How to Present Surcharges: the Case of Restaurant Gratuities

How to Present Surcharges: the Case of Restaurant Gratuities Shuo Wang and Michael Lynn School of Hotel Administration Cornell University

Price Partitioning • Price partitioning: Divide and Conquer • Calculating Bias Hypothesis (Morwitz et al., 1998) • Inaccuracy in metal arithmetic and the use of heuristics • Recall of lower total price Better deal perception / Increased demand • Judging Criterion: recalled total price 2008 Behavioral Pricing Conference Presentation

Price Partitioning • Attention Arousal Hypothesis (Bertini and Mathieu, 2008) • a partitioned price increases the amount of attention paid to surcharges • Characteristics of surcharges such as perceived value, relative importance, and evaluability play an important role in price perception 2008 Behavioral Pricing Conference Presentation

The Framing Effect of Presentation Format • Prospect Theory (Kahneman & Tversky, 1979) • Discount Promotion (Chen et al., 1998; Hardesty & Bearden, 2003; Heath et al., 1995) : • Consumers tend to value deep, significant discounts and use them as a heuristic in their deal evaluation • % discounts for low-priced products: (50% off vs. $3 off for a $6 pen) • $ discounts for high-priced products: (15% off vs. $150 off for a $1000 laptop) 2008 Behavioral Pricing Conference Presentation

Percentage vs. Dollar Surcharges • Percentage surcharges are more cognitively taxing relative to dollar charges • Consumers are more likely to ignore surcharges or take mental short-cuts • Percentage surcharges lead to perceptions of lower total price but greater value (Morwitz et. al, 1998) • However… 2008 Behavioral Pricing Conference Presentation

Percentage vs. Dollar Surcharges • The advantage of percentage surcharges is qualified by its relative magnitude to the base price of a product and/or service (Chen et al., 1998; Darke & Freedman, 1993; Xia & Monroe, 2004) • When the surcharge is comparatively high, consumers tend to be more involved and motivated to accurately process the price information, irrespective of its presentation format 2008 Behavioral Pricing Conference Presentation

Research Question • Whether the level and format of automatic gratuities influence consumers’ perception and evaluation of menu prices, and if so, under what conditions 2008 Behavioral Pricing Conference Presentation

Hypothesis 1 • The advantage of restaurant gratuities is contingent on levels of surcharges relative to their reference range • Restaurant gratuities have more magnitude salience (Lambert, 1978) or evaluability (Bertini & Wathieu, 2008) than menu prices • Determined by social norms • Small variations, narrow reference range • Usually in relative terms (%) 2008 Behavioral Pricing Conference Presentation

Hypothesis 1 • Slight deviations from their conventional range would make restaurant gratuities more salient, biasing consumers’ assessment of menu prices with little or no account of other aspects of the price information, including total price • Menu prices with automatic gratuities below or within the conventional range will be evaluated more favorably than financially equivalent all-inclusive menu pries, and vice versa. 2008 Behavioral Pricing Conference Presentation

Hypothesis 2 • Surcharge levels moderate the impact of surcharge formats on evaluations of partitioned prices • Converting Process: • Consumers need to convert restaurant gratuities in dollar terms to a percentage in order to meaningfully evaluate the menu price • Anchoring and Adjustment Process: Using 15- or 20-percent as anchors  Converting them to dollar amounts (15% of $20 is $3)  Comparing the converted dollar amount with the presented dollar gratuities ($3 < $3.5)  Make adjustments to the estimated percentage gratuities (15%15-17%?) 2008 Behavioral Pricing Conference Presentation

Hypothesis 2 • Adjustments are often inadequate and consumers often end up with a percentage level closer to the anchor level than it actually is • As a result, consumers tend to be less sensitive to the deviations of gratuities from their reference range when they are specified in dollar terms rather then percentage format 2008 Behavioral Pricing Conference Presentation

Online Experiment • Computer-based experiment using a national consumer panel • Experiment Stimuli: A Prix fixe Pre-theatre Menu http://www.magnasoftinc.com/shuo4/index.php • 3 (surcharge level: 12 percent vs.18 percent vs. 23 percent) x 3 (price format: all-inclusive vs. percentage vs. dollar) between-subject design 2008 Behavioral Pricing Conference Presentation

Online Experiment 3 X 3 between-subjects design 2008 Behavioral Pricing Conference Presentation

Online Experiment • Main Dependent Measures (7-point scale): • Deal Perception (3 items) • Recalled total price • Recalled/Derived gratuities amount (% or $) • Recalled/Converted gratuities amount (% or $) 2008 Behavioral Pricing Conference Presentation

Results: Deal Perception Index 2008 Behavioral Pricing Conference Presentation

Results: Recalled Total Price 2008 Behavioral Pricing Conference Presentation

Results Deal Perception Index 12% vs. 18% 2008 Behavioral Pricing Conference Presentation

Results: Recalled Total Price12% vs. 18% 2008 Behavioral Pricing Conference Presentation

Results: Converting Hypothesis 2008 Behavioral Pricing Conference Presentation

Results: Converting Hypothesis % vs. $ 2008 Behavioral Pricing Conference Presentation

Results: Magnitude of Gratuities % vs. $ 2008 Behavioral Pricing Conference Presentation

Conclusion and Limitation • Our hypotheses are marginally supported at 12% vs. 18% level • Strong support for the “converting process” across three levels • 18%  15% • Replicate the experiment on students in a lab setting 2008 Behavioral Pricing Conference Presentation

Discussion and Suggestion Questions? 2008 Behavioral Pricing Conference Presentation

How to Present Surcharges: the Case of Restaurant Gratuities