When essentially the same item is sold at different prices, framing matters – a lot – to how it is perceived.

There is a classic behavioural economics finding from 1983 research by Nobel laureate Richard Thaler involving beer (I wrote about it here). Briefly, it features two parched people on a beach, and explores what they would be willing to pay for a cold beer. If the only place where it could be obtained was a posh hotel, the price participants would be prepared to pay was 75% higher than if it was a rundown shop. This suggests that differential pricing for the same beer is acceptable, depending on who the seller is. Different prices for the same beer from the same seller, at different times, that is a different affair, though. A few weeks ago, it transpired that British pub chain The Slug and Lettuce will shortly start charging 20 pence (23 eurocent, 24 dollarcent) more than their standard price for a pint of beer at peak times. Unsurprisingly, the social media chorus was not amused. I say, ‘unsurprisingly’, but isn’t it odd that we accept that the circumstances of a posh hotel justify its higher price compared to a humble store, but not that the conditions of a pub at busy times might justify higher price compared to a quieter moment?

What’s in a price?

Generally, the most important determinants for the price of a good in a free market are supply and demand. If the quantity supplied is larger than the demand, then goods will remain unsold unless the price is lowered, which then increases demand: a supplier with excess stock will seek to shift it by offering it more cheaply. If the opposite applies and the good is scarce, some buyers will offer a higher price, so it will rise until the demand falls to match the supply. This might even happen through a secondary market: the hand-built cars from UK manufacturer Morgan are scarce because demand outstrips the limited supply, so buyers can buy a brand new Morgan Plus 4 at £43,389, which is not available, and, for example, a three-year-old model with nearly 3000 miles on the clock offered at £49,991, which is available immediately.

Price movements are also a signal to the suppliers. Price rises might encourage additional suppliers to enter the market and decrease scarcity (which will eventually reverse the price rise). Price drops might cause any suppliers that can no longer profitably provide the good to exit, thus eliminating the excess.

But there is more than quantity demanded and quantity provided. Perceived value (in the eye of the buyer) is one example, as Thaler’s thought experiment illustrates: in town, people might walk past the posh hotel until they find a more affordable beer, but on a hot summer’s day on the beach, they are prepared to dig deep into their pocket, because the perceived value of cold beer in that situation is high. Suppliers who expect this can raise prices; if they are right, they will experience little or no drop in sales volume. The other side of this coin is that the cost of supplying the goods affects the seller’s willingness to accept. Running a posh hotel is more expensive running a humble store, and that is reflected in the price they charge for a beer.

Sellers have other strings to their bow to play with price, supply and demand. They may be able to crank up the perceived value of the product in the buyer’s eyes, through advertising for example, and thus to increase the price they can obtain. They can also create different price segments in the market for what is essentially the same product, by impairing the cheapest product relative to the more expensive one (or by enhancing the more expensive one). With cheap return tickets for air travel your bum ends up on exactly the same seats, but there has to be a weekend between the outbound and inbound legs, which makes it unappealing to business travellers, who are then compelled to fork out more.

Several of these price characteristics can explain why the pub chain might raise prices at busier times. The high demand may well push the place to its capacity or beyond – the place is full. With more expensive pints, drinkers who don’t value the beer as much will stay away, so there is more capacity for the keener customers prepared to pay more. The beer is thus allocated more efficiently, and goes to those who appreciate it the most.

The pub chain also claims that, at busy times, its costs are higher. They refer specifically to security costs, and it is not unreasonable to consider that these may rise disproportionately with the number of patrons. Similar arguments can be made about cleaning and even damage.

Unfair uplift vs fair discount

But why, if a higher price at peak times is so easy to explain, do people seem to have such a problem? Aside from the fact that we generally prefer prices to be low rather than high, and to go down rather than up, a price, or a price rise, that seems unfair makes us cross.

Fairness is a slippery concept (I wrote about it here), and when it comes to buying things, the feeling that we are overcharged really gets our hackles up. A price somehow needs to be justified, not by the amount of value that it provides, but by the cost and effort that went into supplying it. Remarkably, another paper with Richard Thaler as a coauthor (alongside Daniel Kahneman and Jack Knetsch) deals with exactly that phenomenon: in the research, participants were given a series of vignettes depicting hypothetical commercial decisions, and had to judge how fair these decisions were. An oft-cited example: a hardware store owner who sold snow shovels $15 apiece, but who, the morning after a heavy snowstorm, raised the price to $25, which 82% of participants judged as unfair.

Why unfair? The authors dissect fairness judgements into three determinants. The reference transaction (the ‘normal’ situation) implies a sale at a certain reference price to the customer which, assuming a reference cost, gives the seller a certain reference profit.  The outcomes to the seller and the buyer – the changes following a pricing decision – are then judged by comparing them with the reference transaction in terms of relative gain or loss. Finally, the motivation for the pricing decision provides the key to (un)fairness. If the seller’s costs rise, then a price increase to protect the reference profit is seen as fair. If the seller’s costs fall, for example through efficiency gains, then the additional profit from maintaining the price (rather than reducing it) is considered fair, too. However, taking advantage of market power, e.g., if through a shock in the market the supply falls, or demand rises (as in the snow shovels vignette), is seen as unfair.

How does this explain the displeasure with the price hike at peak times in the Slug and Lettuce? The claim that costs are higher when the pub is busy may be true, but it does not pass the fairness criteria: that cost differential is not new, and so the sudden price hike is seen as a blatant attempt to beef up the profit margin. It is seen as profiteering.

The pub also seems to have missed a trick by not framing their tactic differently and offering off-peak prices instead. Imagine they had absorbed the 20p peak top-up in the more general price rise due to inflation, and at the same time offered a discount at quieter times, using the same logic in reverse and with a different narrative. “When it is less busy our operating costs are lower, and we are reflecting these in lower off-peak prices” would quite likely have achieved exactly the same financial outcome, and earned praise from customers and social media commentators rather than disdain and derision.

To paraphrase the Fun Boy Three hit It ain’t what you do, it’s the way that you do it, it ain’t what you do, it’s the way that you say that you do it.