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Dynamic pricing is on the rise

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Lerner professor explains why Wendy’s got pushback for plans to test new pricing strategy

Those who try to mess with fast food should be prepared to face Americans’ wrath. 

Wendy’s faced an outcry earlier this year after CEO Kirk Tanner told investors that the chain would start testing out dynamic pricing, or charges that vary for different customers depending on the situation. That can include surge pricing, when costs go up during peak times, as famously happens with ride-sharing services like Uber. (Those hikes have also caused consternation among customers in the past.) 

Wendy’s clarified its intentions under pressure, claiming this wasn’t about surge pricing at all, The Washington Post reported, but “discounts and value offers.” 

As national media outlets covered Frostygate, they frequently turned to the University of Delaware’s Timothy Webb, an assistant professor of hospitality business management at the Alfred Lerner College of Business and Economics. Webb has experience with dynamic pricing in the corporate world, helping implement strategies at iconic hospitality locations such as New York’s Rockefeller Center and major league sports stadiums. He has brought his experience to the Lerner College and has been researching it in academia

UDaily spoke to Webb about dynamic pricing and what people should know about it. 

How common is dynamic pricing right now?

Webb: Well, from the hospitality perspective, it's been operating like this probably the last 20 to 40 years, starting with airlines and hotels and moving to rental car companies and so forth. The conditions traditionally are that the product is perishable. For instance, if you have a hotel room you don't sell tonight, you can't store that inventory. So to maximize what you could get out of the asset at that moment, you can leverage pricing strategies. 

Technology is the key here and being able to communicate the price changes. So as we get more technology, it's easier for companies to do some of these things. If you have a restaurant-affiliated app on your phone, prices may be consistent; however, the offers you receive may be different. Therefore we’re paying different prices even if we simply think we’re being incentivized with a deal. 

So, is there an advantage for consumers? Or is this all about a benefit for business?

Webb: The results can be mixed. It’s going to impact different people differently. 

For airlines to survive, they might need to get, say, $300 for a seat. But not everyone can pay that. And so what the airlines historically knew was that when business travelers book two weeks prior to their flight to close a deal, and their companies are paying for their flights — it's not discretionary income. Airlines know these customers have a higher willingness to pay, so they can increase prices and capture more revenue. 

If those customers are paying $500 or $600 for that spot, then you can reduce the rest of the plane. In that case, you know, one customer is paying more and another one is paying less.

In the restaurant setting, you're not getting these (large) surge price swings. (With Wendy’s), people were like, “Oh, I’m going to have to pay an extra $5 or $10 like you do for your Uber ride.” And you're not going to, because in this hyper-competitive industry, you can walk down the street from Wendy’s and go to Burger King or another competitor and purchase at a more reasonable price. 

So these incremental adjustments are likely very small. For Wendy's, if they can make an extra quarter or 10 cents across all the sites in a one hour window, that's huge. It adds millions of dollars.  

What's the logic behind dynamic pricing?

Webb: The thought historically is you have this perishable item, such as a hotel room. And the demand varies — there's different demands in the summer versus the winter. 

I think it's even comical to think now that if you want to go stay at one of the Delaware beaches on the Fourth of July, that it'd be the same price as in the middle of winter. At some point it just makes sense; in many cases it's not hard to justify with the consumer. 

[With restaurants] I think part of the thought is, if you have price-sensitive customers that are willing to move their order or come a little earlier to save a buck or two, you've taken a car (in line) at 6 o'clock, moved it to 4 o’clock when you have no line and the ability to serve that customer. So you could serve more people, generate higher revenue and give everyone a better customer experience. Your employees are also in a better mood because they’re not as stressed at peak time. 

Part of it is being able to segment the market and the customers, and it really comes down to that technology and communication component. These companies are getting really smart at communicating with you through their app. You could have the Starbucks app, I can have the Starbucks app. But we might have different offers marketing different prices, and it’s the same idea [as Wendy’s]. 

Starbucks knows [if] it has no customers at the store right now. They know what product you like and might send you an offer at half price. And essentially, they're going to make a smaller margin than they would have. But you [originally] had no plans to go. Now you’re turning around and going to Starbucks. 

So it's being able to communicate with individual people regularly. They can really start to hone in on what you’re looking for and customize your experience while simultaneously driving their own business. But the communication is all possible through the app. So whether they're just changing the drive-thru price while you’re in line, or you order on your phone and pick it up, I think everyone's doing this. [Wendy’s] just kind of put it out there and it got a very bad rap.

Why has there been backlash in the Wendy's case? 

Webb: I think there's always an initial backlash. But in some cases, it's the only way for innovation to occur.

Generally, people want fairness in the price. The idea is that nobody wants a loss. If they increase the price, and I could have gotten it cheaper, I’m going to be mad about it, but every time I'm getting a discount, I feel like a winner. It's a fundamental application of prospect theory. 

So maybe the strategy is for Wendy’s to just increase all the prices, set the new standard, and then just discount it to each customer based on what they know about you at the time. Everyone feels like they're either paying full price or they're getting a discount. 

I think what happened is with the communication. Now they're talking like they're only going to discount, which again, I think that is the way to do it. If there's going to be different prices, but you're going to be getting a discount, then people aren't upset about it, right? 

The CEOs want to sound positive, like we're doing these cool things, and it's advanced. We're trying to be cutting-edge and leading in this area. But what ended up happening (to Wendy’s) sort of spilled over from the earnings call, and it led to people rephrasing and paraphrasing. The New York Post just attached the [term] surge pricing, so it just kind of ran a little wild from there. Ultimately, the messaging unintentionally spiraled and led to some unintended negative press. 

I’ll leave you with this. If I asked you what you spent the last time you went to McDonald's, would you know what you paid for the individual products? Sure, you might recognize if the price changed $5 or $10. But 10 or 25 cents, not many can finger-point that. For this reason, and offers through mobile applications, I think dynamic pricing in the restaurant industry is only just beginning and is here to stay.

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