David Jones: Surge pricing is increasingly common, but backlash against Wendy's is just one reason why it isn't right for restaurants
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Surge pricing at Wendy’s? Despite the girlish freckles and pigtails on its iconic logo, the fast-food giant’s innocence was called into question last week after reports circulated that it planned to implement “dynamic pricing,” a term that usually implies charging more when demand is highest.
While already a feature of other industries, such as air travel, a policy of hiking food prices during the lunch and dinner hours would have been a first for a major restaurant chain. The notion sparked a strong public backlash.
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Of course, it was all a big misunderstanding. Wendy Co.’s chief executive Kirk Tanner stepped in to clarify that he was referring to off-peak deals, rather than the kind of “surge pricing” during high demand periods that customers of the ride-hailing app Uber love to complain about.
For Wendy’s, it was a well-timed clarification.
There are several reasonable justifications, from an economic and business perspective, for a company to hike prices when demand rises, but fast-food restaurants don’t convincingly tick the boxes.
First, higher prices can ration demand. The most salient example is Uber: Higher prices during surges periods identify who is willing and able to pay the most for a limited supply of rides. Prices for seats on airlines and at entertainment venues also fluctuate depending on the popularity of the flight or act performing. A slightly less dynamic form is peak versus off-peak tariffs for public services, such as trains, which help to allocate scarce capacity.
Such dynamics sometimes irk customers, and can even increase inequalities, but if someone really wants a particular good or service, this mechanism may increase their likelihood of getting it, by pricing out those who value it less.
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Second, surge pricing can support demand management. Energy networks have a relatively inflexible capacity in the short term, and electricity networks specifically must equate supply and demand in real time. By increasing energy prices when weather conditions constrain supply, dynamic pricing helps to balance the grid. While demand rationing applies generally, demand management often occurs in public services, to support their sustainability, e.g. by avoiding blackouts.
Third, a rise in prices can incentivize an increase of supply. This is the most underrated aspect of Uber’s surge pricing: Higher prices increase the income of drivers, which can bring more of them onto the roads. For example, without dynamic pricing, on New Year’s Eve there would be a large shortfall of Ubers and a lot of people standing in the cold outside nightclubs.
Finally, though not surge pricing per se, sales are a form of accepted dynamic pricing. For example, think of half-price sushi in the hour before closing. Boxing Day sales or cocktail bar happy hours are less dynamic versions of the same principle. They enable companies to recoup some costs, albeit at a lower profit margin.
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So how would those options apply to Wendy’s and other restaurants?
Does Wendy’s need to ration demand? Not really. In most cases, a restaurant can just pop a few more burgers on the grill.
Does Wendy’s offer a vital public service that requires demand management? Hard to argue that one.
Would higher prices increase supply? Not materially. Barring the introduction of “dynamic wages,” an unexpected Saturday night rush on spicy chicken sandwiches will not incentivize additional staff to pick up shifts at the last minute.
Finally, Wendy’s could of course offer sales. Surge pricing, no. But downwards dynamic pricing, yes.
There is another, potentially controversial rationale for surge pricing: price discrimination. This involves differentiating the price of a good across different consumers and/or volumes sold.
Price discrimination by private firms involves the use of market power to improve profits by extracting consumer surplus. But this can be strategic without being cutthroat. For example, think of different cinema ticket prices for adults and students.
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Moreover, in the public sector, what appears as price discrimination — such as peak versus off-peak prices — may primarily aim to manage capacity.
For Wendy’s, could price discrimination via surge pricing reasonably justify charging more during peak periods, to reflect stronger demand? It’s not clearcut. With recent increases in the use of food banks, it would not be a great look.
Putting aside for a moment the notion of fairness, there is also the financial impact on Wendy’s. Thinking in terms of long-term profit (which implicitly takes into account margins, volumes, reputation, etc.), the impact of surge pricing would be uncertain.
On one hand, several studies from the U.S. and U.K. demonstrate that fast food has a price elasticity smaller than one (in absolute terms). Applied to Wendy’s, this means that an increase in prices would increase profits, as the fall in the volumes sold would be proportionately smaller.
On the other hand, in the current climate of food inflation, in which Canada’s largest grocers have found themselves under a microscope and accused of profiteering, there is unlikely to be any first-mover advantage in introducing surge pricing. Quite the opposite: Whoever sticks their neck out could attract media attention and face a backlash from customers.
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It seems, then, that surge pricing’s limited justifiability and uncertain profitability are good news for fast food fans.
Recommended from Editorial
The most promising avenue for dynamic pricing in that industry is precisely the opposite: AI-informed, social media-promoted discounts to increase volumes during off-peak periods.
There are other ways technology will help these companies boost their profit — such as weather-sensitive menus and tailored advertising — without needing to squeeze a few extra cents from their most loyal customers.
David Jones is a policy analyst and economist. He is a fellow at the Canadian Centre for Health Economics and is studying public policy at the Munk School of Global Affairs and Public Policy, University of Toronto.
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Why surge pricing isn't coming to a fast food menu near you - Financial Post
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