Senator, This Is a Wendy’s

Alas, after an internet backlash, including calls to boycott the chain, it doesn’t seem like we’re going to see surge pricing for Baconators or flash sales of Chocolate Frostys any time soon. In a statement yesterday the firm claimed that it had “no plans” for such algorithmic dynamic pricing. “We said these menu boards would give us more flexibility to change the display of featured items. This was misconstrued in some media reports as an intent to raise prices when demand is highest at our restaurants,” an official statement declared. A former pricing manager at the company agreed, detailing on Twitter that the old menu boards took months to adjust. He doubted the firm ever wanted a floating spot price for burgers. Their intention behind “dynamic pricing” was to use it as a means to react, say, expected heatwaves with promotions of Frostys or discounting certain senior‐​friendly menu items on appropriate days of the week.

So perhaps this was all a misunderstanding. Or maybe the company just flaked after pushback on social media. The broader point is that many other businesses are harnessing new algorithmic technologies to vary prices (up and down) in real‐​time based on market conditions. Computer technologies now mean that the same supply and demand movements that drive cheaper booze during Happy Hours, evening theater tickets being more expensive than matinees, or flights being more expensive over Christmas can be applied more rapidly. Bars, some restaurants, bowling alleys and other entertainment industries are thus testing out pricing strategies that vary hour‐​to‐​hour as demand fluctuates.

Now, we’ve broadly accepted this principle in several areas of life already — with rideshare being the classic example. But, for some reason, whenever it gets mooted for a new sector, panic ensues. Dynamic pricing seems particularly unpopular as a concept when it comes to food sales. And where there is concern, you can count on populist politicians to jump on the bandwagon. Thus, yesterday, Senator Elizabeth Warren — who seems to have an opinion on every company’s pricing strategy — slammed Wendy’s reported plans as “price gouging,” painting it as a greedy attempt to get you to pay more for lunch.

This sort of language and intervention from a senior politician is worrying, considering that most states already impose effective price controls to prevent “price gouging” after emergencies. I fear it won’t be long until we see proposed legislation against dynamic pricing in some food sectors too.

Ultimately, Warren’s perspective reflects a weird principle that much of the public seems to hold about market pricing: that it’s somehow illegitimate for prices to go up if originally driven by sharp rises in consumer demand, rather than an unexpected jump in costs. We saw this with the recent inflation, of course, during which hugely expansionary fiscal and monetary policy — driving up total spending in the economy — was given a free pass for rising prices by much of the public, who concluded that, except for genuine supply‐​shocks, corporate greed must be to blame.

But the thinking is faulty. Not only does it misunderstand the economics of dynamic pricing, but it underestimates the power of markets to deliver what consumers really want and need.

Why Consider Dynamic Pricing?

At lunch or dinner times or after a local sports match has ended, demand rises for Wendy’s in a fairly predictable way. Why, then, does the price of a Wendy’s burger and fries remain stable?

Well, in an economic sense, it doesn’t. If you go to Wendy’s at a packed time of day, you’re likely to be standing in line for longer waiting to order or pick up your food. The total “price” paid for the meal, inclusive of this cost, is thus higher than at off‐​peak times. We ration by more queuing, in other words, rather than price. Yet nobody captures this time payment.

Dynamic pricing would mean higher prices at peak times and shorter lines. Dynamic pricing can thus smooth consumption by encouraging off‐​peak sales and partially mitigating the quantity demanded during high‐​demand periods. In addition, dynamic pricing for some food outlets could make inventory management easier. For example, during off‐​peak hours, flash sales on meals could help sell items that would otherwise perish, thus minimizing waste and improving resource utilization. With fixed prices, firms can be left with surpluses or shortages if they misjudge demand levels. To avoid shortages, Wendy’s and others are likely to keep a buffer of stock. Managing this is likely to marginally raise prices for all consumers.

So why doesn’t every restaurant just switch to dynamic pricing? Well, as Josh Hendrickson has explained, uncertainty about price creates new costs for certain consumers. In this case, “search costs.” If you turn up to Wendy’s and realize the price of a meal is higher than you’re willing to pay, you then have to go search to find food elsewhere. Even with prices advertised on phones, you’ll have to spend more time Googling around and then driving or walking to a different location. If these search costs tend to exceed the costs of just standing in line to get a fixed price meal, then your consumer base, on average, is more likely to prefer stable pricing (or, at least, pricing that’s not upwardly mobile — a lot of the opposition to dynamic pricing seems to be about marketing and anchored expectations of what the “normal” price is).

A lot of restaurants rely on return customers who like their brand. At some stage these customers engaged in search and determined they wanted to eat at Wendy’s. Having tried it, they realized they valued the bundle of price and quality. They will return in future. But if you inject a whole bunch of uncertainty about what the price will be on any given day, the consumer might search around again and find somewhere else they prefer, and Wendy’s might lose that customer permanently. When thinking through whether to introduce dynamic pricing, firms must therefore judge how sensitive their customer base is to the effects of this price uncertainty. It’s a risk.

No Reason to Intervene

To date, it seems, most fast‐​food chains have determined this latter consideration the overwhelming important one and so concluded that dynamic pricing would harm their profitability. Fair enough. I’m skeptical dynamic pricing would be a wise business move for Wendy’s too. As Tyler Cowen says, “I know I can go to Wendy’s and get my favorite meal there for $XX” is a powerful meme.

But that consumers presently might prefer today’s arrangements shouldn’t mean dynamic pricing is treated as inherently immoral, nor should there be laws against this form of pricing innovation. In fact, as the technological cost of doing dynamic pricing falls, and consumers become more familiar with it in other spheres, I wouldn’t be surprised by a big chain restaurant experimenting in this direction. It would be good if they did!

This is the virtue, in fact, of a competitive market economy. If consumers like the results of the price‐​quality bundles available to them under dynamic pricing, then that firm will make higher profits. But before Elizabeth Warren calls “gouging,” remember that this will encourage more firms to enter and compete against it with similar approaches. If customers utterly reject this pricing strategy, in contrast, then firms that adopt it will make losses. Other restaurants will be deterred from doing it. In reality, we’re likely to see different types of restaurants price in different ways to attract different types of customers.

And that’s…ok. We don’t want or need the federal government or Elizabeth Warren to use their bully pulpits to browbeat companies or legislate on how a hamburger company structures its prices. Then again, we don’t want or need them to determine how much airlines charge for families on basic economy tickets for sitting together either…