Is prix fixe the path for restaurant revenue optimization?

No restaurants are more laid back than those remote non-touristy ones in Italy. You get a table, it is yours until they close for the night. I remember pleading with the waiter at 1130PM for the check.

Me: Signore, il conto por fovore (delivered really badly)

Waiter: il conto domani!

Sure enough I did not get the check until 00:15. To me this screamed of the need for revenue optimization.For a restaurant, revenue optimization is all about maximizing the spend per table. It can come from two sources
  1. Increase the number of times the table turns over
  2. Increase the spend per table
From the moment the customers are seated to the time they leave the goal for any restaurant should be to ensure that the table is generating revenue.When you look at the tables at a restaurant, different tables generate different revenue even for same amount of occupied time. Since different customers have different willingness to pay, each choose to spend different amounts during their stay. Providing a menu of options at different price points achieves this price discrimination but also means difference in revenue generated per table.Wouldn’t it be great if a restaurant can get same high revenue from all its tables? What if it let in only those with the same high willingness to pay? In addition what if the restaurant took away the temptation to spend less by taking away the menu?

One restaurant in New York is trying to do just that with prix fixe menu.

Is that the path for  revenue optimization?

It is not for two reasons. One it leaves out those customers who can still be profitably served and two it leaves out up-sell opportunity. Not only do different customers have different willingness to pay, even the same customer has different willingness to pay based on purchasing occasion.

We will never know how many potential diners avoided us because of the prix fixe, or how many were displeased but too civilized or bashful to say something. All in all, check averages increased and traffic remained steady.

It is better for a restaurant to settle for lower revenue from a table as long as it is higher than the opportunity cost. For example, it is profitable to serve a customer who spends $30 if there is a 50% chance the table will remain unoccupied and 50% chance of seating a $55 customer.

So should a restaurant ever do prix fixe menu?
  1. It can if it is offered alongside a la carte option so it is not the only option and customers self-select.
  2. On specific occasions when they are capacity limited and want only those with high willingness to pay to visit (e.g., Valentine Day dinner and New Year Dinner at special high prices).

Otherwise I do not recommend prix fixe menu because even for restaurants, if one price is good, two are better.

We are increasing prices because …

[tweetmeme source=”pricingright”] I saw a notice posted on the external doors of an ice rink that said,

Please close the doors behind you otherwise the rink will fog up

I did not stand around to measure how many followed the advice and whether this number was better than what it would have been if the sign had simply asked “Please close the door behind you”.  But other people have done such studies.

In the book Influence: The Psychology of Persuasion (Collins Business Essentials) author Robert B. Cialdini narrates the work done by Harvard Social Psychologist Ellen Langer on the power of the word “because”.

People simply like to have reasons for what they do.

It does not matter how relevant or meaningful the reason is. The word “because” made the difference in people accepting your request. This isn’t to say that giving reasons for requests works universally but  it does help to reduce resistance.

Take the case of price increases. When a marketer pushes through price increases without extending any reason customers resist those increases and perceive the price increase as unfair. But if the price increase were justified with a reason, a greater number of customers will accept it. In their paper titled, Perceptions of Price Fairness, researchers Gielissen, Dutilh,and Graafland  validated the hypothesis that price increases justified with cost arguments were perceived to be fair by customers.

Ellen Langer’s and Cialdini’s work point to another possible reason for customer acceptance of higher prices – it is not the justification itself but the mere presence of one.  This opens up opportunities for both B2C and B2B marketers to re-price their offering or capture greater value without turning away customers – just give a reason.

We see that in the earnings results of CPG brands that used commodity price increase in 2008 to push through their price increases.

Another case is for two-part pricing – asking customers to pay an upfront fee and then a per unit price.  Examples are mobile phone activation fee or registration fee charged by services. These upfront fees are nothing but pure profit for the marketer and find customer acceptance when justified with reasons, however trivial, like  processing fee or registration fee.  For B2B case, a marketer can charge additional upfront price with reasons like customizations or order processing.

Just give a reason! – “We are increasing prices otherwise we will go out of business”

I should note that this is a pricing tactic and not a strategy – if your strategy is wrong, any number of fine tuning tactics, even with reasons, are not going to help.

Footnote: It is a good idea to A/B test your reasons even though Cialdini and Langer say the specific reason is immaterial.

Two Part Pricing – Why you should charge a setup fee

YMCA offers many classes to children, from swimming to ballet. These classes are priced separately and are available to non-members as well. While members get a discount, non-members are asked to pay a yearly “program membership” fee of $25-$35.

There is a children art school that asks for $25 “processing fee” at the time of sign-up. There are many examples of additional upfront fee customers are asked to pay.

Costco does it with its annual membership fee.

In microeconomics this is called two-part pricing.

The purpose of these fees is to capture some upfront value. Then the marketer can position their services at a lower price. They are looking at customer margin – maximizing profit from the customer through multiple sources.

In the extreme case, like amusement parks or Amazon Prime, the marketer captures all the value with the initial fee and gives away the individual services at their marginal cost.

The membership fee is not only pure profit it also helps to encourage people to spend more throughput the year. The fact that people paid the fee should not matter in future purchases, because it is sunk. But people do not think rationally, they want to maximize the utility of their upfront fee by buying as many services as they can.

When you have multiple interactions with a customer, sell multiple widgets to them or offer subscription services you should almost always capture upfront value with two part pricing.