Some time ago, I found that my favorite Italian place for lunch breaks had introduced a few changes to its pricing system.
My favorite restaurant changed its pricing system.
Now it offers 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 price change – and whether it made economic sense.
Today we will find out.
What appears to be a straightforward case is a bit trickier:
“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 critical tasks than calculating precise discounts on noodles.
Based on related research on the perception of discounts, I expect many people would treat this discount as 10% off (actually, it is 1/11 = 9.09%) and overestimate the discount.
If you take your loyalty card always with you and redeem all discounts, you will get 10% off.
So, the pasta cost only €6.50 minus €0.65 = €5.85. This new price is lower than before (applying the actual discount of 9.09%, the new price after the 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.
Consumers are overconfident about their future.
However, research shows that people overestimate their future behavior.
Let us assume for a few that you don’t redeem all your discounts. Maybe you do .
But assume some other customers never plan to take the card with them, some lose the damn card halfway through and start a new one, some customers forget to bring the card now and then, and a few customers do not return to the restaurant ten more times.
Without more reliable data, at least one source considers a loyalty program with a redemption rate between 25% to 35% as healthy.
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 – who knows ).
However, people are only dissatisfied with price increases if they assume the business owner is responsible for it.
But who is responsible for the price increase? Do you blame the restaurant owner?
No – the only reason you might pay more is that you do not exert the discipline to take advantage of the discount, the treat for a free meal. You just refused the hospitality and generosity of the restaurant owner. Shame on you .
This is a beautiful example of the power of psychological pricing.
You increase prices that customers hardly recognize, and if the price increase materializes (or becomes recognized), it is the customer’s responsibility, not the restaurant owner’s—a pretty neat pricing tactic.
Lesson learned: Rethink your pricing system and consciously think about how to communicate and “package” your price increase.
PS By the way, I already have two stamps – and, honestly, for this great place, I would even pay 20% more.
Burnett, Sallie (2018): Customer Insight Group. Loyalty Program Breakage: Health Measure of Program.
https://www.customerinsightgroup.com/loyaltyblog/brandloyalty/loyalty-program-breakage-health-measure-of-program (last accessed Sep-19, 2022).
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.