The Social Function of Surge Pricing

Author
Dr. Robert P. Murphy
Date
March 3, 2024
Categories
Economics, Dynamic Pricing, Labor, Purchasing Power
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Wendy’s recently announced that it would experiment with “dynamic pricing” (but denied that it was “surge pricing”), in which the electronically displayed price for meals would adjust based on the time of day or other conditions of demand. Thereupon followed predictable gnashing of teeth from certain quarters:


Quick Reaction

Let me state my quick reaction to the Wendy’s case, and then spend the rest of the post elaborating on my stance. So, to put it briefly, I think in general the use of dynamic pricing makes sense, and allows businesses to more effectively deploy scarce resources. The overall increase in efficiency will benefit the shareholders of the companies that first implement dynamic pricing, but over time competition will lead to a “leakage” where the efficiencies result in lower prices for customers.

However, in the current environment, companies in food service are being pushed to “cut corners” because of the untenable position that monetary inflation, minimum wage hikes (in some areas), and a general cultural shift have placed them. It wasn’t that the old baseline could continue, and the companies are able to implement dynamic pricing as a cherry on top. No, they are being forced to stay ahead of the shrinking margins, and thus the customer experience may still decline, even though the “surge pricing” per se was a net benefit.

Nothing New Under the Sun

Dynamic pricing is nothing new. Nobody bats an eye when movie theaters charge cheaper “matinee” prices than the evening price. Bars have “happy hour” discounts to get people there earlier. The people flying first class obviously pay more than the people flying coach (or as they call it now, “economy”). And I’ve written elsewhere on how Uber’s surge pricing performs a valuable social function.

Even so, let me spell out how dynamic pricing might impact a typical Wendy’s restaurant.

An Example

Here’s the basic logic of how surge pricing could actually benefit poorer customers, especially in the long run. Suppose originally, a Combo #1 at Wendy’s costs $15 no matter when it’s sold. There’s a surge in demand at lunch time, then a lull, then another surge going into dinner time.

These surges make it harder to have an appropriate number of workers on hand at the right time, because you don’t want too many people standing around doing nothing during the lull from 2:30pm – 4:30pm. Sure, you can try to slot in kids working 3-hour shifts at the peak times, but then they wouldn’t get as much experience and you would have to carry a larger crew, necessarily staffed with people you wouldn’t hire if you could get away with carrying fewer people who were more dependable.

All of that to say, you can imagine that the total labor costs over the course of a typical week would actually be lower, if a particular Wendy’s location could smooth out the peaks in demand, so that more customers bought their combo meals in the middle of the afternoon. That would allow for consolidation on the employee side, with the manager relying more on a consistent crew who worked long shifts because the business was steady throughout the day. They might end up getting paid more per hour, but the extra amount they make would be more than counterbalanced by the savings on the other employees who were no longer needed.

Even setting those considerations aside—and I confess, I have never run nor even worked at a fast food place (though I did work in a cafeteria)—what is more obvious is that the customers who value their time would appreciate reducing the lines at Wendy’s during rush hour, coming home from work.

Specifically, suppose in the surge setting, the price of the Wendy’s Combo #1 rises a buck to $16 during rush hours but falls to $13 during the slow hours. If a third of the original people (plus new outsiders) who went to Wendy’s during rush hour are induced by the $16 - $13 = $3 savings to either eat early or eat late, and there’s not a larger exodus of customers from Wendy’s altogether, then Wendy’s ends up collecting the same amount of revenue. But it’s probably saving on labor costs, so its profits increase.

The owners of the Wendy’s store are better off, some of the workers gain and some of the workers lose, and with the customers, each group has pros and cons. For those who continue to drive at rush hour, they now pay $1 more for a combo meal, but the line is shorter. And since these are the people who pay the surge price, they presumably value their time the most.

On the other hand, the people who alter their eating schedule in light of the dynamic pricing, now get their combo meals for $2 less. But they admittedly had to change the time they got their food. However, since they are the ones who made the switch, these are precisely the people from the original group who valued a few dollars over the hassle of switching plans.

So even right out of the gate, there are plusses and minuses to the other stakeholders (to use the popular term), besides the clear boon to the shareholders. But over time, other restaurants would see that Wendy’s increased its profits (if the plan in fact worked), and so they would follow suit. Because each restaurant would now how a bigger margin to play with, they could each undercut the other just a bit to capture more of the market—either in lull times or rush hour. Eventually, maybe the prices would fall to $12 during lulls and $15 during rush hour, and the restaurants would hire more of the original workers back, because total hamburger sales were up. (Remember, originally combos were always $15, whereas in this new equilibrium, they are $12 during lulls. So presumably more people end up eating at Wendy’s than before.)

The Federal Reserve Has Entered the Chat

But unfortunately, overlaid on top of the above scenario, is that the USD will continue to fall in purchasing power over the coming years. (It may happen in fits and starts, reacting to a financial crisis or other calamity.) So the introduction of dynamic pricing, even if it worked qualitatively in the benign way I describe above, quantitatively will probably not result in what seems to us to be “cheap fast food.” Rather, the dynamic pricing might slow the pace at which Wendy’s combos increase in price.

NOTE: This article was released 24 hours earlier on the Infinite Banking (IB) 3.0 - The Future of Finance Group

Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.

Twitter: @infineogroup, @BobMurphyEcon

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