OPERATIONS: Pricing and perceived value

May 26, 2004

Jim Moran is a pizza and restaurant industry veteran, and an industry consultant and speaker with Restaurant Trainers, Inc.

Here's a subject that's very important to pizza operators: perceived value. I define that as the value your customers give to your products relative to what you charge for them. In short, the perceived value of an item is revealed in the answer to the ever-nagging question, "Is this a good deal for the money?"

I learned a good lesson about perceived value long ago, when I was as a young man living in Los Angeles. There I frequently purchased a Double-Cheeseburger at a local McDonald's for $1.29. Compared to the Quarter-Pounder with cheese, which cost $1.69, I perceived the Double-Cheeseburger

Jim Moran

as a better value.

When that McDonald's had a 99-cent sale on Double-Cheeseburgers, I started buying them more often. From my perspective, at least, the promotion was a success—but only in the short term.

When the sale ended, something interesting happened. The $1.29 I once perceived as a good deal, wasn't such a value anymore. Worse for the restaurant, not only did I not shift my orders to Quarter-Pounders, I just stopped going there completely. That was almost 15 years ago and I have not paid $1.29 since. Apparently I was not alone, because McDonald's permanently changed the price to 99 cents.

My point: When making similar pricing decisions on your menu, weigh the temporary order frequency increase against the possibly permanent decrease in perceived value.

Mega confusion

I did just that when the Mega-Deal phenomenon came to Domino's Pizza. For those who might not know, the Mega-Deal is "Any Pizza, Any Size, Any Toppings for $9.99." Stores in some areas actually went as low as $7.99! The attraction of this special, which is still widely used today, is multi-fold.

Its benefits were not lost on me years ago, when I was attempting to win Manager of the Year for Domino's. The previous winner at the national convention the year before had used the Mega-Deal to turn in staggering sales increases—despite running a single-digit profit percentage on those sales. That same year I ran a higher profit-dollar than he had, but with much lower sales. Suffice it to say, no one noticed unless you achieved your marks with Mega Deals.

Not that the Mega Deal was a bad thing; it was a useful means of boosting sales quickly, and especially if a store was facing new competition. And though our franchise looked down on them at first because we were doing well without them, as more competition moved in, we used them successfully.

With such low-price, high volume deals, however, come some risks. As an area manager, I was challenged to motivate managers to put the same amount of food on a $9.99 item for which they used to charge upwards of $15.99. Customers had the reverse problem in areas where the Mega Deals were limited-time offers. Before the offer, they willingly paid $15.99 for the same product, but once they got used to paying $9.99, reversing the price was next to impossible. In their minds, we'd lowered the perceived value of our product and couldn't reclaim the price point we once enjoyed.

Volume deals also increase the risk of product degradation via the large increase in order count. That worried me, and in the end, I stayed away from Mega Deals, and the franchisee I worked for eventually followed suit.

Am I saying this type of price structure is bad for everybody? Not at all. I am, however, warning that you should consider the long-term implications of such a move.

Raising prices

The other side of the coin happens when you want to raise prices. One of my clients operates a moderately upscale sit-down restaurant, whose most popular appetizer is Lobster Pot Stickers. Like 99.9 percent of all lobster appetizers, it's short on lobster, but the flavor and sauce in theirs is excellent. The client priced all its appetizers so that the food cost was around 20 percent, which is about right for appetizers. The pot stickers cost $5.95 for five of them.

(I should note that I believe all menu prices should be based on profit dollar generated, not just food cost percentage. To figure this, calculate your food cost and add that to all related fixed and variable expenses [labor, paper, etc.] Subtract that from the sale price to get your real profit.)

The dilemma for my client was that the pot stickers represented about 75 percent of his appetizer sales—which is just about unheard of. Knowing that, I recommended raising the price to $6.95 to raise the profit on that item. Sure, that was risky, because it can hurt sales—which it did. However, the decline was small, and overall appetizer sales did not drop at all. Ultimately, my client's P&L reflected higher profits immediately.

And now, for how this all ties back to value perception ... Some time later, (without consulting me), my client reduced the number of pot stickers in that appetizer to four, while keeping the price at $6.95. A drop in sales followed, but when they punched in the numbers it was clearly a positive move overall given the now-enormous profit they were making.

Yet the client went to the well one more time and raised the price to $7.50, and as you might assume, sales dropped by a large margin. Despite lowering the price back to $6.95, sales of the appetizer have not returned to their past highs, though they may eventually, as positive word-of-mouth circulates. Clearly, this client's customers no longer view the Lobster Pot Stickers to be a real value.

Consider all this before making changes to your menu prices.

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Topics: Operations Management

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