There are many different pricing and packaging schemes for serving food in restaurants, and they all seem to coexist. But there are some significant differences, and thinking in terms of transaction costs and adverse selection can help us understand why.
Plus, a TWEJ on the eternal optimism of Keynesians: THIS time it might work!
Some links:
Yoram Barzel, Measurement Cost and the Organization of Markets. The Journal of Law & Economics, Vol. 25, No. 1 (Apr., 1982), pp. 27-48 https://www.jstor.org/stable/725223
There are many different pricing and packaging schemes for serving food in restaurants, and they all seem to coexist. But there are some significant differences, and thinking in terms of transaction costs and adverse selection can help us understand why.
Plus, a TWEJ on the eternal optimism of Keynesians: THIS time it might work!
Some links:
Yoram Barzel, Measurement Cost and the Organization of Markets. The Journal of Law & Economics, Vol. 25, No. 1 (Apr., 1982), pp. 27-48 https://www.jstor.org/stable/725223
If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !
You can follow Mike Munger on Twitter at @mungowitz
Speaker 1:
This is Mike Munger of Duke University, the knower of important things. We're going to talk about the singularity, all you can eat buffets and a famous political philosopher who closed one restaurant by forcing it to pretend there was a fire in the kitchen. Also, pricing and packaging policies for restaurants. In terms of transaction costs Also Twed and this week's letter Straight out of Creedmoor. This is Tidy C. I thought they'd talk about the system where there were no transaction costs. It's an imaginary system. There always are transaction costs when it is costly to transact, institutions matter and it is costly to transact.
Speaker 1:
Last week, kr wrote about salad bars in our letter. The question was in a salad bar, all the items cost different amounts but they charge a single by the ounce price or worse, they charge a single fixed upfront price for all you can eat. Now some people would pay more for a per ounce price and some would pay more for a fixed price. What's going on? Well, kr thanks. I think the easiest answer to the question of who would prefer a per ounce price and who would prefer a fixed price comes from Andy Rooney's famous question why is it? I often say to myself that most of us have a desire to eat more than we need. Interestingly, this problem is a common point of contention and argument among chefs and restaurant owners, and we would expect the stakes are pretty high. The source that I'm mostly going to use today is an article in the Journal of College and University Food Service by David Pavesic in 1994, and also a textbook that David Pavesic worked on, and I'll put out the references in show notes.
Speaker 1:
The big problem is the consideration that the restaurant must cover its average costs. The original costs are up to the consumer based on what items they choose from the salad bar, and you get a problem of what's called adverse selection. If you charge a low price by the ounce, people will just buy regular salads and maybe put on some dressing, but then they're going to take quite a bit of the food. If you're losing money, you charge a higher price. People will not buy as much of the cheap heavy stuff beans, tomatoes, pasta and dressing. They'll load up more on meat and cheese and maybe then use their own dressing, particularly if it's takeout. Now, if it's an all you can eat salad bar, then the difficulty is that patrons are more likely to take quite a bit more than they can eat.
Speaker 1:
Running a salad bar is a tough proposition. There's a lot of ways, both on food items not taken that you have to throw away at the end of the night and on items taken but not eaten. The alternatives are you can charge a fixed price for all you can eat. You can have by the ounce pricing with maybe a fixed entry cost or some kind of two part tariff, or you can have prepared, prepackaged or mixed from a recipe. So there's a restaurant chain called Roots. They mix up the stuff for you but you get substantial choice about the items that you put in, but they choose the proportion. So it's kind of a compromise, and then those things are priced by the restaurant.
Speaker 1:
Now, all of this did make me want to go full, andy Rooney. He started so many of his commentaries with the question have you ever wondered? Well, have you ever wondered what is the most expensive all you can eat buffet in the world? As far as I can tell, it's the saffron brunch buffet at Atlantis at the Palm Hotel in Dubai. It appears to be $150 per person. Now it also has some really, really excellent Asian and other kinds of food in that buffet. And I have bad news. I'd pay that and that would be bad news, not for me but for the restaurant, for reasons that we'll see In the textbook Fundamental Principles of Restaurant Cost Control by David Pavesik.
Speaker 1:
Paul Magnet, which was the original article by David Pavesik, was 1994. The book the second edition I have, 2005, they have a chapter on Buy the Outs Pricing for Salad and Food Bars. Let me summarize it. They note that a new pricing strategy is being tried in operations offering self-service salad and food bars. Restaurants are experimenting I'm quoting, are experimenting with buy the ounce pricing as an alternative to the traditional per person price for all you can eat. Now this was first written in 1994. This is no longer really an experiment. Probably at groceries and universities the buy the ounce pricing is more common than the all you can eat. One of the ideas they're testing is whether pricing by the ounce will increase the marketing value of all you can eat promotions to nutrition and diet conscious patron. In addition, all you can eat operations that do not permit carryouts or doggy bags for leftovers can now do so with pricing by the ounce. With the increasing demand for takeout service, buy the ounce pricing would allow operations to offer the same price value to both carryout and dining customers. Restaurants can basically charge customers only for what they take and they're likely only to take what they want because they're having to pay for it. So it should reduce food waste of things that are thrown away at an all you can eat arrangement where the cost at the margin is zero.
Speaker 1:
Arriving at a buy the ounce price pavesse and magnet say is complex because items offered range from inexpensive croutons and bean sprouts to the more costly chicken and salmon salad. A random check of operations pricing by the ounce and I updated this revealed prices ranging from about 50 cents to 75 cents per ounce. The per person prices for all you can eat buffets range from a low of about $6 for a basic salad bar to double digits or elaborate buffets with meat and seafood entrees and, as I already said, I found several examples over 100. How does one arrive at a price that it's acceptable to the customer's price value perception and the operator's profit and food cost goals? The most widespread method used today for pricing all you can eat food bars is the set per person price. Now again, this was written in 1994. I think it's an interesting question in terms of the number of meals served between all you can eat buffets and buy the ounce sort of buffet style where you put together your own food in a plastic clamshell container and then you have one checkout person.
Speaker 1:
Notice that there can be a big labor saving cost compared to table service, where you have someone prepare it, someone else take it out to the table and yet a third person, usually in charge of handling the payment. Operations offering smorgasbord buffet and the traditional sundae brunch typically charge one price for all you can eat. Other operations serve family style at the table for a set price per person. In each case, the portion size and food cost varies with each man, woman and child that partakes. These two key cost factors make it difficult to arrive at a single price point that's acceptable to all customers because of the individual differences in perceptions of what constitutes value. Unlike the controlled plating of food served from a kitchen, there's no such thing as a standardized portion with salad bars. The variance in individual portions complicates the task of determining a single food cost that will serve as the basis for a single price for all adult customers. And of course, the problem is that at an all you can eat place you actually are forced to charge a single price. Now you can get around that a little bit because you can have discounts for children and discounts for senior citizens, those two groups are each likely to eat somewhat less. You probably would like to be able to discriminate between men and women, but that, at least so far, has not. I've never seen a restaurant that distinguishes between men and women for their buffet. A listener has ever seen that then? I would be interested in knowing about it.
Speaker 1:
Pricing by the ounce provides the operator an opportunity to establish what is perhaps the most equitable menu pricing methodology for all customers, regardless of sex, age or income level. Well gosh, is it equitable? It is the most equal. It's not clear, though, that having one price for all people is equitable. There's a couple of cross subsidies. Someone who eats less is going to subsidize those who eat more, because you're charging a price that has to equal to your average food costs plus whatever profits you're getting. So it's not really clear to me that that's equitable, but that's the claim that's being made here. The operator seeks to set a price that will cover costs and return the desired profit mark.
Speaker 1:
Arriving at a set price per person requires an estimate of the average food cost per customer. The question is, how does one determine the average cost of food per customer when, at any given day, the mix of customers may range from senior citizens to growing adolescents. When a single price is used, it must reflect the wide range of portion sizes that are consumed in the total mix of consumers. The set price per person. Pricing decision begins by determining the food cost for all the items needed to set up the bar, plus the backup inventory used to replenish the bar during the meal period.
Speaker 1:
What I think is interesting about this discussion of Povacic and Magnet is that they're starting with nuts and bolts. So you think you want to have a buffet. They're assuming that there's a certain amount of beginning inventory of food and then there is a value of the food remaining at the end of the meal period. The cost of food consumed is the difference between the opening inventory and the ending inventory. Whether you should value the ending inventory is whether or not it has been prepared or put out yet, whether it will last until tomorrow. If all the food has to be thrown away at the end, then the ending inventory doesn't actually have any value.
Speaker 1:
The number of customers going through the buffet that day was, say, 225, then the average cost per customer served can be determined by dividing the number of customers into the cost of the food consumed. So you take the beginning inventory, subtract the ending inventory and that's the cost of food consumed, and you divide it by the 225 people that went through the line and you'll get an average food cost per customer. Then you'll have to increase the price over that in order to get yourself enough return to cover labor cost of the buffet itself, the rent on the restaurant and so on. But that'll give you the average cost of food at least. This procedure should be repeated for each meal period for two to three weeks. So what they're trying to do is give you a way to come up with an average, and the reason to do it over the course of a week is that some days are going to be better than others. It may be that Sunday morning is pretty good and late Tuesday afternoon is not so great. The average food cost per customer will vary slightly from day to day because the mix of customers, the meal period and the day of the week all impact business. A weighted average can be calculated to approximate a standard portion cost for a set price per person.
Speaker 1:
Although this is a satisfactory way to estimate average food cost prior to setting the price, certain customers, especially women, dieters and older patrons, are likely to question the price value. Now let me stop paraphrasing there for a moment and raise what I think is an interesting question. The problem is that if you say I'm not charging a high enough price and the people who eat less feel that they're not that excited about being there maybe they just came to the buffet because they're going to eat with someone who really wants to eat a lot and therefore wants to go to the all-weekend eat buffet If you raise the price, you're going to start losing the people who were the value proposition in the first place. The only people that are going to pay a higher price are those who are likely to eat even more than the value even of the new higher price. So you're going to get adverse select. So the problems that you have are that the people who are eating less and would prefer a price by the ounce to an all-you-can-eat buffet are going to drop out from the all-you-can-eat buffet and the selection of people who come into the restaurant in the first place is going to change, and so this can just get away from you. Raising the price may actually reduce your profit because the only people who still come into the restaurant are those who intend to eat all they can eat, and in some cases that can be quite a bit.
Speaker 1:
With per-person pricing, the light eaters subsidize the heavy eaters because they pay just as much as the customer who goes back for seconds. And thirds, nutrition conscious customers are not as motivated to purchase by all you can eat promotion. In fact, all you can eat may be viewed negatively by those who only wanted salads and vegetables and feel they should pay less than those eating all the meats and desserts. Operators who use multiple price categories for adults, children and seniors are often challenged by the customer and in all likelihood, those charges are not consistently applied by servers, who must classify the customers into those different price categories, and sometimes people get angry about it. Pricing by the ounce addresses two difficulties that are sometimes associated with per-person pricing of all you could eat food and salad bar. Those are the customer who shares food with another member of his or her party who did not order, and second, the issue of taking home leftovers in doggie bags. Carry out meals could also be sold by the ounce, thereby allowing customers to pay only for what they take and so creating additional marketing opportunities.
Speaker 1:
Problem is there's a food cost trade-off. If you use buffet service, food costs will be 4% to 6% more with a buffet than if you employ the standard order-taking system of full service restaurant. The reason it'll be more is there's more leftovers and waste. When you cook to order, you eliminate, having cooked, leftovers and waste. Keep in mind that a buffet must be fully stocked even five minutes before closing, as fully stocked as it was at the start of the meal period. Typically, food choices will also be entirely different from those found on the regular menu and leftovers cannot be worked off with daily specials or in regular menu items, thus increasing waste. So, to emphasize, there's really two kinds of waste. One is food that the restaurant throws away from all those full trays that are still there at closing time, and the other is the food that is thrown away on the plates because the buffet line eaters didn't eat everything that they took. Those two kinds of waste can really be very substantial.
Speaker 1:
So again, let me stop for a second from looking at the pavessec and magnet and note that the cost savings, the difference between an all-you-can-eat buffet and pricing by the ounce, gives us a number of reasons to prefer pricing by the ounce. For one thing, it allows us to sell purely takeout, which is not possible with an all-you-can-eat buffet. Well, it is possible, but it means you just have to take one plate and not many people are likely to do it. Another is that you're likely to attract back those people who you lost to adverse selection by trying to have a higher price for you can all you can eat buffet. Flip side is you might lose those people who were eating more than the average cost of the meal, because pricing by the ounce is much harder to take advantage of. But you'd actually like to lose the people who were costing you more than the average food cost. So that isn't so bad.
Speaker 1:
Now there is a problem with pricing by the ounce because a lot of the products cost different things. So if you have a fixed price per ounce and again I was finding something like 50 to 75 cents per ounce of the the upper reaches of that is, at Whole Foods, for example, they're at about 75 cents an ounce now. It means that there are a number of articles and I think probably people could just come up with this on their own about how to hack the kind of buffet lines where you end up with pricing by the ounce. So what? What you don't want to take a lot of is the wet, heavy, inexpensive item, and that might include things like tomatoes, salad dressing. If you avoid those, then you're better able to take advantage of the buy the ounce pricing. What it's likely that you want to do is buy light stuff that has high prep cost, and that was the other thing that I thought was interesting from a transactions cost perspective. Here it's not just the food cost, but from the consumer's perspective, all costs are transactions cost, and so maybe carrots are kind of heavy, but you don't feel like peeling the carrot and then shredding it and so being able to buy shredded carrots. The food cost of that isn't very high, but it's also prepared, and so when you just get that in your clamshell, that's actually cheaper for you, including the costs of having prepared it for yourself at home. So there's an interesting article about hacking the Whole Foods salad bar and a ranking of different approaches.
Speaker 1:
Now, as I said, I myself had the experience of going out with a famous gourmand political philosopher and we went to an all you can eat oyster buffet a breakfast buffet that had all you can eat oysters in the Jefferson Hotel in Richmond, virginia. Now the Jefferson Hotel is quite an elegant old hotel in downtown Richmond and this political philosopher, who I'm not going to name, but his initials are Lauren Lomaski. The two of us went into the all you can eat buffet at the Jefferson and, honestly, they probably considered closing as soon as they saw us, because this is not going to be good now. As I said at the outset, I think of this as a kind of singularity, because on one side you have Lauren Lomaski and on the other side you have a place that is claiming that it is going to allow all you can eat oysters. And the question is is this just dividing by zero? Because there's something that doesn't add up. Lauren Lomaski can't have all the oysters that he can eat. There's always one number bigger than that, like any proof of infinity.
Speaker 1:
We probably got there at 9 30 and started having oysters. I remember Lauren having quite a bit of food, but he had at least three dozen oysters just by himself. Lauren was very happy about slurping the oysters and having them to eat and talking. Finally, about 11 30, they came out and said we're closing. There's a fire in the kitchen. It was obvious that they had just been checkmated and that the Jefferson hotel had decided there was no one else in the restaurant at that point and they normally closed at noon. They closed the buffet at noon.
Speaker 1:
I don't think there was a fire in the kitchen. I didn't hear an alarm. I didn't see any fire trucks come. I think they were just hoping that we would leave, and of course we did. Now you might think maybe they just should have paid us to leave. But it probably would have taken even more to solve the problem of the singularity, because having to pay us enough to prevent us from eating an infinite number of oysters would have been more expensive than just pretending to have a fire in the kitchen. Well, again, thanks for that letter. I was glad to get a chance to discuss the problem of pricing by the ounce and it's an interesting question because it raises the difficulty that we started out with in talking about economist yoram barzell's consideration of how things are packaged, and raises it by adding the difficulty of getting adverse selection in the customer base. Whoa, that sound means it's time for the twedge.
Speaker 1:
Three Keynesian economists took a small plane to the wilderness in Northern Canada to hunt moose over the weekend. The last thing that the pilot said before he left was remember this is a very small plane. You'll only be able to bring one moose back, just one, but of course they killed one each, and come Sunday they tried to talk the pilot into letting them bring all three of the dead moose on board. Finally, the pilot relented Just before takeoff. The plane was rumbling, managed to lift off, headed for the trees, tried to gain altitude, but then it stalled and crashed In the wreckage. The economist shook their heads and sputtered for a moment and then they looked around and started cheering loudly. The pilot said why are you people cheering? We crashed. One of the economists stopped cheering for a second and said jubilantly yes, but we made it 200 yards further than any flight of the last decade. Things are clearly getting better.
Speaker 1:
This week's letter is from RK. I'd like to have you expand upon a topic that you mentioned in a recent TIDYC what are the strongest economic arguments and you might touch on moral and ethical and practical arguments as well, and maybe even transaction costs against taxing richer people at a higher tax rate? Well, thanks, rk. We'll talk about that next time and thanks to all of you for listening. We'll work on that puzzle. Have another hilarious twedge and more next week on TIDYC.