levels of risk that are hidden from view until it is too late
  • An opportunity - Recognition that accepted models do not apply to a particular case allows businesses to enter into profitable enterprises without competitive pressures

Whenever presented with a model, one must always ask oneself what assumptions have been made and whether those assumptions are valid for the given situation. Just ask Myron Scholes and Robert Merton. They were awarded the Nobel Memorial Prize in Economic Sciences for a model of their own design in 1997, but had to be bailed out by the government the following year.

Questions come from readers like you. If you'd like your questions answered, send them my way.

Pricing in the News

From the Blog Archives

Notable Pricing Quote

"If there is only one lawyer in town, he'll go broke, but if there are two lawyers in town, they'll both get rich." -- American Proverb

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