Trust me - the price is right...

Philip Delves Broughton
18 Jan 2010

Restaurants are a lousy business. The margins are small, the inventory is short-lived and customers have so many options.

A few scratch out a living, some do very well, but there are easier ways to make money. So one has to forgive restaurant owners a few tricks.

Customers are wise to some of them: the highest margin wine is often the second cheapest because that's the one people gravitate to; the specials, which in the best cases are special products bought fresh that morning, are often cobbled together out of food about to go bad.

But the greatest tool in prising open the diner's wallet may be the design of the menu. Take the menu at the Wolseley. One's eye is drawn to the centre of the left-hand column, a box titled Crustacea. Halfway down are plateaux de fruits de mer to be shared by two people, one for £28.50pp, the other for £39.75pp.

At the bottom of the left-hand column is another box marked Caviar. One can choose 30g or 50g servings of Sevruga or Beluga. Prices range from the 30g Sevruga at £55 to 50g of Beluga at £195.

The menu is broken up into sections, and the text is mostly centered in each column, rather than set left, so that the prices do not form an intimidating column down the right-hand side.

There are no pound signs. Only in the cheaper “starters and salads” section is there a column of numbers.

But here we find examples of “bracketing”, the same dish offered in different sizes, which encourages you to trade up even thought the smaller size may be adequate.

On the right, under “entrées, roasts and grills” is a box for “Steak Frites”, which comes in two options, the 225g Rib Eye for £21.75, the 200g Fillet for £28.75.

With the crustacea, steak and caviar, the most expensive items on the menu, the Wolseley is offering options. The more expensive option anchors the price high, which leads diners to feel the cheaper one is good value.

It's a trick seen in luxury goods stores. The £10,000 handbag is there to anchor a high price in customers' minds so that they think nothing of paying £300 for sunglasses or £70 for a money clip.

All of this pricing voodoo is explained in a terrific new book published in the US called Priceless: The Myth of Fair Value (and How to Take Advantage of It), by William Poundstone.

It rattles through a century of economic and psychological research into how we think about prices, and how businesses can exploit us.

It begins with the indentation in the bottom of peanut butter jars, which allows peanut butter companies to sell less peanut butter while keeping the price steady and consumers happy.

Cereal makers experiment constantly with box sizes, keeping the height and width the same so that they look the same on the shelf but making them thinner while not dropping the price.

An entire industry of price consultants now exists which helps companies through the miasma of pricing.

At the top of this industry, Poundstone reports, is Simon-Kucher & Partners (SKP), founded 24 years ago by three academics, now with a client list which includes almost any major consumer products company you'd care to think of.

Some of the pricing tricks are timeworn, like prices ending in 9, rather than 0. Others are more sophisticated.

Consider the price of a text message, which requires a tiny shard of bandwidth, one-millionth of that required by an average email.

An SKP survey found consumers considered an email to be worth just 3.5 times as much as a text message.

This vagueness has allowed mobile phone companies the chance to charge outlandish sums for a service which costs them virtually nothing.

Car dealers have a deserved reputation for price negotiations.

The business of selling cars is, according to one of the many economists Poundstone cites, a “search for suckers”, the few people ready to pay the sticker price.

At many dealerships, these suckers make up just 10 per cent of sales but account for half the dealerships' profits.

Car salesmen anchor the price high enough to give room for haggling downwards, which is what most car buyers try to do.

House flippers follow this, putting a house on the market at a ludicrously high price, then dropping it days later.

That way it looks to potential buyers as if the seller is desperate and the house a bargain, when neither is the case.

Another trick is to have a neighbour put their house on the market at a very high valuation on a “private sale” website at the same time as you try to sell yours. As long as your house is relatively cheaper it will look more attractive.

In any price negotiation, be the first to establish that anchor, because our tendency is to haggle around the first number tossed out rather than pull back and establish another number based on our own determination of value.

It is why people accept that £5 for a packet of peanuts is a reasonable price to have them there in your hotel mini bar when you want them. You are paying for the service, not the nuts.

For many businesses, moving customers away from hard products, whose costs can be guessed, towards vague intangibles is the grail.

Because it's here that our sense of value breaks down and pricing becomes wildly imaginative and leads to far greater profits.