There is a Mexican gourmet casual restaurant in Berkeley,CA called Picante. During evenings, the lines are always long even on weekdays and it received fairly good reviews. Their appetizer menu pricing caught my attention:
Chips and Guacamole: $5.50
Chips and Salsa: $2.80
A rational customer looking at the three chips options above will pick the one that gives them the “biggest smile”. The size of their smile is the consumer surplus. When the size of their smile is the exactly same for two version then the customers will most likely pick the higher version. In most cases customers do not really know the absolute value they get and decide their choice based on relative values. In other words, “which versions leaves them with bigger smile”, even though they do not know the size of the smile itself.
In Picante’s case, I believe there is a problem with the relative pricing. The lowest priced option is priced too low and hence leaves a much bigger consumer surplus than it should. Customers looking at $1 chips and $2.80 Chips and Salsa, will most probably find the $1 option leave a bigger smile than the $2.80 option and hence will pick the former. The same can be said about the a customer comparing $2.80 and $5.50 versions. Of course I cannot say for sure without looking at their sales data. If I were doing pricing for Picante I would start by looking at the volume of each version and anecdotal data on how many custmers trade down at the point of purchase.
I definitely will do one of the two things, remove the Chips only option or improve its price to $2, because at $1 it leaves a big consumer surplus.
If one price is good, two are better. But if the prices of multiple versions are not done right, customers will end up picking the lesser version than they should.