Answer to Pricing Puzzles – Restaurants Charging Fee for Sharing

I tweeted a series of pricing puzzles. This series is my interpretation of what the answers could be. Do not treat them as absolute answers. Alternative explanations are possible.

There are two parts to this question.

  1. Why do restaurants charge a fee for sharing?
  2. Why do they charge two different prices based on what is shared?

It is safe to say that those willing to share are most likely couples and they likely pay for it from the same shared budget. For everyone else, those not sharing budgets, the question of sharing does not even come into play.

A restaurant’s goal is to maximize spend per table.  Their wait-staff are essentially the sales team trying to generate more sales per table during the period it was occupied.

So when customers share, it cuts (almost in half) the spend (and hence profit) per table. To discourage customers from doing so, they make the price of the single entree look a little more unattractive by adding the split fee. This is second degree price discrimination. With the split fee, customers may see higher value (consumer surplus) when they order two vs. one.

For those who still want to share for any number of reasons including limiting portions, even with added fee sharing will provide higher consumer surplus and the restaurant gets to recoup profit.

Why charge different split fees? Price discrimination done right. If you charge one split fee, you might as well charge two.

Should they do it? What about customer backlash?

To repeat my earlier point, this is a limited segment that will share food. The rest won’t even notice the split fee.  So by all means do it as this is money that flows straight to bottom line. However they should consider their customer mix and capacity utilization.

What does this mean to you as a Tech Product Manager?

I do not recommend you following in the restaurant’s footsteps. Start with the customers and their needs. Consider how your webapp is being used by your customers.

  1. Do they share login?
  2. From what budget are they paying for it?
  3.  Is there value for them in keeping separate logins?
  4. Do they want to keep their Netflix video queue/history or Evernote clip archive separate?
  5. Do they consume your limited capacity without adding to revenue?

My recommendation: Instead of trying to tack on split fees, make the price of adding second (or third) user attractive that most will do it.  (Like SurveyGizmo did)


You better not bake your costs into pricing

The Atlantic boldly declares, “prices are people”.

“Baked into the price of everything we buy is the rising cost of advertising, accounting, legal services, insurance, real estate, consulting, and the like — jobs performed by the high-wage workers of our modern economy,”

Quoting data on our food spending, they say increasing share of our spending goes to services (wages to people that is) while less and less goes to commodity producers. Hence their case, baked into price is people cost. They explain to us that is why hand-made handbags are more expensive than the mass-made.

Just think about the $629 you just paid for the new iPad 4G, 32 GB.  Was it priced high because it is made one at a time using US labor, costs Apple a lot to pay those high-wage geniuses who work at Apple stores or because of their rising cost of advertising?

You can see how naïve Atlantic’s argument is and that how it completely misses the mark on economics and marketing front.

First the economic point – customers are not going to keep buying products when the manufacturers keeps adding their rising cost to the price. Demand is a function of price. Not only demand moves with price, the entire demand curve may shift (as they do in case of economic shocks). On the flip side, look at the farmer’s share as the price they charge for the products they delivered. Their pricing power keeps going down because of excess supply and practically no product differentiation.

Next the marketing point – customers are not paying to offset your costs. They are paying to fulfill their needs –utilitarian or hedonistic. It does not matter to them what your costs are or how you are allocating them.  When was the last time you were at a coffee store and paid separately  for employee salary or the decorative lighting?

It is not the cost that comes first, it is the price that comes first. Apple and Starbucks don’t bake their cost into pricing. They find the price customers are willing to pay for the value they get and deliver the product at cost that is profitable to them. In case of Apple, insanely profitable prices and costs. There are many customers who are not willing to pay Apple prices, Apple simply chose not to target them.

Shoppers brandishing their newly purchased iPa...
(Photo credit: Wikipedia)

It is not the salaries of Apple Store Geniuses that is baked into each iPad. To target those customers who are willing to stand in line and hand over $499 to $799, Apple has to hire the Geniuses. The  experience is part of the product. Apple is willing to pay higher wages the Geniuses demand because, one they cannot deliver the same customer experience with someone willing to take lower wages and two it can still make profit at these wages.

Prices are not people. People costs do not determine prices.

Hope you are not taking economic insights or worse pricing advice from such articles.

Other readings:

  1. If you think organic produce is priced higher because of costs
  2. Why is iPad 3G priced $129 more than Wifi but Kindle 3G is only priced $50 more
  3. What is the difference between Apple and a drycleaner? (password: iPad2)

Dropped Mobile Profits

There is a price war starting now in the prepaid mobile sector. MetroPCS wants to attract new customers (and keep its current customers) by paying all their taxes and fees, which amounts to a price cut of $10.  Technically the list prices remain the same but instead of the customers paying all the taxes and fees, MetroPCS picks it up. Since the 6.6 million MetroPCS customers are not under any contract, all of them can get this  $ 10 price cut – a profit loss of $66 million a month!

MetroPCS said that they will make up for the lost profit through increased addition and retention. But the stock market is not buying that argument. To compensate for $66 million lost profit MetroPCS must add, at least, a total of  1.65 million new subscribers (assuming a generous profit per customer of $40). That is 25% of its current subscriber base just to get back to where it was before the price cut.

MetroPCS has a churn rate of 1.77% per month (percentage of subscribers who quit). Even if it acquires additional 1.65 million subscribers, it has to find 144,000 new subscribers every month, unless it reduced the churn rate. The lowest churn rate in the industry is 1.1% but that is for subscribers under contract. Prepaid customers are by definition susceptible to high churn.

Other prepaid players like Boost and Leap are not going to stand still. MetroPCS said it wants to be the low price leader but tha is possible only of other prepaid operators cannot match the price cut. Since the marginal cost to serve one single customer is  $0 and all the investments in the infrastructure are sunk, no one player can claim price leadership. If Boost and Leap match the price cuts, MetroPCS will simply end up with lower profits despite gaining some customers.

It is not a surprise that the stock market is feeling less positive about all the prepaid operators. War results in destruction and casualties and price war leads to value destruction.

Anyone can calculate what a cost is, but no one knows what a cost ought to be

This is a direct quote from Henry Ford’s, My Life and Work (now out of copyright). This shows his  remarkable thought process on marketing and price based costing. You do not determine what your costs are and then determine the price (like tacking on a margin). You find what the market will buy at different price points and produce the units at costs that are profitable. (See also: Number one pricing question to ask)

Our policy is to reduce the price, extend the operations, and improve
the article. You will notice that the reduction of price comes first. We
have never considered any costs as fixed. Therefore we first reduce the
price to a point where we believe more sales will result. Then we go
ahead and try to make the price.

We do not bother about the costs. The
new price forces the costs down. The more usual way is to take the costs
and then determine the price, and although that method may be scientific
in the narrow sense, it is not scientific in the broad sense, because
what earthly use is it to know the cost if it tells you you cannot manufacture at a price at which the article can be sold?

But  more to thepoint is the fact that, although one may calculate what a cost is, and of course all of our costs are carefully calculated, no one knows what a cost ought to be. One of the ways of discovering what a cost ought to be is to name a price so low as to force everybody in the place to the
highest point of efficiency.

The low price makes everybody dig for profits. We make more discoveries concerning manufacturing and selling under this forced method than by any method of leisurely investigation.

Behind Crest White Strips Multi-Version Strategy

P&G practically created the teeth whitening white Strips category. Introduced under the powerful Crest brand it helped create new revenue stream  after all  it is not easy to grow 10% YoY when each brand bring in $1 billion revenue. The part that interests and impresses me the most is their multi-version pricing for the White Strips category. While I expressed concern about P&G’s other brand Downy’s horizontal product line extensions, Crest White Strips serve as an example of effective pricing  strategy, tactics and execution.

Take a look at the Crest White Strips page from P&G and here are some insights on their versioning strategy:

Side bar – Value Tag: For brand managers from Colgate-Palmolive and Unilever this article is worth $9999 to you.

  1. If one price is good two are better and four are even better if designed and positioned correctly. Crest offers four different versions of the product, offering increasing benefits from low to high end version.  This is vertical product line extension.
  2. Versions are designed in such a way that customers self-select  themselves to the right one (Second degree price discrimination).
  3. The lowest priced version is the Classic at $24.99 and the super premium version ($44.99) is the Crest Advanced Seal, introduced in early 2009.  That is a $20 price differential between the lowest and highest product creating great profit opportunity from up-selling.
  4. The price jump is non linear and reflects customer’s diminishing utility. From Classic to Premium it is a $10 jump indicating customers assign most value in this upgrade. Between other versions it is $5 jump indicating customer utility flattens out or grows slowly as they move up the versions.
  5. Note that the listings are benefits and not product features. Customers care about benefits  and not about the features – compare this to many of the technology offerings that simply list feature differences across versions.
  6. Look at  the images showing the packages. These are designed to visibly show that not only are these versions different but also  help “tangibilize the intangible” (Ted Levitt).
  7. In behavioral economics, the effect of  presence of high priced versions has been extensively studied. The netof those findings is that while these may not sell much, the  presence of high priced versions help improve customer willingness to pay for the other versions. But that is not the case with Crest Advanced Seal. I make this claim based on the number of reviews and rating for this product.
    Versions Reviews Rating (on a scale of 5)
    Classic 58 4
    Premium 34 3.75
    Pro Effects 17 3.5
    Advanced Seal 77 4

    If we use the number of reviews as a stand-in for the market share, Advanced Seal, despite being the super premium version, is their most popular seller. The ratings also indicate that customers are happier with their super premium version. At $20 price premium and arguably not much cost difference this is a big contribution to their profits.

  8. Their Pro Effects, scored the least both in terms of number of reviews and rating. Until P&G introduced Advanced Seal an year ago, this was their most expensive version. We can hypothesize that it served then as the expensive decoy but did not add as much value to the customers and hence did not get market share. Going forward we should expect to see P&G allocating fewer marketing resources to this version and keeping its price levels.
  9. All their prices end in 99, as seen again in behavioral pricing literature this is a good tactic. It is easy for everyone to have prices end with 99 but it takes marketing strategy and a clear understanding of customers to maximize profits.

Overall Crest White Strips serve as a great example of marketing strategy, versioning and pricing for profit maximization done right!

Good and Bad Price Discrimination

Note to new readers: Do check out my other articles on versioning and price discrimination. It would help me greatly if readers coming from Rutgers or New Jersey let me know how they found this article.

Discrimination has a bad connotation to it, it is safe to say that any kind of discrimination is not only disapproved by most democratic societies and but also is unethical.

Does that spill over to price discrimination? If general discrimination is treating different people differently based on demographic or psychographic characteristics, price discrimination is charging different prices to different people based on value they get and their willingness to pay.

However it is not possible to find what everyone’s true WTP is and consumers revolt marketers take the short cut – treating the demographic and psychographic variables as a stand in for value difference and implement third degree price discrimination.

The alternative is second degree price discrimination – offering multiple versions at different price points so that consumers self-select themselves to the right version.

I am starting to collect and list pairs of bad and good price discrimination. Do add yours in comments and I will add here.

Bad: A supermarket charging higher prices in low income neighborhoods, where there are fewer alternatives.

Good: Merchants in touristy places charging exorbitant prices.

Bad: Charging different prices for women and men for haircut.

Good: Charging different prices based on length of hair and on stylist level.

Bad: A restaurant charging people different prices because of their ethnicity.

Good: Offering many different menu items that appeal to different pallets at different price points.

Bad: Charging different prices for checkin at airports based on passenger’s skill set.

Good: Charging additional price for agent assistance for checkin and giving automated checkin for free.