Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.

Aspect	Explanation
Definition of Menu Costs	Menu Costs are the economic expenses or inconveniences that businesses incur when they adjust their prices in response to changing economic conditions or market factors. These costs stem from the need to update and communicate new pricing information to customers, suppliers, and within the organization itself. Menu Costs can encompass various expenses, including printing new price lists, updating digital price displays, retraining staff, and dealing with potential customer confusion or resistance to price changes. The term “menu costs” is metaphorical, likening the process to a restaurant updating its menu with new prices.
Key Concepts	Several key concepts define Menu Costs:
– Price Adjustment	Menu Costs arise from the necessity of adjusting prices, whether upward or downward, in response to changing economic conditions. This adjustment is crucial for businesses to maintain profitability, competitiveness, or to align with inflation or deflation rates.
– Communication	Effective communication of price changes to customers and suppliers is a fundamental aspect of Menu Costs. Businesses must ensure that the new prices are understood, and this may require updates to catalogs, websites, signage, and communication with vendors to negotiate terms.
– Operational Impact	Menu Costs can have operational impacts, as they often necessitate changes in point-of-sale systems, accounting practices, and staff training. The process of updating prices can disrupt normal business operations and requires careful planning and execution.
– Customer Perception	Businesses need to consider how price changes may affect customer perception and loyalty. Sudden or frequent price adjustments can lead to customer confusion, dissatisfaction, or loss of trust. Balancing the need for price changes with maintaining positive customer relationships is a challenge.
Characteristics	Menu Costs are characterized by the following attributes:
– Economic Friction	Menu Costs introduce economic friction into price adjustment processes. Businesses must allocate resources to handle these costs, and this allocation can result in inefficiencies and delays.
– Inflexibility	Businesses may hesitate to adjust prices frequently due to the costs involved. This inflexibility can impact a company’s ability to respond quickly to changing market conditions or to optimize pricing strategies.
– Cost Heterogeneity	The actual Menu Costs can vary widely depending on the scale of the business, the complexity of its pricing structure, and the methods used for price dissemination. Smaller businesses with simpler pricing may experience lower Menu Costs compared to larger, more complex enterprises.
– Psychological Impact	Beyond the financial and operational aspects, Menu Costs can have a psychological impact on businesses. The decision to change prices, especially when accompanied by the anticipation of customer reactions, can be stressful for business owners and managers.
Examples of Menu Costs	Menu Costs can manifest in various business scenarios:
– Retail Pricing	Retailers frequently face Menu Costs when updating the prices of products. They must adjust prices in-store, online, and on printed materials. This can include updating price tags, revising e-commerce product listings, and informing customers about new pricing through advertising or communication channels.
– Restaurant Menus	Restaurants provide a literal example of Menu Costs when they need to change menu prices. They must reprint menus, update pricing on digital menus, and inform waitstaff about the changes. This process incurs costs related to printing, design, and staff training.
– Subscription Services	Subscription-based businesses, such as streaming services or software providers, may incur Menu Costs when altering subscription prices. Communicating price changes to existing subscribers, updating billing systems, and handling customer inquiries can be part of these costs.
Benefits and Considerations	Menu Costs come with specific benefits and considerations:
– Pricing Strategy Impact	Menu Costs can influence a business’s pricing strategy, making frequent price adjustments less appealing. Companies may opt for less frequent but more substantial price changes to minimize Menu Costs, affecting their approach to pricing and competitiveness.
– Customer Relations	Managing Menu Costs requires a delicate balance between maintaining positive customer relations and addressing economic realities. Careful communication and transparency about pricing changes can help mitigate potential negative customer reactions.
– Operational Efficiency	Businesses may invest in more efficient pricing systems and technologies to reduce Menu Costs. Implementing dynamic pricing strategies, where prices automatically adjust based on algorithms and market conditions, can help streamline the process and reduce the manual effort required for price changes.
– Competitive Positioning	Consideration must be given to how pricing changes affect a business’s competitive positioning. Lowering prices may attract more customers, but it should be balanced with maintaining profitability. Conversely, raising prices may lead to higher margins but could deter price-sensitive customers. Businesses must weigh these factors when addressing Menu Costs.

Table of Contents

Understanding menu costs

The theory behind menu costs harks back to the late 1970s with research performed by Israeli economists Eytan Sheshinski and Yoram Weiss. In more recent times, menu costs have been influenced by aspects of New Keynesian economics which promoted the idea that a business would only make price adjustments if the benefits of doing so outweighed the costs.

Menu costs are one explanation for sticky prices, or a tendency for the price of goods and services to remain static despite fluctuations in supply and demand. Menu costs also vary according to the industry or context. The restaurant, for example, will discover that it is more expensive to alter its printed menu prices than it is to alter online menu prices. Less literal examples of menu costs include the hiring of a consultant to identify profitable values and the installation of updated point-of-sale systems.

Implications of menu costs for businesses

Menu costs play a crucial role in determining how prices can be adjusted to an optimum level where profits are maximized, expenses are minimized, and consumer expectations are met. Every business should quantify its menu costs – not only to measure profitability but also to evaluate the capacity to adjust its prices in the first place.

In a 1997 study entitled The Magnitude of Menu Costs: Direct Evidence From Large U.S. Supermarket Chains, the researchers noted that menu costs in five multi-store supermarket chains required dozens of steps and a significant investment. In fact, menu costs comprised 35.2% of net margins and cost 52 cents per change, with the cost per change increasing to $1.33 for supermarkets required by law to place a price on each item in addition to the shelf price.

The implications of this research for supermarkets and indeed other retail businesses are clear. No change in price should be made until the increase in revenue can compensate for the expenses incurred – though it can sometimes be problematic to determine the correct market equilibrium price. For the supermarkets in the above study, this meant the profitability of an item needed to drop by more than 35% to justify the cost associated with raising its price.

On occasion, it can also be difficult for a business to determine all relevant menu costs. One such cost that flies under the radar is the consumer reaction to an increase in price. In other words, will consumers become more hesitant to make a purchase? With shoppers now savvier than ever before and a diverse range of products on the market, there is a very real chance that an individual will simply choose to shop elsewhere.

Case Studies

Restaurant Menu: A restaurant decides to increase the prices of several items on its menu due to rising food costs. They must incur the expense of reprinting physical menus and updating their online menu.
Retail Store: A clothing store offers a sale with discounted prices on selected items. After the sale period ends, they need to update price tags and labels on the remaining inventory to reflect the regular prices.
Supermarket: A supermarket chain needs to adjust the prices of numerous products, including shelf tags and individual item prices, in response to changing supplier costs. This requires labor and materials to update the pricing information.
E-commerce Website: An online retailer wants to run a flash sale, reducing the prices of various products for a limited time. They invest in website development and marketing efforts to update prices, create banners, and promote the sale.
Automobile Manufacturer: An automaker introduces a new pricing structure for its vehicles based on changes in production costs and market demand. They need to update brochures, advertisements, and dealership materials to reflect the new prices.
Software Company: A software company releases a new version of its product with adjusted pricing tiers. They must update the pricing information on their website, marketing materials, and customer communications.
Financial Services Firm: A bank decides to modify the interest rates for its savings accounts and loans. They need to update account statements, online banking platforms, and customer agreements to reflect the changes.
Airline Industry: An airline adjusts its ticket prices based on factors like demand, fuel costs, and competition. They incur costs related to updating prices on their website, reservation systems, and ticketing materials.
Hotel Chain: A hotel chain revises room rates due to seasonal fluctuations. They need to update their booking system, website, and promotional materials to display the new prices accurately.
Manufacturing Company: A manufacturer changes the prices of its products in response to changes in production costs or market dynamics. This requires updating product catalogs, price lists, and sales presentations.
Digital Advertising: An online advertising agency needs to adjust bid prices for digital ads based on real-time market conditions. They invest in automated bidding software and real-time data analysis tools.
Consulting Firm: A consulting company modifies its hourly rates for different services. They update their contracts, proposals, and client billing systems to reflect the new pricing structure.

Key Takeaways:

In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.
Menu costs play a crucial role in determining how prices can be adjusted to an optimum level where profits are maximized, expenses are minimized, and consumer expectations are met.
In theory, changing item prices should not occur until the increase in revenue can compensate for the expenses incurred. However, ascertaining the equilibrium point of the market may be more difficult in practice and the business must also consider the impact of the increased price on consumers.

Key Highlights of Menu Costs:

Definition: Menu costs refer to the expenses incurred by a business when it decides to change its prices, often originating from the need to update physical menus, price tags, or other pricing materials.
Origins: The concept of menu costs was influenced by research conducted by Israeli economists Eytan Sheshinski and Yoram Weiss in the late 1970s. It aligns with the principles of New Keynesian economics, suggesting that businesses adjust prices only when the benefits outweigh the associated costs.
Sticky Prices: Menu costs help explain the phenomenon of sticky prices, where the prices of goods and services remain unchanged despite shifts in supply and demand. Prices are less likely to change if menu costs are high.
Industry Variation: Menu costs can vary across industries and contexts. For example, updating printed restaurant menus is more costly than adjusting online menu prices. Other non-literal menu costs include expenses related to hiring consultants or implementing new point-of-sale systems.
Profit Optimization: Menu costs are critical in determining the optimal price adjustments that maximize profits, minimize expenses, and meet consumer expectations. Businesses must assess menu costs to make informed pricing decisions.
Supermarket Study: Research on menu costs in large U.S. supermarket chains found that menu costs accounted for a significant portion of net margins (35.2%) and cost around 52 cents per price change. For supermarkets required by law to display individual item prices, the cost per change rose to $1.33.
Price Adjustment Considerations: Businesses should refrain from changing prices until the expected increase in revenue can offset the incurred expenses. Determining the market equilibrium price can be challenging, and companies must also consider how price hikes might affect consumer behavior.
Consumer Reaction: An often-overlooked menu cost is the potential impact of price increases on consumer behavior. Shoppers may become more reluctant to make purchases, potentially leading them to seek alternatives in the market.