Will the Oil Shock Lead to Unbundled Services?

When I was visiting Sweden I found it shocking that they charged me 4 Kroner for a 8oz glass of tap water. As I traveled a bit more in Europe I found this common practice of restaurants charging extra for things that in US we take for granted. Sitting at a table has a surcharge, bread has a surcharge, water too. I compare this to a sign that I saw outside a Hot Dog stand near UC Berkeley, “All toppings always free”, this captures the characteristic of US restaurants.

These are not really free, restaurants here use bundled pricing. The problem with this bundling is some of the added items are valued below cost by the customers and hence the restaurants do not reap the advantages of bundling.

Now in US, as the food and fuel prices keep increasing, restaurants are finding it hard to keep their margins. All these free toppings and additions that are “always free” add to the cost with no relief through higher pricing. Until now they have not passed on much of the supplies cost increases to their customers in the form of higher prices. It is not that it is difficult to keep changing prices (economists call this the menu costs).

Restaurant owners are wary of customer reaction and competitor moves. There may also be lingering doubts on whether we are experiencing a temporary price shock or the higher prices are here to stay. If the businesses and the public are convinced that is is the latter, then the cost increases will flow into prices.

However, an acceptance of increased prices does not mean the demand will stay the same. There are substitutes, eating at home and packing lunch from home. So restaurants may still be reluctant to increase prices. That leads us to unbundled pricing. Should the US restaurants do costing right (do not price items below their cost)? Should they price the food items at its current levels and start charging for service, water, bread, toppings, paper napkins, plastic ware etc?

It is not clear to me.

Customers may not value some of the items included in the bundle but will consider these essential to support the main product they are buying. If customers do not value something by itself, they also will not be willing to pay it. So charging a quarter for toppings may find fewer takers. While the costs will go down, I am not certain if the demand for the main product will remain steady.

It is definitely worth experimenting at a smaller scale before unbundling the whole burrito.