Clearing Up Costs: Justifying Dynamic Pricing to the Consumer
Yale Center for Customer Insights
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As dynamic pricing becomes more prevalent, or simply recognized, consumer acceptance hinges on how it's framed. YCCI explores strategies for businesses to justify price changes, emphasizing transparency and perceived fairness.
In recent months, businesses — from food chains to e-commerce — seem to be growing more fond of dynamic pricing strategies. The benefits of dynamic pricing are clear; by adjusting product prices in response to changing supply and demand, companies have more flexibility in the way they reach customers and can optimize profitability.
We explored this perspective in depth in a prior blogpost , however, this growing trend isn’t always taken well by consumers. Earlier this year, Wendy’s CEO announced that the burger chain plans to test dynamic pricing by 2025 — and its decision was not met by happy customers. A spokesperson for the company had to clarify that Wendy’s new pricing model would NOT take advantage of customer pockets.? It’s not just Wendy’s that’s facing a framing problem, More generally, how should firms justify dynamic pricing to the consumer?
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“Many restaurants are already doing this,” said Assistant Professor of Marketing at Yale School of Management Soheil Ghili . “For example, restaurants charge more for the same item on a dinner menu than on a lunch menu. Also, if you do not have multiple prices, you’re not going to always get the lowest price. It swings both ways.” Consider a firm that sells an item at the fixed price of $20, Ghili suggested. He explained that when the firm decides to do dynamic pricing, part of the time they charge $25, but sometimes you only charge $15. Thus, despite the backlash it typically causes, dynamic pricing can in fact, at times, benefit customers. Yet that perception isn’t always there.
Nathan Novemsky , Professor of Marketing at Yale SOM, described how consumer acceptance of dynamic pricing in restaurants may depend critically on why consumers think prices are changing. “Consumers would find it unfair to pay more simply because the restaurant knows consumers want to eat at a certain time,” Novemsky said. “That would be like raising the price of shovels in a snowstorm — a very unwelcome tactic.”
On a Positive Note
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But this perspective can change, depending on how marketers frame dynamic pricing. Novemsky suggests that marketers could frame dynamic pricing around a reference point — that is, are consumers paying more or less than the regular price??For the average consumer, dynamic pricing in the form of coupons and discounts is generally welcomed. Raising prices, on the other hand, can be troubling. All in all, consumer acceptance of dynamic pricing in restaurants may depend critically on why consumers think the prices are changing, he explains.
To address this, marketers could emphasize that any price shown is at or below the regular price, rather than an unnecessary ‘add-on.’ Raising the regular price may play a key role in this strategy, if for example, food costs are rising and the firm has to take that into account.?
A YCCI Experiment
YCCI researchers conducted a test to understand how customers reacted to price changes. They asked subjects to imagine that they were planning to order a burger at their favorite restaurant, which had cost $10 for the past several years until now, when the price has been raised to $11. The researchers found that alerting customers to the change in price is associated with a higher likelihood of purchase, rather than quietly raising the price without acknowledging any change. They also noted that framing the $1 upcharge as a service fee resulted in negative effects, reducing the likelihood of purchase and perceptions that the pricing was fair.
On the other hand, they found that framing the price increase as a needed measure to increase staff wages increased perceptions of fair pricing. This goes well along with Novemsky’s insights, which emphasized the perception of fairness on the consumer’s side. “Consumers find it fairer if costs at the restaurant go up when prices go up,” Novemsky said. “We [the firm] have to hire more people to deal with the busy time so it costs more to serve customers.”
While our previous blog showcased the benefits of dynamic pricing as a pivotal part of many businesses’ growth, these businesses should be aware that its ability to succeed depends on how customers perceive its use. Marketers, in particular, should be wary of how they justify dynamic pricing when communicating with customers and building base relationships.