February 10

[Nugget #18] Price fairness: Price increases everyone loves

Last week, I found that my favorite Italian place for lunch breaks introduced few changes to its pricing system.

[1] My favorite restaurant changed its pricing system

Now it is offering loyalty cards: after ten orders you receive the eleventh for free. But the loyalty card came with a caveat: prices went up from €6.00 to €6.50 for standard pasta meals.

I wondered whether I was happy with the change. In particular, whether I was happy with the price increase.

What appears to be a straightforward case is actually a bit trickier:

[2] “What price increase are we talking about? This is a price drop after all.”

The loyalty card gives you a discount. Most people are simplifying math calculations – in particular when it comes to percentages – to save precious mental energy for more important tasks than calculating precise discounts on noodles. Based on related research on the perception of discounts (Chen et al. 2012), I guess many people would treat this discount as 10% off (actually it is 1/11 = 9.09%).

If you take your loyalty card always with you and redeem all discounts, you would get 10% off.

So the pasta cost only €6.50 minus €0.65 = €5.85. This is less than before (applying the actual discount of 9.09% the new price after discount is €5.91 per meal – but still less than €6.00).

Okay – if you ALWAYS use the loyalty card and your VERY LAST PASTA in this place will be the eleventh that is for free (or at least you eat very, very often at this place) so that all your pasta meals will be partially discounted then you are better off. Point taken.

[3] Consumers are overconfident about their future

However, people overestimate their future behavior (Morwitz 1997).

But – let’s assume for a few minuti (this pun is for all who have their lunch breaks at the same place) that you don’t redeem all your discounts. Maybe you do – but assume some customers never plan to take the card with them, some lose the damn card half-way through and start a new one, some customers forget to bring the card every now and then, and few customers just do not return ten more times. Lacking reliable data, at least one source considers a loyalty program with a redemption rate between 25% to 35% as healthy (Customer Insight Group 2018).

[4] Sad truth: prices might actually increase

As a simplified calculation, the restaurant sells 110 meals to 10 customers. 10 meals would be for free, but only 4 are redeemed (redemption rate 40%). The average price per meal is 106 (meals paid) x €6.50 (price per meal) / 110 (meals consumed) = €6.26 which is 4.3% higher than before. Overall, a price increase on average is pretty likely (and maybe even intended by the price setter – who knows).

However, people are only dissatisfied with price increases if they assume the business owner is responsible for it. Xia, Monroe and Cox (2004) summarize various studies showing that customers perceive price increases as less fair (and are less satisfied with the new price) if the business owner increases price to make more profits (instead of just adding cost increases and keeping the same margin).

[5] But who is responsible for the price increase? Do you blame the restaurant owner?

No – the only reason why you might pay more is because you do not exert the discipline to take advantage of the discount, the gift, the treat for a free meal. You just refused the hospitality and generosity of the restaurant owner. Shame on you ;)

This is a wonderful example for the power of psychological pricing. You increase prices which is hardly recognized and if the price increase materializes (or becomes recognized), it is the customer’s responsibility not the restaurant owners. Pretty neat pricing tactic.

Lesson learned: Rethink your pricing system and consciously think about how to communicate and “package” your price increase.

By the way, I already have two stamps – and, honestly, for this great place I would even pay 20% more.

References
Customer Insight Group (2018). Loyalty Program Breakage: Health Measure of Program. https://www.customerinsightgroup.com/loyaltyblog/brandloyalty/loyalty-program-breakage-health-measure-of-program (last accessed Feb-9, 2020).
Chen, H., H. Marmorstein, M. Tsiros, and A. R. Rao (2012). When More is Less. The Impact of Base Value Neglect on Consumer Preferences For Bonus Packs Over Price Discounts. Journal of Marketing, 76(4), 64-77.
Morwitz, V. (1997). Why Consumers Don’t Always Accurately Predict Their Own Future Behavior. Marketing Letters, 8(1), 57-70.
Xia, L., Monroe, K. B., & Cox, J. L. (2004). The Price is Unfair! A Conceptual Framework of Price Fairness Perceptions. Journal of Marketing, 68(4), 1-15.


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