Written by Christopher Qian
Red Lobster, famously, once canceled its “Endless Crab” buffet after losing over USD 3.3 million. While this may seem shocking to many, from an economics perspective, such a case should be the norm. What restaurants face when opening a buffet is an issue of adverse selection – when one party (the customer), uses private information (the capacity of the customer’s own stomach), to the counterparty’s (the restaurant’s) disadvantage. This theory could explain Red Lobster’s failure to correctly anticipate the costs to the restaurant per consumer and why buffets, in general, should not exist.
Adverse selection occurs because consumer appetites are varied. For each consumer eating above the average portion expected by restaurants, the restaurant needs other consumers to eat below the average to balance their costs. However, rational consumers with small appetites should order cheaper a-la carte options with smaller portions as that is all they need to be full. Based on this logic, only consumers eating enough to be worth the average, or above the average price would want to eat at the restaurant. As a result, restaurants would have to raise their prices, which in turn drives away another portion of their consumers and so on. As seen, this creates some form of a positive feedback loop that would eventually lead to buffets serving only one person: the single biggest eater in the area. A similar phenomenon to the one described above has been observed by Akerlof in the health insurance market: Health conditions of insurance applicants fell, leading to increasing insurance premiums. In a world of homo economicus, buffets should not exist, much less be profitable, yet the buffet industry in the United States rakes in around USD8 billion in revenue each year.
So how do buffets exist at the scale they do today?
Adverse selection is conditional on one party having an exploitable advantage. One hypothesis is that consumers cannot accurately gauge their appetite due to the existence of cognitive biases. Slovic, Griffin and Tversky suggest that incompatible stimuli and responses can lead to errors in judgement. In the context of this investigation, it is unlikely the consumer has been full on whatever they are about to eat in the buffet due to the abundance of options. Hence, the stimulus (food that filled one’s stomach in the past) and response (the amount of buffet food needed to fill one’s stomach) are incompatible and hence consumers’ estimates for their appetite will be error-ridden.
However, if we assume consumers incorrectly estimate their appetite, consumers will revise their beliefs of their own appetite if they believe they are not maximizing their utility such as if they feel they overpaid for their meal. As consumers begin to frequent the same buffet they will begin to learn from their past visits and derive a more accurate estimate of their appetites, giving them the informational advantage outlined above. Assuming cognitive bias is the main cause of buffets’ profits, they would require a constant stream of new consumers in their region, meaning these restaurants would be most successful in hotels or other tourist areas where there aims high turnover of new consumers. However, buffets can still be seen in many areas where these conditions are not met, such as in Ann Arbor at the Wolverine Sushi Bar which serves all-you-can-eat sushi from Thursday to sunday.
Perhaps the existence of buffets could be explained by other types of utility generated by its unique characteristics.
If we assume a restaurant serves two categories of substitute goods: the buffet meal and an a-la carte option and for any portion eaten at a buffet, there is an equally sized a-la carte option. As the two goods fill the consumers up the same, we can infer that they can be priced similarly. An assumption in the adverse selection problem proposed in the introduction is that these two goods cost the same to produce. However, in reality this is not the case. Buffets are not made to order and hence can be prepared en-masse, allowing restaurants to exploit economies of scale leading to huge cost savings. Furthermore, buffets reduce the demand for waitstaff and kitchen staff. As a result, the two goods comparable in price and level of filling can cost restaurants drastically different amounts.
On the consumer side, consumers usually enter a buffet expecting to eat more than usual. While ordering a-la carte, consumers may aim to order an item where the portion size is most fitting to their own appetite in order to maximize their utility from the meal. For those going to buffets however, consumers are shown to engage in behaviors that can lead to over-eating (Thompson). As a result, it can be inferred that consumers will be willing to pay more for a buffet meal than what they would usually be willing to spend on an a-la carte meal as they are eating more. As consumers are willing to pay more, firms are able to increase revenue.
Furthermore, consumers may in fact value a buffet meal more than an a-la carte option. Research conducted by Professor Koc of Bahcesehir University shows that people tend to prefer salads that they create themselves from a salad bar over a virtually identical salad served by the restaurant. This example of an illusion of choice shows how consumers can assign higher utility to picking their own combination of items in a buffet rather than ordering from a comparatively more choice rigid menu. As such, consumers may in fact value a buffet more, and their willingness to pay.
As demonstrated above, buffets may in fact be cheaper to produce for restaurants but more valuable in the eyes of consumers. Hence, consumers could feel satisfied eating a certain portion of food that is profitable for the restaurant too, allowing there to be return customers who may eat below the average portion.
Even as Red Lobster was forced to close down its endless crab buffet, there are still a plethora of buffet restaurants open in America. They pose an interesting economic question and lend a unique insight into the complexity of the human psyche outside the bounds of traditional economics.
Bibliography
“Adverse Selection.” Adverse Selection – an overview | ScienceDirect Topics. Accessed October 28, 2020. https://www.sciencedirect.com/topics/economics-econometrics-and-finance/adverse-selection.
Akerlof, George. “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.” The Quarterly Journal of Economics 84, no. 3 (1970): 488–500.
Hogarth, Robin M., Hillel J. Einhorn, Paul Slovic, Dale Griffin, and Amos Tversky. “Compatibility Effects in Judgment and Choice.” In Insights in Decision Making: a Tribute to Hillel J. Einhorn, 5–27. Chicago, IL, Illinois: University of Chicago Press, 1990.
Koc, E. (2017). The Influence of Open Buffet System in All-Inclusive Holidays on Illusion of Control, Gluttony and Obesity. ts, Bandırma Onyedi Eylül University.
Published by S. Lock, & 12, N. (2021, November 12). Buffet Restaurant Market Size us 2021. Statista. Retrieved April 19, 2022, from https://www.statista.com/statistics/1175854/buffet-restaurant-industry-market-size-us/
Tharp, Paul. “’ENDLESS CRAB’ PIGOUT IS END FOR RED LOBSTER BOSS.” New York Post. New York Post, July 8, 2019.
Thompson, A. (2008, December 2). Buffet behavior: The science of pigging out. LiveScience. Retrieved April 19, 2022, from https://www.livescience.com/5206-buffet-behavior-science-pigging.html
https://nypost.com/2003/09/26/endless-crab-pigout-is-end-for-red-lobster-boss/.Thompson, A. (2008, December 2). Buffet behavior: The science of pigging out. LiveScience. Retrieved April 9, 2022, from https://www.livescience.com/5206-buffet-behavior-science-pigging.html