I recently visited a nice lagoon in the reserve of Sian Ka’an, near Tulum, in Mexico (to say near Cancun would perhaps be a better indicator of the location for many). You can imagine the place is pretty much in the middle of nowhere. Once we were done visiting the ruins and the boat trip, one of my friends was hungry, so we crossed the street and bought food from a local business, which is pretty much a tent with a cooler in which there was chicken and bbq ribs. The price of half a chicken was roughly 7 dollars. This made me think about how such a price was determined?
To answer the question, one has to consider multiple factors. Firstly, it could be that the owner of the business is factoring in total average costs. Clearly it is a necessary condition that the price has to be above the cost in order for it to remain profitable, and therefore not to shut down in the long run. This, however, is not sufficient supposing there is little competition. The reason why one can think that there is little competition is precisely because the place is located in the middle of nowhere, or rather, in front of a touristic spot with little commerce surrounding it. Therefore, this seller actually has some advantage, the first of which is location, let alone the idiosyncratic willingness to stand there all day to sell (or all weekends? as far as I remember this was on a Thursday).
But how much exactly is his markup? There is some stochastic element on his sales. Namely, the demand of my friend was relatively random, starting with the fact that only he wanted to eat (my other friend and I were not really hungry or simply did not feel like eating in that particular place). From the customer perspective, it could very well be the case that you want to wait, say, half an hour more, and get food from another restaurant. Furthermore, eating there implies a relative risk, as the food literally had flies flying around when the cooler was opened to show us the chicken. I will not even consider how serious hygiene is for such a business.
For the record, the chicken included a gracious amount of tortillas, rice, pasta and salad, making it a nutritious meal, rich in carbohydrates, proteins and fiber. Also for the record, my friend, however, did get sick after one day, arguably due to the chicken (especially as he did not finish the rest of the plate). This could be a less serious risk for the locals that buy there.
The risk factors in negatively for the consumer, but how much exactly? A simple price discrimination could do the cut: price it higher and only those who would anyways buy it will do. But how much more? Suppose that one can get half a chicken at a regular restaurant in Tulum, the nearest population, at 100 pesos. Waiting an extra 30 minutes is not well proxied by the value of the opportunity cost in terms of labor, because first of all it is generally speaking overall not reasonable to think that the tourist would work, as he most likely is in a whole weekend or week break. Secondly, there will be a demand of locals that will be interested in getting the chicken, although that implies making a small stop. A better model would be one that tries to capture how much a person is willing to pay more to get the food immediately versus 1 hour or so of traffic. The willingness to pay will be different for every person, and one could survey a representative sample, but that would imply a relatively large cost, especially for the small business. Furthermore, there will be clearly a huge seasonality as we are talking about a touristic region.
What would be a sensible approach, then, in order to make sure the profits remain stable? My intuition tells me that the owner does not have a well reasoned pricing structure. So one possible answer is: don’t worry much and simply price what your gut tells you. This of course, does not sound like a satisfactory answer.
I think the best approach would be to perform some sort of price discrimination, by offering bundles that attract the type of customer who would be willing to consume the given products. My friend, for example, was not so much interested in the rice and pasta, but certainly including some drinks would have made him happy (he actually bought a soda from the business next door). Furthermore, the second business could be used as a lever for this same type of discrimination. While this would require some level of experimenting by changing the prices, as well as directly asking the customers what they want, plus observing methodically what they actually consume, after some months or even weeks, one can get a pretty good estimate of what an optimal pricing structure would be. This would not account for the full demand, and potentially could lead to a second best, in the sense that it would probably not explore the hidden aspects of demand, which would indeed require an actual survey over a sample. However, such an anecdotal exercise shows how powerful having the right pricing strategy could be for a business. Once one identifies the value created, it is important to capture it. Otherwise, the altruism could backfire, especially if at some point (like in covid) the business faces important challenges.
Below is a picture of the lagoon.