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Psychological aspects of menu pricing
ht. J. Hospitality Management Printed in Great Britain
Psychological
02784319489 $3.00 + 0.00 @ 1989 Pergamon Press plc
Vol. 8 No. 1, pp. 43-49,1989
aspects of menu pricing
David V. Pavesic School of Hospitality Administration, College of Public and Urban Affairs, Georgia State University, Atlanta, Georgia 30303, U.S.A.
There are a number of ‘costless’ considerations that must be taken into account when pricing menu items. Pricing cannot be reduced to a purely quantitative exercise as one must consider the subjective and psychological aspects of the customers’ purchase decision. Key words:
price consciousness value engineering
reference price mental accounting
value analysis
Introduction Regardless of the methodology used to mark up food and beverages, prices charged by commercial food services must not only cover costs but return a profit as well. Pricing is an important function that directly influences customers counts and sales revenue. The optimum price must not only include some contribution to profit, it must also be deemed fair and reasonable by the public. One cannot remain in business long if costs are not covered. However, costs are not the sole consideration in determining menu prices. Costs must be known in order to measure profit contribution on each sale. Some costs can be accurately calculated and assigned to specific menu items, while other costs must be subjectively allocated across-the-board. At most, costs serve as a reference to begin developing a pricing strategy. Many operators are experiencing intense competition, rising operating costs, labor shortages and falling customer counts. Such factors will definitely impact on profits. Therefore, the pricing policy is a major factor in developing a strategic plan to meet such obstacles. Most businessmen seek logical and objective criteria on which to base their pricing strategy. This is the main reason we start with determining the cost of a product or service. There is a tendency to rationalize price as a means of returning an amount that will reflect a fair profit for the time, effort and materials consumed. Of all the business decisions a restaurateur has to make, one that causes much anxiety is pricing the menu. Whenever pricing decisions require raising existing prices, the operator mentally prepares for some adverse customer response. The usual feedback comes in the form of spoken comments and the dreaded dropping customer counts. Consequently, the task of menu pricing is beset with misgivings and uncertainty. Prices that are too high will drive customers away 43
44
David V. Pavesic
and prices that are too low will sacrifice profit. The main reason for this anxiety may well be the highly subjective methodology used to price the menus in the first place. Anxiety results over which approach to pricing is best or right given the respective menu items, existing market conditions and the operational concept. Prices partially influence which menu items will sell and therefore impact the overall profitability of the sales mix. Menu items will differ widely in cost, popularity and profitability. Thus, pricing is not a simple matter of cost mark up, but an intricate combination of factors that involve both financial and competitive elements. What it basically comes down to is that prices can be either market driven or demand driven and depending upon the uniqueness or monopolistic aspects of the menu item and operational concept, the approach to pricing will differ. Prices that are ‘market driven’ must be more responsive to competition. Menu items that are relatively common, found on most restaurant menus, e.g. hamburgers, steaks, fried chicken, prime rib and the like, and in markets where customers have a wide choice on where to go for such items, must be priced rather competitively. This approach must also be used on new items being introduced or tested and before any substantial demand has been established. Prices that are market driven tend to be set on the low to moderate side. This is contrasted to those prices that are ‘demand driven’ where the customers’ openly ask for the item and where there are little if any alternatives in the market. Perhaps it is a speciality item or signature food item that can only be obtained at one particular restaurant. Consequently, a monopoly of sorts is created and along with the monopoly comes pricing advantages. Thus prices that are demand driven will be higher, at least until the demand starts to wane due to competitors offering the product or changes in customer tastes. Prices will eventually stabilize and become more competitive. Costing out an entree and accompaniments is a relatively objective and logical process. Establishing a price for it is more of an art. Whatever the pricing methodology, there is no single method that can be used to mark up every item on any given menu. One must employ a combination of methodologies and theories. Therefore, when properly carried out, prices will reflect food cost percentages, individual and/or weighted contribution margins, price-points and desired check averages, as well as factors driven by intuition, competition, demand and consumer price perceptions. If pricing were a purely quantitative exercise, a computer program incorporating operating costs, profit objectives and raw food costs could be used to set menu prices. However, such an approach lacks important qualirative factors that enter into the pricing decision. It has been said of most retail products and services that the buyer determines the price, not the seller. Therefore, the seller must be able to offer a product or service and make a profit selling at the price the customers are willing to pay. Value judgments are hard to program into a cost-mark up pricing program. Minimum profit objectives can be analytically determined, based upon an operation’s financial and budgetary idiosyncrasies. However, an operation’s financial limitations or profit demands may result in cost standards that are not compatible or realistic with the existing economic or market conditions. If prices are too high relative to what competition is charging, quality too low or portions so small as to negate the price-value relationship, sales and profit objectives may still not be realized. What price should be charged? There are two perspectives from which one can approach this question and each is at the extreme ends of the price continuum. Finding the ideal price
Psychological aspects of menu pricing
is not easy. One perspective says to charge the ~~g~~~rprice you think the customer is willing to pay. When you take this approach you should expect your customers to be more demanding and critical of the food and service and your operation must be on the ‘cutting edge’ with food, service and ambience. The extreme opposite approach is to charge the lowest price at which you can still make a reasonable profit. When this approach is taken, customers almost always will comment on the reasonableness of the prices, the large portion sizes and the high quality of the ingredients. Therefore, the two perspectives on how much to charge are: charge as much as you can or charge as little as you can. Keep in mind that the success of any pricing methodology is influenced by many factors including, among others, location, competition, clientele and the restaurant concept. What works for one may not work for another. More often than not, prices are predominantly influenced by competition and/or customer demand. Whenever demand is greater than supply, pricing methodologies that favor higher prices can be used. On the other hand, if customer counts are flat and strong competition exists for the products and services, a different tactic is required. The market ultimately determines the price one can charge. If you charge too much, your customers will go somewhere else. However, it is important to interject a warning at this point. Lower prices do not automatically translate into value and bargain in the minds of the customers. Having the lowest prices in your market may not bring customers or profits. Too often operators engage in price wars through discount promotions and find that their market image falls along with their profit on each sale. White tablecloth restaurants using coupons have quickly learned the pitfalls of discounting (Martin, 1988). Few, if any coupon redeemers return in the future to pay full price. The frugal coupon customer cannot be readily converted to a regular upscale patron and rarely do they spend the entree savings on extras such as desserts or wine. Coupons foster the opinion that white tablecloth menu prices are overstated. When regular customers start redeeming coupons, little is gained. Every restaurant will be categorized by its customers according to the prices it charges. They will place it into one of three categories: low-priced, moderate-priced and highpriced. Specific numerical check averages are not given because customers, depending upon their income, wiil apply their own dollar ranges when rating restaurants in each category. A fourth category, ultra-priced (Hayes, 1988), is even mentioned and a price range of $75 per person is indicated. The idiosyncrasies of a given operation, its menu, location and clientele could target a $40 check average as being moderate and a $25 check average as being low. This is very much the case in certain parts of CaliforniKand New York. Customers will evaluate a restaurant as a place to eat-out or as a place to dine-our. If a restaurant is considered an eat-our operation during the week (a substitute for cooking at home), customers will be more price conscious. If a restaurant is considered a dine-out operation, the visit is regarded more as a social occasion or entertainment and price is not as much of a factor. Clearly, the eat-out/dine-out aspects vary as much as the check averages. it is difficult for most patrons to accept a $25 check average for just eating-out. In most cases, only dining-out will justify such prices. Restaurant operators are responding to more conservative spending habits by switching their concepts and images from dine-out to eat-out in order to boost the frequency of visitations of ‘regular’ customers. point
16
David V. Pavesic
Knowing how patrons evaluate a restaurant is important to the pricing decision. Rarely will a restaurant be rated in both categories by the same patron. Eat-out operations will experience more frequent visits by patrons than dine-out operations but the average check will be lower per visit. Regular weekday customers may go elsewhere for special celebrations like anniversaries or birthdays. Weekend clientele may differ greatly from week-night customers. For example, local residents may be the bulk of traffic during the week, while weekends may bring visitors, tourists or people travelling from outside the restaurant’s normal market area. Such patrons categorize the operation as a dine-out or special occasion restaurant and will not be as price conscious. The restaurants’ menu prices must be in line with the price category in which the majority of its customers place the operation. If prices exceed this range, customers will not purchase many of those items. If prices are too low, there is the danger of lowering the overall image and check average. What then is the proper price to charge? From the customers’ point of view, it is the price that makes them buy. From the sellers’ perspective, the best price is the one that moves the product and produces a profit. Prices can reflect such factors as atmosphere, service entertainment and unique product presentation. Customers sense an additional value in being able to receive additional amenities. One cannot arrive at a selling price without considering some highly subjective factors that have ‘refined’ the interpretation of traditional economic theory on consumer buying behavior. Psychologists are teaming up with marketing analysts and economists to provide some new perspectives on pricing. The methods offered here are largely subjective and for the most part, ignore traditional cost considerations. These ‘costless’ approaches that ‘fine tune’ the actual mark up are (Schmidgall, 1986): (1) (2) (3) (4)
competitive pricing; intuitive pricing; trial and error pricing; and psychological pricing.
Regardless of what they are called, these approaches to pricing reflect two of the three critical factors in pricing: demand and competition, the third, of course, being cost. The ‘competitive’ approach to pricing is very simple. The operator collects menus from competitors and then meets or beats their prices on his menu. This method is highly ineffective because it assumes that the customers make their purchase decisions based on price alone as well as not recognizing the likelihood of cost differences in ingredients, labor and operating expenses incurred in getting the food or beverage to the guest. It also fails to account for the many other factors that influence the purchase decision such as product quality perceptions, ambience, service and even location. ‘Intuitive’ pricing is practiced by operators who do not want to take the time to gather information from their competitors. They rely instead on what they can remember from past experiences and set prices on what they feel the guests are willing to pay. This method relies on estimating the demand for one’s particular products and services. ‘Trial and error’ claims to be responsive to customer perceptions of prices and is based on customer reactions and comments on existing prices. This can be employed on individual menu items to bring them closer to the price the customer is willing to pay. However, this ‘wait-and-see’ perspective is not practical for new operations and getting a dissatisfied customer to return is very difficult.
Psychological
aspects
of menu pricing
47
The fourth ‘costless’ pricing approach, ‘psychological’ aspects, presents a number of interesting theories that enter into the pricing decision. The first, buyer price consciousness, influences the way prices are perceived and the importance of price in the buyer’s choice of products or services. Researchers have suggested that price consciousness is inversely correlated with social class, implying that price is more a factor with low-income customers and the lower-priced restaurants they are likely to frequent (Gabor and Granger, 1961; Monroe and Kirshnan. 1984). When the buyer lacks specific qualitative information about a menu item and is unable to judge quality prior to purchase. higher prices are often associated with higher quality in the mind of the customer. Price perceptions on the part of the customer are critical. Perceptions are often based on the ‘last price paid’ or reference price. The reference price may be the price charged by a competitor and if it was lower other factors will have to be shown by the seller to justify charging more (Monroe, 1973). The order in which buyers are exposed to alternative prices will affect their perceptions. Buyers exposed initially to high prices will perceive subsequent lower prices as bargains. However, dropping prices to meet a competitor or discounting your regular price is not always effective. Low price does not always result in a dominant market position because people will often refrain from purchasing a product, not only when the price is perceived as being too high, but also when it is perceived to be too low. When prices for two competing products or services are seen to be similar by the customer, the price is unlikely to be a factor when choosing between similar products or services (Della Bitta and Monroe, 1973; Monroe and Petroshius, 1973). Current evidence would suggest in such cases that it is the buyer’s perception of the total relative value of the product or service that influences their decision to choose between purchase alternatives and their willingness to pay the asked price. The total relative value consists of such elements as atmosphere, convenience, quality, service and location. The relative value is enhanced by either ‘value analysis’ or ‘value engineering’. Value analysis concentrates on increasing perceived value through improving performance (service) relative to customer needs, e.g. guarantees, brand recognition, payment options, carry-out and delivery. Value engineering concentrates on increasing value by decreasing operating costs while maintaining performance standards, e.g. cost efficiencies, purchasing programs and waste reduction (Monroe and Kirshnan, 1984; Monroe, 1986). The element of customer perception is an important determinant of buyer behavior. Buyers use such cues as product quality, corporate image and name recognition along with price to differentiate among alternatives and to form impressions of product and service quality. Whether the customer will pay the price or balk is the question. Should one start off pricing on the low side and gradually increase prices or start off on the high side and then discount? Precise answers to such questions depend upon one’s market position, the demand for the product or service and the stage in the market life cycle of the product and/or operation. Obviously, conceptually obsolete operations and products with decreasing demand cannot command the prices that the trendy and popular operations may be able to charge. Another psychological theory on pricing looks at the impact of ‘mental accounting’. This theory suggests that as consumers we mentally code purchases into budget categories, e.g. food, housing and entertainment and that each category is controlled to some degree by a budget constraint. Consequently, the amount spent on a meal away from home will vary
48
David V. Pavesic
depending on whether the expenditure is debited to food or entertainment expense. The reference price mentioned earlier also comes into play. For example, while at a football or baseball game, the price we are willing to pay for a Coke and hot dog is going to be higher than the price we would be willing to pay in a neighborhood sandwich shop. This is analogous to eating out while on vacation vs eating out on a week night in a neighborhood restaurant. Spending is going to be more liberal while on vacation (Thaler, 1961). If we assume that restaurant expenditures can be assigned to the budget categories of either food, entertainment or recreation, we can approach the pricing decision from the consumers’ perspective. The objective is to have the expenditure classified into a higher budget category or combine categories. There is likely to be freer spending from an entertainment budget than from a food budget. The mental budget category can change depending on the occasion and the day of the week. Such considerations may prompt promotions such as early bird specials and discount coupons to entice week-night ‘eaters’ using their food budgets to eat out instead of at home. Such strategy may not be necessary on weekends, when dining out is done more for entertainment or social purposes and when budget restraints are relaxed. In any purchase decision there are elements of ‘pain’ and ‘pleasure’ that are derived from the transaction. The pleasure comes from the enjoyment of or benefits derived from the purchase and the pain comes from having to part with one’s hard-earned cash. The ‘pain’ aspect of parting with one’s money suggests use of one of the two primary ways most menus are priced: ci la carte and combination pricing (modified ruble d’hote). In price sensitive markets, operators in the low-price units usually price each menu component separately (d la carte) to keep prices down and leave it to the customer to decide whether to purchase extra items. Upselling strategy is then employed by servers and order takers to increase check averages, e.g. suggesting large drinks, fries and dessert. The combination pricing (table d’hote) charges a higher price but includes accompaniments that otherwise must be purchased separately. The larger, one-time payment is considered less painful than several individual purchase decisions. In addition, the combination price is lower than the sum of the accompaniments purchased separately (Kahneman and Tversky, 1979). In addition to these pricing perspectives, the practice of using certain combinations of numbers to stimulate sales has been studied. The most popular terminal digits used for prices on restaurant menus are 5,9 and zero. This ‘fine tuning’ of prices affects only the terminal digits and has little cost purpose. Its greatest impact is on customer perception when contemplating the purchase of two or more competing items. This has been referred to as ‘odd-cents’ pricing. The assumption is that customers perceive a price of $9.95 as being a better buy than $10.00. In addition, the use of odd-cents pricing makes price increases less noticeable (Kreul, 1982). In the past, operators set menu prices primarily to cover food costs or to achieve certain gross profit margins. The decision was also tempered with what the competition was doing. However, today’s operators must study customer demographics, market trends and give greater thought to the wants and needs of their customers. Price-value perceptions are not made from prices alone. It is a feeling that the customers have about receiving their money’s worth when they pay their check. It is a combination of price, quality, portions size, ambience, service and psychological factors. Therefore, the pricing of a menu is both a science and an art.
Psychological
aspects
of menu pricing
49
References Della Bitta, A. J. and Monroe, Kent B. (1973) The influence of adaptation levels on subjective price perceptions. In Advances in Consumer Research, Vol. 1. Ward, Scott and Wright, Peter (eds), pp. 353-369. Association for Consumer Research, Ann Arbor, Michigan. Ferguson, Dennis H. (1987) Hidden agendas in consumer purchase decisions. Cornell Quarterly 28, 31-39.
Gabor, Andre and Granger, Clive (1961) On the price consciousness of consumers. AppliedStatistics 10, 170-188. Hayes, Jack (1988) Fine-dining operators shift from chic to casual. Nation’s Restuuranr News 22, l-232.
Kahneman,
Daniel and Tversky, Amos (1979) Prospect theory: an analysis of decision under risk. March, 263-291. Kreul, Lee M. (1982) Magic numbers: psychological aspects of menu pricing. Cornell Quarterly August, 7&75. Martin, Richard (1988) Fine-dining coupons flop. Nation’s Restaurant News 22, l-7. Monroe, Kent B. (1986) Techniques for pricing new products and services. Virginia Polytechnic Institute. Monroe, Kent B. and Kirshnan (1984) The effect of price on subjective product evaluations. In PerceivedQuality, Jacoby, Jacob and Olson, Jerry C. (eds). pp. 209-231. Lexington Books, Mass. Monroe, Kent B. and Petroshius, Susan M. (1973) Buyer’s perceptions of price: an update of the evidence. Journal of Marketing Research 10,70-80. Thaler, Richard (1985) Mental accounting and consumer choice. Marketing Service Summer, 199-214. Economoetrica
About the Author David V. Pavesic is the Director of the Cecil B. Day School of Hospitality Administration, Georgia State University, Atlanta, GA. The article is part of a chapter in his new book for Van Nostrand Reinhold Publishers on menu design and pricing.
Psychological
02784319489 $3.00 + 0.00 @ 1989 Pergamon Press plc
Vol. 8 No. 1, pp. 43-49,1989
aspects of menu pricing
David V. Pavesic School of Hospitality Administration, College of Public and Urban Affairs, Georgia State University, Atlanta, Georgia 30303, U.S.A.
There are a number of ‘costless’ considerations that must be taken into account when pricing menu items. Pricing cannot be reduced to a purely quantitative exercise as one must consider the subjective and psychological aspects of the customers’ purchase decision. Key words:
price consciousness value engineering
reference price mental accounting
value analysis
Introduction Regardless of the methodology used to mark up food and beverages, prices charged by commercial food services must not only cover costs but return a profit as well. Pricing is an important function that directly influences customers counts and sales revenue. The optimum price must not only include some contribution to profit, it must also be deemed fair and reasonable by the public. One cannot remain in business long if costs are not covered. However, costs are not the sole consideration in determining menu prices. Costs must be known in order to measure profit contribution on each sale. Some costs can be accurately calculated and assigned to specific menu items, while other costs must be subjectively allocated across-the-board. At most, costs serve as a reference to begin developing a pricing strategy. Many operators are experiencing intense competition, rising operating costs, labor shortages and falling customer counts. Such factors will definitely impact on profits. Therefore, the pricing policy is a major factor in developing a strategic plan to meet such obstacles. Most businessmen seek logical and objective criteria on which to base their pricing strategy. This is the main reason we start with determining the cost of a product or service. There is a tendency to rationalize price as a means of returning an amount that will reflect a fair profit for the time, effort and materials consumed. Of all the business decisions a restaurateur has to make, one that causes much anxiety is pricing the menu. Whenever pricing decisions require raising existing prices, the operator mentally prepares for some adverse customer response. The usual feedback comes in the form of spoken comments and the dreaded dropping customer counts. Consequently, the task of menu pricing is beset with misgivings and uncertainty. Prices that are too high will drive customers away 43
44
David V. Pavesic
and prices that are too low will sacrifice profit. The main reason for this anxiety may well be the highly subjective methodology used to price the menus in the first place. Anxiety results over which approach to pricing is best or right given the respective menu items, existing market conditions and the operational concept. Prices partially influence which menu items will sell and therefore impact the overall profitability of the sales mix. Menu items will differ widely in cost, popularity and profitability. Thus, pricing is not a simple matter of cost mark up, but an intricate combination of factors that involve both financial and competitive elements. What it basically comes down to is that prices can be either market driven or demand driven and depending upon the uniqueness or monopolistic aspects of the menu item and operational concept, the approach to pricing will differ. Prices that are ‘market driven’ must be more responsive to competition. Menu items that are relatively common, found on most restaurant menus, e.g. hamburgers, steaks, fried chicken, prime rib and the like, and in markets where customers have a wide choice on where to go for such items, must be priced rather competitively. This approach must also be used on new items being introduced or tested and before any substantial demand has been established. Prices that are market driven tend to be set on the low to moderate side. This is contrasted to those prices that are ‘demand driven’ where the customers’ openly ask for the item and where there are little if any alternatives in the market. Perhaps it is a speciality item or signature food item that can only be obtained at one particular restaurant. Consequently, a monopoly of sorts is created and along with the monopoly comes pricing advantages. Thus prices that are demand driven will be higher, at least until the demand starts to wane due to competitors offering the product or changes in customer tastes. Prices will eventually stabilize and become more competitive. Costing out an entree and accompaniments is a relatively objective and logical process. Establishing a price for it is more of an art. Whatever the pricing methodology, there is no single method that can be used to mark up every item on any given menu. One must employ a combination of methodologies and theories. Therefore, when properly carried out, prices will reflect food cost percentages, individual and/or weighted contribution margins, price-points and desired check averages, as well as factors driven by intuition, competition, demand and consumer price perceptions. If pricing were a purely quantitative exercise, a computer program incorporating operating costs, profit objectives and raw food costs could be used to set menu prices. However, such an approach lacks important qualirative factors that enter into the pricing decision. It has been said of most retail products and services that the buyer determines the price, not the seller. Therefore, the seller must be able to offer a product or service and make a profit selling at the price the customers are willing to pay. Value judgments are hard to program into a cost-mark up pricing program. Minimum profit objectives can be analytically determined, based upon an operation’s financial and budgetary idiosyncrasies. However, an operation’s financial limitations or profit demands may result in cost standards that are not compatible or realistic with the existing economic or market conditions. If prices are too high relative to what competition is charging, quality too low or portions so small as to negate the price-value relationship, sales and profit objectives may still not be realized. What price should be charged? There are two perspectives from which one can approach this question and each is at the extreme ends of the price continuum. Finding the ideal price
Psychological aspects of menu pricing
is not easy. One perspective says to charge the ~~g~~~rprice you think the customer is willing to pay. When you take this approach you should expect your customers to be more demanding and critical of the food and service and your operation must be on the ‘cutting edge’ with food, service and ambience. The extreme opposite approach is to charge the lowest price at which you can still make a reasonable profit. When this approach is taken, customers almost always will comment on the reasonableness of the prices, the large portion sizes and the high quality of the ingredients. Therefore, the two perspectives on how much to charge are: charge as much as you can or charge as little as you can. Keep in mind that the success of any pricing methodology is influenced by many factors including, among others, location, competition, clientele and the restaurant concept. What works for one may not work for another. More often than not, prices are predominantly influenced by competition and/or customer demand. Whenever demand is greater than supply, pricing methodologies that favor higher prices can be used. On the other hand, if customer counts are flat and strong competition exists for the products and services, a different tactic is required. The market ultimately determines the price one can charge. If you charge too much, your customers will go somewhere else. However, it is important to interject a warning at this point. Lower prices do not automatically translate into value and bargain in the minds of the customers. Having the lowest prices in your market may not bring customers or profits. Too often operators engage in price wars through discount promotions and find that their market image falls along with their profit on each sale. White tablecloth restaurants using coupons have quickly learned the pitfalls of discounting (Martin, 1988). Few, if any coupon redeemers return in the future to pay full price. The frugal coupon customer cannot be readily converted to a regular upscale patron and rarely do they spend the entree savings on extras such as desserts or wine. Coupons foster the opinion that white tablecloth menu prices are overstated. When regular customers start redeeming coupons, little is gained. Every restaurant will be categorized by its customers according to the prices it charges. They will place it into one of three categories: low-priced, moderate-priced and highpriced. Specific numerical check averages are not given because customers, depending upon their income, wiil apply their own dollar ranges when rating restaurants in each category. A fourth category, ultra-priced (Hayes, 1988), is even mentioned and a price range of $75 per person is indicated. The idiosyncrasies of a given operation, its menu, location and clientele could target a $40 check average as being moderate and a $25 check average as being low. This is very much the case in certain parts of CaliforniKand New York. Customers will evaluate a restaurant as a place to eat-out or as a place to dine-our. If a restaurant is considered an eat-our operation during the week (a substitute for cooking at home), customers will be more price conscious. If a restaurant is considered a dine-out operation, the visit is regarded more as a social occasion or entertainment and price is not as much of a factor. Clearly, the eat-out/dine-out aspects vary as much as the check averages. it is difficult for most patrons to accept a $25 check average for just eating-out. In most cases, only dining-out will justify such prices. Restaurant operators are responding to more conservative spending habits by switching their concepts and images from dine-out to eat-out in order to boost the frequency of visitations of ‘regular’ customers. point
16
David V. Pavesic
Knowing how patrons evaluate a restaurant is important to the pricing decision. Rarely will a restaurant be rated in both categories by the same patron. Eat-out operations will experience more frequent visits by patrons than dine-out operations but the average check will be lower per visit. Regular weekday customers may go elsewhere for special celebrations like anniversaries or birthdays. Weekend clientele may differ greatly from week-night customers. For example, local residents may be the bulk of traffic during the week, while weekends may bring visitors, tourists or people travelling from outside the restaurant’s normal market area. Such patrons categorize the operation as a dine-out or special occasion restaurant and will not be as price conscious. The restaurants’ menu prices must be in line with the price category in which the majority of its customers place the operation. If prices exceed this range, customers will not purchase many of those items. If prices are too low, there is the danger of lowering the overall image and check average. What then is the proper price to charge? From the customers’ point of view, it is the price that makes them buy. From the sellers’ perspective, the best price is the one that moves the product and produces a profit. Prices can reflect such factors as atmosphere, service entertainment and unique product presentation. Customers sense an additional value in being able to receive additional amenities. One cannot arrive at a selling price without considering some highly subjective factors that have ‘refined’ the interpretation of traditional economic theory on consumer buying behavior. Psychologists are teaming up with marketing analysts and economists to provide some new perspectives on pricing. The methods offered here are largely subjective and for the most part, ignore traditional cost considerations. These ‘costless’ approaches that ‘fine tune’ the actual mark up are (Schmidgall, 1986): (1) (2) (3) (4)
competitive pricing; intuitive pricing; trial and error pricing; and psychological pricing.
Regardless of what they are called, these approaches to pricing reflect two of the three critical factors in pricing: demand and competition, the third, of course, being cost. The ‘competitive’ approach to pricing is very simple. The operator collects menus from competitors and then meets or beats their prices on his menu. This method is highly ineffective because it assumes that the customers make their purchase decisions based on price alone as well as not recognizing the likelihood of cost differences in ingredients, labor and operating expenses incurred in getting the food or beverage to the guest. It also fails to account for the many other factors that influence the purchase decision such as product quality perceptions, ambience, service and even location. ‘Intuitive’ pricing is practiced by operators who do not want to take the time to gather information from their competitors. They rely instead on what they can remember from past experiences and set prices on what they feel the guests are willing to pay. This method relies on estimating the demand for one’s particular products and services. ‘Trial and error’ claims to be responsive to customer perceptions of prices and is based on customer reactions and comments on existing prices. This can be employed on individual menu items to bring them closer to the price the customer is willing to pay. However, this ‘wait-and-see’ perspective is not practical for new operations and getting a dissatisfied customer to return is very difficult.
Psychological
aspects
of menu pricing
47
The fourth ‘costless’ pricing approach, ‘psychological’ aspects, presents a number of interesting theories that enter into the pricing decision. The first, buyer price consciousness, influences the way prices are perceived and the importance of price in the buyer’s choice of products or services. Researchers have suggested that price consciousness is inversely correlated with social class, implying that price is more a factor with low-income customers and the lower-priced restaurants they are likely to frequent (Gabor and Granger, 1961; Monroe and Kirshnan. 1984). When the buyer lacks specific qualitative information about a menu item and is unable to judge quality prior to purchase. higher prices are often associated with higher quality in the mind of the customer. Price perceptions on the part of the customer are critical. Perceptions are often based on the ‘last price paid’ or reference price. The reference price may be the price charged by a competitor and if it was lower other factors will have to be shown by the seller to justify charging more (Monroe, 1973). The order in which buyers are exposed to alternative prices will affect their perceptions. Buyers exposed initially to high prices will perceive subsequent lower prices as bargains. However, dropping prices to meet a competitor or discounting your regular price is not always effective. Low price does not always result in a dominant market position because people will often refrain from purchasing a product, not only when the price is perceived as being too high, but also when it is perceived to be too low. When prices for two competing products or services are seen to be similar by the customer, the price is unlikely to be a factor when choosing between similar products or services (Della Bitta and Monroe, 1973; Monroe and Petroshius, 1973). Current evidence would suggest in such cases that it is the buyer’s perception of the total relative value of the product or service that influences their decision to choose between purchase alternatives and their willingness to pay the asked price. The total relative value consists of such elements as atmosphere, convenience, quality, service and location. The relative value is enhanced by either ‘value analysis’ or ‘value engineering’. Value analysis concentrates on increasing perceived value through improving performance (service) relative to customer needs, e.g. guarantees, brand recognition, payment options, carry-out and delivery. Value engineering concentrates on increasing value by decreasing operating costs while maintaining performance standards, e.g. cost efficiencies, purchasing programs and waste reduction (Monroe and Kirshnan, 1984; Monroe, 1986). The element of customer perception is an important determinant of buyer behavior. Buyers use such cues as product quality, corporate image and name recognition along with price to differentiate among alternatives and to form impressions of product and service quality. Whether the customer will pay the price or balk is the question. Should one start off pricing on the low side and gradually increase prices or start off on the high side and then discount? Precise answers to such questions depend upon one’s market position, the demand for the product or service and the stage in the market life cycle of the product and/or operation. Obviously, conceptually obsolete operations and products with decreasing demand cannot command the prices that the trendy and popular operations may be able to charge. Another psychological theory on pricing looks at the impact of ‘mental accounting’. This theory suggests that as consumers we mentally code purchases into budget categories, e.g. food, housing and entertainment and that each category is controlled to some degree by a budget constraint. Consequently, the amount spent on a meal away from home will vary
48
David V. Pavesic
depending on whether the expenditure is debited to food or entertainment expense. The reference price mentioned earlier also comes into play. For example, while at a football or baseball game, the price we are willing to pay for a Coke and hot dog is going to be higher than the price we would be willing to pay in a neighborhood sandwich shop. This is analogous to eating out while on vacation vs eating out on a week night in a neighborhood restaurant. Spending is going to be more liberal while on vacation (Thaler, 1961). If we assume that restaurant expenditures can be assigned to the budget categories of either food, entertainment or recreation, we can approach the pricing decision from the consumers’ perspective. The objective is to have the expenditure classified into a higher budget category or combine categories. There is likely to be freer spending from an entertainment budget than from a food budget. The mental budget category can change depending on the occasion and the day of the week. Such considerations may prompt promotions such as early bird specials and discount coupons to entice week-night ‘eaters’ using their food budgets to eat out instead of at home. Such strategy may not be necessary on weekends, when dining out is done more for entertainment or social purposes and when budget restraints are relaxed. In any purchase decision there are elements of ‘pain’ and ‘pleasure’ that are derived from the transaction. The pleasure comes from the enjoyment of or benefits derived from the purchase and the pain comes from having to part with one’s hard-earned cash. The ‘pain’ aspect of parting with one’s money suggests use of one of the two primary ways most menus are priced: ci la carte and combination pricing (modified ruble d’hote). In price sensitive markets, operators in the low-price units usually price each menu component separately (d la carte) to keep prices down and leave it to the customer to decide whether to purchase extra items. Upselling strategy is then employed by servers and order takers to increase check averages, e.g. suggesting large drinks, fries and dessert. The combination pricing (table d’hote) charges a higher price but includes accompaniments that otherwise must be purchased separately. The larger, one-time payment is considered less painful than several individual purchase decisions. In addition, the combination price is lower than the sum of the accompaniments purchased separately (Kahneman and Tversky, 1979). In addition to these pricing perspectives, the practice of using certain combinations of numbers to stimulate sales has been studied. The most popular terminal digits used for prices on restaurant menus are 5,9 and zero. This ‘fine tuning’ of prices affects only the terminal digits and has little cost purpose. Its greatest impact is on customer perception when contemplating the purchase of two or more competing items. This has been referred to as ‘odd-cents’ pricing. The assumption is that customers perceive a price of $9.95 as being a better buy than $10.00. In addition, the use of odd-cents pricing makes price increases less noticeable (Kreul, 1982). In the past, operators set menu prices primarily to cover food costs or to achieve certain gross profit margins. The decision was also tempered with what the competition was doing. However, today’s operators must study customer demographics, market trends and give greater thought to the wants and needs of their customers. Price-value perceptions are not made from prices alone. It is a feeling that the customers have about receiving their money’s worth when they pay their check. It is a combination of price, quality, portions size, ambience, service and psychological factors. Therefore, the pricing of a menu is both a science and an art.
Psychological
aspects
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References Della Bitta, A. J. and Monroe, Kent B. (1973) The influence of adaptation levels on subjective price perceptions. In Advances in Consumer Research, Vol. 1. Ward, Scott and Wright, Peter (eds), pp. 353-369. Association for Consumer Research, Ann Arbor, Michigan. Ferguson, Dennis H. (1987) Hidden agendas in consumer purchase decisions. Cornell Quarterly 28, 31-39.
Gabor, Andre and Granger, Clive (1961) On the price consciousness of consumers. AppliedStatistics 10, 170-188. Hayes, Jack (1988) Fine-dining operators shift from chic to casual. Nation’s Restuuranr News 22, l-232.
Kahneman,
Daniel and Tversky, Amos (1979) Prospect theory: an analysis of decision under risk. March, 263-291. Kreul, Lee M. (1982) Magic numbers: psychological aspects of menu pricing. Cornell Quarterly August, 7&75. Martin, Richard (1988) Fine-dining coupons flop. Nation’s Restaurant News 22, l-7. Monroe, Kent B. (1986) Techniques for pricing new products and services. Virginia Polytechnic Institute. Monroe, Kent B. and Kirshnan (1984) The effect of price on subjective product evaluations. In PerceivedQuality, Jacoby, Jacob and Olson, Jerry C. (eds). pp. 209-231. Lexington Books, Mass. Monroe, Kent B. and Petroshius, Susan M. (1973) Buyer’s perceptions of price: an update of the evidence. Journal of Marketing Research 10,70-80. Thaler, Richard (1985) Mental accounting and consumer choice. Marketing Service Summer, 199-214. Economoetrica
About the Author David V. Pavesic is the Director of the Cecil B. Day School of Hospitality Administration, Georgia State University, Atlanta, GA. The article is part of a chapter in his new book for Van Nostrand Reinhold Publishers on menu design and pricing.