Priceonomics

Photo credit: Rick Dikeman via Wikimedia

If you want to dine at State Bird Provisions, you’ll have to get in line. The small restaurant, winner of the James Beard Award for Best New Restaurant (2013) and a Michelin Star, only accepts a few reservations that are snapped up as soon as they are released -- at midnight, sixty days in advance. So nearly every day, people line up on Fillmore Street in San Francisco an hour or more before State Bird’s 5:30pm opening time to score a table. 

It may seem silly to line up for State Bird Provisions in a city full of renowned restaurants and good food. But as anyone who has eaten brunch in the city knows, San Franciscans view long restaurant lines as social proof more than as a deterrent. Besides, State Bird offers determined diners a relative bargain. While its offerings are not cheap -- even without indulging on wine, bills can reach $50 per person -- State Bird’s prices are more modest than almost any other local Michelin Star restaurant. 

This makes State Bird something of an economic mystery. If economists owned popular restaurants like State Bird, they would take one look at the long lines and raise prices. After all, the overwhelming demand is pretty clear. Or at the very least, given how reservations disappear like Coachella tickets, they would start charging for them. In fact, since restaurants do not do this, a number of startups in San Francisco and New York City have started to sell reservations to users, often by reserving tables and scalping them.

In contrast to the executives who run large restaurant chains, the restaurateurs behind celebrated restaurants and local favorites are often chefs first rather than professional managers. This raises the question: Are restaurants like State Bird Provisions, which seems to resist simple economic analysis, the exception or the norm? And if they are the norm, is that because it is somehow self-defeating to raise prices even at booming restaurants? Or are chef proprietors a unique breed in the business world, immune to supply and demand and content to leave money on the table?

The Restaurant Biz: Socialism or Capitalism?

To understand the economics of the restaurant business, we spoke to the founder and manager of a mid-sized San Francisco restaurant. She asked that we print neither her name nor that of her restaurant, as she had experienced negative reactions from readers and diners in response to what she considered vanilla details described in past articles. (We will refer to her by the pseudonym Alicia.)

When we ask Alicia about charging for the most desirable reservations or raising prices in response to long lines, she responds that “a menu should be priced fairly” and that “your prices are your prices.” This would raise eyebrows in most industries, where management often hires consultants to figure out how much it can raise prices without losing customers. It also jives with this author’s observation that prices seem correlated with a restaurant’s decor or the type of food, but less so with deliciousness or popularity: State Bird Provisions has a Michelin star, but as it serves California food, dim sum style, in a casual setting, it’s less expensive than hundreds of white tablecloth establishments that serve forgettable dinners. 

So why might owners try to set “fair” prices, rather than push them up toward greater profits? Alicia’s reluctance to user her and her restaurant’s name suggests one reason: customers are very sensitive not only to prices but to the perception of a rip-off.

Why are prices always higher at lackluster, white tablecloth restaurants than at very popular (but slightly more casual) restaurants? Do we really care that much more about bow ties than great food?

The best example of eaters’ highly calibrated sense of fair food prices is how they respond to people paying a premium for something -- whether that is San Francisco’s $3 artisanal toast or Vincent asking Mia in Pulp Fiction about a five dollar milkshake, “Milk and ice cream…costs five dollars? You don’t pour bourbon in it or anything?” Even if it’s so good people line up for it, it’s an outrage. Some people in the food industry do jump on bandwagons and sell ordinary items at inflated prices, but it does seem strange that people react to the idea of paying a couple extra bucks for the world’s best chicken sandwich, donut, or shake as some sort of mass hysteria. 

As Alicia tells us, “There are limits to what people will pay.” Customers compare menu prices to what it would cost to make a dish at home (even though restaurants also pay rent, taxes, and waiter salaries -- ingredients usually represent 20% to 40% of a dish’s cost) or have a fixed idea of how much a meal should cost. Accordingly, restaurant managers are not only loath to raise prices, but they are responding to the current drought, which has increased meat prices, by incurring that loss rather than passing it on to consumers. And while people are used to a chicken or vegetable dish costing less than steak, people are not always ready to pay the full premium for, say, high quality salmon. So on some dishes with expensive ingredients, restaurants may only break even or lose money by pricing it too low. 

A business analyst would hate the sound of these practices, and he or she would certainly not like Alicia’s sentiment of taking a loss on some foods like truffles or pricey proteins that you “serve out of love” and really want to include on the menu. But this fluffy talk of items “served out of love” can be translated to business-speak -- they act as loss leaders, luring in customers who will also spend money on cocktails, side dishes, and grain-heavy options that have higher margins. And every new restaurant owner checks out the surrounding competition in order to price competitively.

Bay Area residents, who live in an area of $13 hamburgers (cheese one dollar extra), may bristle at the suggestion that restaurant prices are anything other than exorbitant. Alicia’s talk of fair pricing could be no different from other industries -- Comcast executives may very well consider their prices fair even as they charge higher prices for substandard service. But here is at least one piece of evidence that we receive a pretty good deal: a slew of startups are popping up to take advantage of the money restaurants leave on the table. 

The first companies appeared in 2007, then disappeared with the recession. But with the 1% economy booming again, a number of sites like Reservation Hop and Resy are trying to turn reservations into a profitable commodity by calling for reservations and then selling them. Resy partners with restaurants to split the revenues, yet most make and hawk reservations independently and have been shunned by aghast restaurateurs. From an economist’s perspective, these hot restaurants are so underpricing their product and undervaluing their one-of-a-kind appeal that an industry is popping up to pocket some of that value. So why don’t owners of restaurants like State Bird claim that value themselves?

One reason is that price changes and extra charges are anathema in the hospitality industry, as it can ruin the experience by reminding people that the restaurant is a business. As food writer Gabriella Gershenson writes in the New York Times, restaurants are “an exchange of goods and services [but] hospitality is the finesse that makes us forget about the mercenary nature of it all.” Similarly, Alicia describes a restaurant from the owner’s perspective as “your house” and adds (in reference to raising prices) that “you wouldn’t abuse guests in your home.” Many managers and owners are looking for ways to cut costs and increase profits, but they risk drawing the ire of customers and violating the code of the hospitality industry. 

In particular, raising prices and charging for reservations can alienate one crucial group: the regulars. Even the hottest restaurants rely on a staple of regulars who eat on Mondays and Tuesdays, in bad weather, and during the off-season. A restaurant may draw endless lines for a year or two, but it’s near impossible to maintain that level of interest indefinitely. “You’re only as successful as the relationship you keep with your customers,” Alicia tells us, adding that regulars (who often know the names of the staff) and their friends make up some 30% to 40% of her business. Raising prices can alienate the regulars who keep restaurants in business through lean periods -- the same reason that sports teams and famous musicians price tickets so low that scalpers pocket half the profit. It can be smart business to price at a level seen as fair rather than what the market will bear. 

But a reluctance to raise prices or maximize profits may be a trait characteristic of even restaurateurs successful enough to get away with it. As Ryan Cole, general manager of Stone’s Throw, a trendy San Francisco restaurant, put it in an open letter:

Just because you can charge the premium doesn’t mean you should. Sometimes the value of providing an unforgettable experience for everyone interested in dining at your restaurant, not just those that can afford to pay a premium to get in, is much more rewarding both financially and morally.

A recurring refrain among restaurant owners and managers is that you don’t get into the industry for the money. Margins are low, the hours long, and protective barriers to entry non-existent. The fact that so many people love restaurants and see cooking as a skill they’d like to leverage into a career is why so much competition exists and keeps prices low. 

As such, it seems part of the restaurateur identity to look past profits in favor of the prestige of running a great restaurant and having a place in the city’s food culture. A cynical reading of the hospitality industry is that avoiding talk of prices is a way to prevent customers from thinking with their wallet, but as evidenced by Alicia describing a restaurant as “your house,” hospitality is also internalized. 

A striking part of Ryan Cole’s letter, which he wrote to disavow the practice of charging for reservations, is that he opens by noting that “I recently helped a friend get a reservation at a restaurant many would consider to be one of the hottest tickets in town.” (It’s also common at some fancy restaurants to reserve tables for VIPs and the concierges of fancy hotels.) In the restaurant business, allocating scarce reservations by social capital is a cherished part of “the experience”; allocating them by actual capital is the equivalent of slipping the maitre d’ a twenty. As with any art, there is good money to be made at the top of the food industry and not much at the bottom. But you should pretend not to care: cash is not the currency.  

Dynamic Pricing: That’s the Ticket

One reason entrepreneurs keep trying to sell reservations is that restaurant pricing seems so outdated. Airlines charge significantly more for tickets on weekends and charge much less for flights that depart at 5am, yet all dinner reservations are the same price (free) and with the exception of a few special holiday menus, prices are the same on Tuesday at 6pm as Saturday at 8pm. 

At the very high end of the restaurant business, that may be changing. Nick Kokonas is the co-owner of three expensive, celebrated restaurants in Chicago. He now charges for reservations using a system he developed -- one that restaurateurs may actually like.

When customers reserve a table at one of Kokonas’s restaurants, they pay for their entire dinner. The restaurants have a fixed price tasting menu (although at a more casual restaurant that does not, customers’ reservation charge is a credit toward their bill), so a reservation is actually a pre-paid ticket for a meal at a set time. 

They system can benefit everyone. It overcomes owners’ and managers’ primary objection to charging for reservations, as diners pay for their meal rather than for a table. It also eliminates the need for reservation staff and prevents no-shows. It also can benefit customers, as it uses dynamic pricing that increases prices during prime hours and reduces them during off-peak times. So while wealthy patrons have an easier time getting reservations on Saturday night, those same wealthy patrons subsidize the Tuesday night dinners of foodies on a budget. 

Kokonas plans to license the system for other restaurants’ use, and Coi, a two Michelin star restaurant in San Francisco, will start using the system on September 1. It remains to be seen whether the ticketing system can overcome the attitudes of owners like Alicia, who says she knows what price is fair and works for the restaurant. Which is fine by this author, who lives in San Francisco, loves the food scene, and is loath to suggest the industry focus on profits and pricing instead of making great meals. It seems positive that if dynamic pricing comes to the restaurant business, it will be on the chefs’ and the managers’ terms.

This post was written by Alex Mayyasi. Follow him on Twitter here or Google PlusTo get occasional notifications when we write blog posts, sign up for our email list.


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