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How to Use Game Theory for your Restaurant to win Competition [Case Studies] and Increase Revenue

How to Use Game Theory for your Restaurant to win Competition [Case Studies] and Increase Revenue

The roots of game theory go as far back as the 1500s but only in 1928 did it officially become a separate field of study. As a branch of mathematics, it analyzes competitive scenarios where outcomes depend on more than one party and participants’ decisions and strategies influence others’ choices and strategies.

With the extreme competition of the modern restaurant industry—simply consider how many similar fast-food chains there are on today’s market, all competing against each other, often in close proximity to each other—it makes sense why the theory can be applied. In practice, the theory can help predict and understand decisions in this industry.

Restaurant owners can use this to improve their own standing and stay competitive. Also, the application of game theory stretches to various other industries.

What is Game Theory?

The purpose of game theory is to help predict how parties will act in a specific situation. It started out as an analysis of games, such as those offering the option to act in order to benefit everyone, or only oneself. It even applies to chess, since one person’s move affects the other player’s next move.

Later on, game theory had relevance in other scenarios, starting with political science, and today it’s used to analyze various industries. Although it can’t predict companies’ or individuals’ actions accurately all the time, it does help to have insight into the motivation behind certain decisions and imagine possible outcomes.

The potential outcomes are also used to create strategies and motivate future decision-making. Role-players’ decision-making processes involve studying others in the scenario and making decisions based on others’ actions or assumptions of how the other party will act.

Within this theory, there’s the assumption that each role player in the situation will often pick actions that benefit him or her—or an organization—the most. At first glance, this seems sensible, but often in business, there could be more advantageous outcomes and more freedom of choice for all if only the parties would collaborate. However, rarely do participants choose cooperation.

The Concept Of Strategic Interaction In The Restaurant Industry

In the food service industry, restaurants need to make smart choices to draw the highest possible number of clients. A clear obstacle is having other eateries in the vicinity also catering to these hungry clients.

There will be strategic interactions between all these role players to increase their bottom lines. Also, the restaurants all influence each other’s actions when they make choices that impact customers’ decisions.

A common occurrence in this industry is that multiple restaurants are found close to each other, rather than some choosing locations with less competition. It happens despite this arrangement reducing the number of clients each of them will draw.

In this situation, all role players need to apply strategies to improve their chances of drawing the biggest number of clients. How this applies to restaurant-specific activities will be explained in more detail below.

Game Theory in Pricing Strategies

For consumers, the cost of merchandise—food in this case—is an important factor when deciding which brand to support. This makes it important for restaurants to make pricing decisions that will benefit their bottom line.

Pricing Strategies

Analysis Of Pricing Strategies In The Restaurant Industry

In the restaurant industry, eateries can study each other’s pricing tactics. This can help keep a restaurant’s own pricing relevant for the target market in comparison to other eateries’ prices. In addition, close analysis of competitors can help make predictions about what changes they may make in the future, in order to plan ahead for such eventualities.

The Role Of Menu Design And Pricing On Consumer Decision-Making

Pricing is effective in impacting consumers’ decisions, but in the food service industry, the power of good menu design shouldn’t be underestimated either. For example, eye-catching colors and adding photographs of dishes to the menu can make clients more inclined to commit to a purchase or even buy more than they originally planned to.

It’s smart to consider both menu design and pricing together when creating strategies to draw customers since they affect each other.

For example, selling an item at $9.99 instead of $10 may increase sales, because clients perceive the first as more affordable. This method is called ‘charm pricing’. This could mean that a restaurant with a stunning menu that doesn’t implement charm pricing could lose sales to another eatery that does have a smart pricing strategy.

This proves how essential it is for restaurants to continuously familiarize themselves with what competitors are doing. They can then adjust their own price strategies accordingly, based on these strategic interactions and analysis.

Use Of Dynamic Pricing Strategies In The Restaurant Industry

When restaurants implement dynamic pricing, they make adjustments to menu prices according to demand. For example, it may be necessary to drop ice cream prices during winter months but you can increase the price once summer comes around and more people will be in search of the cold dessert.

With the game theory in mind, restaurants that all sell ice cream may keep a close eye on each other’s dessert pricing and ensure they offer the lowest price or at least the same price in winter. In this manner, they lower the risk of losing out on a sale because of price. With demand low during winter, it will be especially important to secure as many sales as possible.

Using game theory, you can also anticipate other role restaurants’ pricing decisions and be the first to implement a change to gain an advantage.

Game Theory in Competitive Strategies

Restaurants can compete in terms of service delivery, the type of dishes they serve, or offering similar price levels. While affecting their bottom line, it also impacts the value customers receive from them.

Competitive Strategies

The Impact Of Competition On The Restaurant Industry

Having multiple restaurants compete for their patronage means customers can expect better outcomes. Competition motivates restaurants to improve or change an aspect of their service delivery, in the hope of it becoming a feature that draws more customers. Examples of areas that may become better when there’s more competition include:

  • Pricing
  • How quickly dishes are served to waiting customers
  • Friendliness of staff
  • Comfort of seating

Improvements are motivated by the hope of becoming a preferred vendor thanks to providing a better option than another outlet.

Pricing is one of the major factors at play. Motivated by the possibility of becoming a preferred vendor, a restaurant may lower prices and earn less per item, all in the hope of drawing more customers.

The Use Of Game Theory In Developing Competitive Strategies

Restaurants can use game theory principles to make more strategic decisions to give themselves a competitive advantage. By imagining hypothetical situations and predicting other role players’ actions, restaurants can compile a strategy to stay competitive despite others’ decisions. 

Analysis Of The Nash Equilibrium In The Restaurant Industry

Part of game theory covers the Nash equilibrium. Here, all role players know other companies—in this case restaurants—strategies and each also has a competitive strategy implemented. In the equilibrium state, each eatery has come to the conclusion that there’s no benefit to changing something in their own strategies, as no change can further improve their market share.

Game Theory in Staff Management

Many companies use game theory to manage HR matters. Some principles can help restaurants with choosing and managing their staff.

staff management

The Role Of Staff In The Restaurant Industry

Having a good team in your restaurant is essential since they’re integral to developing a good reputation.

Kitchen teams impact the quality of the food customers receive and the front-of-house team engages with patrons. Patrons’ opinions can be based on factors such as friendliness or speed of service. All staff members’ actions, therefore, determine whether clients view the restaurant in a good or bad light.

Analysis Of Staff Incentive Schemes

It’s essential to effectively manage staff, in order that they stay motivated to produce the best possible service. In addition, restaurants should have a strategy to retain talent and good workers, so they will continue to benefit the brand.

One method to ensure you have quality, motivated staff is to have strategies in place that encourage team members. These incentive schemes could relate to work aspects, such as:

  • Flexibility in terms of work hours or shift selection
  • Reimbursement
  • Giving time off
  • Offering free meals

Incentives can be based on performance, attendance, longevity of service, or other factors.

Application Of Game Theory To Optimize Staff Performance

It’s possible to implement game theory in HR, because human behavior has been studied a lot, and therefore understood to a great extent. This makes it possible for managers or restaurant owners to predict the possible outcomes after making a decision affecting their staff, whether it relates to policy, salaries, employee motivation, or any other staff matter.

By using game theory as an approach, restaurants can then create strategies or make decisions that are the most beneficial. Examples of beneficial outcomes are avoiding or minimizing staff complaints, preventing a strike, or getting better performance because of picking the right incentive scheme. 

Game Theory in Supply Chain Management

Over the years, game theory has become a strategy in various aspects of business. As for other industries, it’s helpful when managing a restaurant’s supply chain.

supply chain

Use of game theory to optimize supply chain management

For restaurants, game theory principles applied in supply chain management can:

  • Improve profit margins
  • Reduce ingredient and other costs
  • Make resource management better and easier
  • Give an eatery a competitive edge thanks to a streamlined supply chain, such as ensuring you don’t run out of a scarce product or ensuring you always receive fresh ingredients that impact meal quality

Game theory is relevant since supply chains in the restaurant industry involve multiple role players, such as different suppliers offering similar products. Also, other restaurants may form part of the dynamics, as shown below.

Analysis Of Cooperation And Competition In The Restaurant Industry Supply Chain

When compiling supply chain strategies, there is a possibility of enhancing outcomes if restaurants cooperate in these endeavors. For example, they can share risks or costs, reducing possible negative effects.

However, in applying game theory to scenarios, experts often find that restaurants act in a way that only benefits themselves, with few making decisions that will benefit their competition too.

Game Theory in Competing Food Service Industries: Analyzing Agglomeration Cases

In short, agglomeration refers to a collection or a cluster of elements. In the food industry, agglomeration describes a very common occurrence, where different restaurants pick locations situated close to each other, rather than eateries being spread out across a large area of town.

Of course, this ‘collection in mass’ of restaurants will result in immense competition between the vendors so they draw enough customers and make a profit. For customers, it’s a benefit, because competition may lead to better products and services.

However, there’s still the question of why this is such a common trend in the food service industry. Wouldn’t it be more profitable to establish a restaurant far away from other competitors?

This concept has been widely studied in economics and one theory that helps explain it is game theory. Vendors may decide to establish themselves in the part of town where the most clients are, in order to boost profits. However, as is often the case in situations analyzed with game theory, this decision lowers all restaurants’ maximum profits, since there are more vendors competing for sales.

Specific examples in today’s restaurant industry can clearly portray this trend.

Case Study New York City Restaurant Industry

New York City Restaurant Industry

It only takes a quick glance at Google Maps to notice the agglomeration of pizza restaurants in the Greenwich Village area. The same is true of bagel outlets in Midtown Manhattan, so locals know which part of town to head to if they want one of these meals.

Reasons for agglomeration are numerous, including but not limited to:

  • Pizza is a popular food type in NY, so many entrepreneurs will try and make a success of a pizza restaurant.
  • Demand increases over time, resulting in the possibility of enough customers to support new restaurants.
  • Both bagels and pizza are convenient to eat on the go, which is beneficial in a busy city where people are in a hurry to get to their next destination.
  • The city has large communities of people for whom these dishes form part of their culture. When people from these communities open up restaurants selling these dishes, clients get high-quality products and there’s the chance of turning visitors into loyal supporters.

In addition, the existing competition may drive innovation and result in even better pizza and bagel products. As is clear when game theory is applied, this innovation is essential for competitors to survive and improve their market share, since restaurants must look for strategies to outperform others if they want to stay on top.

With so many competing outlets in close proximity, game theory is an effective tool to analyze the scenario, or for vendors to study each other’s tactics to draw clientele. Strategies can include:

Dropping prices of pizzas or bagels will draw those feeling the pinch of the economy.

Business descriptions clearly show how outlets pursue unique features to set them apart. For example, in terms of bagel eateries, some mention ‘old-school setting’ and ‘classic NY-style bagels’ while others focus on being kosher. You’ll also find mention of ‘counter serve’ as opposed to ‘roomy spot’. As each outlet enhances its offerings, other vendors must find new ways to trump the competition’s services and products.

Case Study Los Angeles Food Truck Industry

Los Angeles Food Truck Industry

In Los Angeles, the current hype is around food trucks, with many of them creating a steady income for owners. Some state the number of these food outlets as over 4000.

A big attraction of this type of business is that it’s a low-cost business venture, affording entrepreneurs a way to be part of the food industry. Also, since vendors are mobile, they can move to where the demand is and LA’s weather makes a food truck a viable business option all year round.

Game theory sheds another viewpoint on why so many food trucks are in one place. With high demand, multiple people choose to position themselves in an area, despite it affecting everyone’s bottom line negatively.

Furthermore, game theory principles will guide food truck owners in making business decisions. For one thing, those offering similar dishes may force each other to drop prices, although it means everyone will earn a little less—all in the hope of being the food truck that clients will flock to.

Case Study Seattle Coffee Shop Industry

Seattle Coffee Shop Industry

Why do some call Seattle the coffee capital of the world? For one thing, Seattle is known for its many cold, overcast days, which is the perfect weather for a warm cup of coffee. Therefore, there’s demand all through the year. But over the last few decades, other factors came into play at the most opportune times, resulting in the city has a unique, buzzing coffee culture, with many outlets found in the commercial area specifically.

Coffee houses like Café Encore opened in the 1950s and were popular because at the time people were looking for places to come together and discuss ideas. For example, the hippie era’s Bohemian culture saw a need for gathering places, and therefore coffee shops had a lot of customers.

Outlets selling quality coffee beans, such as the ones from Peet’s Coffee and Tea, started coffee shops as well. This created another attraction: accessibility to different beans and flavors, all of the top quality. Flavors were also enhanced thanks to the outlets doing their own roasting.

In addition, coffee lovers appreciated changes such as the implementation of advanced techniques like espresso machines. This is in part what made brands like Starbucks become successful.

With a booming market and a clear demand, more people opened coffee outlets. The strategies they implemented to gain an advantage over the competition often involved offering new blends and flavors, since they knew it was something Seattle locals appreciated. Entertainment in the form of local artists has also helped draw an audience over the years.

These days, marketing tactics include everything from employing the most skilled baristas—that won’t disappoint an audience that knows all about good coffee—to providing Wi-Fi for the modern remote employee looking for a place to get work done.

Of course, as stated in game theory, each outlet must continually find strategies to set itself apart. Also, when another coffee shop implements a marketing strategy or a new one opens up, restaurants close by must respond in turn and find more ways to draw enough clientele to survive the competitive market in Seattle.

Case Study Food Court in a Shopping Mall

Food Court in a Shopping Mall

Even in your local shopping mall, food outlets are usually clustered together. This common occurrence can result in malls creating food courts when they plan layouts.

Some may think restaurants open close to each other so customers can find all their food options in one place. However, game theory offers additional explanations. For one thing, instead of socially optimal solutions where each eatery has its own target area and customers don’t have to walk far to find a restaurant, eateries often establish themselves close to the competition. The hope to draw more customers, including that of your competition, often motivates these choices.

To set themselves apart, outlets then implement aggressive marketing strategies, including special offers and eye-catching signage. They may even cut prices, even though it affects profits. Other outlets then need to respond with other strategies and anticipate each other’s decisions to stay competitive. 

Often, these choices result in the Nash equilibrium where none of the restaurants can implement a strategic change to improve their positions any further.

Case Study Street Food Industry in Bangkok, Thailand

Street Food Industry in Bangkok, Thailand

The occurrence of agglomeration is found across the globe, with a well-known example being Thailand’s street food industry. Some say there are over 100,000 food vendors in Bangkok. Head to Yaowarat (Chinatown) and Khao San Road and you can take your pick of flavorful food.

Demand for street food is thanks to many tourists who enjoy the food, along with factors like urbanization, resulting in many locals looking for easy access to traditional food.

In this market, it can be a strategic decision to position a street food outlet near others because vendors can share their resources, such as water or food preparation equipment. Vendors also don’t mind setting up near brick-and-mortar stores, since they often rent sidewalk space from the stores and use their power and water, for which they pay a small fee.

Despite the popularity of street food, these individuals still need to stay competitive in terms of factors like pricing, since customers can easily move on to another stand nearby that’s offering a lower price. The immense competition does force vendors to maintain product quality in order to draw clients, which benefits clients looking for a value-for-money meal.

Why Domino's and Pizza Hut Have Nearby Locations: A Game Theory Analysis

Traveling through many towns and cities, you’ll often notice restaurants clustered together. However, even those selling the same products are found in close proximity to each other, as is often the case with Domino’s and Pizza Hut, pizza restaurants at the forefront of the fast-food industry.

Possible Explanations

There are multiple factors that can explain why similar restaurants end up close together. All or some of the following can play a role in each Domino’s and Pizza Hut scenario:

Eateries cluster together hoping to make it convenient for customers to find the food they want, with a possible outcome that both brands will enjoy high profits.

Restaurants can share resources, such as paying less by each renting a part of the same building. This makes it more affordable compared to one outlet paying for the entire property.

One brand chooses a location close to a similar outlet in order to clearly show its USP. Showcasing the contrast to the other outlet—whether in variety, price or other factors—can draw more customers.

Keeping competition close is also a smart competitive strategy eateries can take from military strategists. For one thing, it forces each party to excel if they want to survive.

Application of Game Theory

Game Theory also sheds light on why it’s common to find Domino’s and Pizza Hut close to each other. Eateries tend to choose locations near others to increase their chances of drawing the competition’s audience.

However, this often results in the Nash Equilibrium where neither of the outlets can improve their positions any further. They may implement various strategies over a period of time, including moving locations, changing prices, and adjusting their menus. When they reach the Nash Equilibrium, there’s no alternative strategy left, as any additional changes will risk their bottom line and/or lose their clientele.

Why McDonald's and Burger King Have Nearby Locations: A Game Theory Analysis

Another type of restaurant that you’ll find clustered together is hamburger outlets, such as McDonald’s and Burger King.

In light of spatial competition, there may be multiple similar restaurants in one area to sufficiently cater to clients. Theories on spatial competition assume that clients will use the restaurant that requires them to travel the shortest distance. With multiple restaurants—such as McDonald’s and Burger King—each positioning themselves some distance from each other, they make it easier for diners to find good hamburgers without traveling far from work or home.

Game Theory Analysis

This arrangement will benefit the clients and often it has the most profitable outcome for the eateries. This scenario is a socially optimal solution. 

However, with game theory analysis, you’ll often find that restaurants decide to migrate and move closer to one another. This is why Burger King and McDonald’s restaurants invariably end up on the same block or corners very close to each other.

Reasons for Fast Food Chains to Locate Near Each Other

Similar restaurants being close to each other is a phenomenon across the fast-food industry. The reasons for setting up in one area, rather than being spread out across the city include:

  • Visibility: Restaurants want to be visible to the clientele of the competition, in the hopes of drawing them and converting them into loyal supporters.
  • Convenience: Eateries may want to make it easier for clients to reach them, so they don’t have to drive all over town to find all their favorite food vendors.
  • Cost savings: Restaurants renting in the same building and using similar services, such as delivery vendors, may find ways of cutting back on costs.
  • Competitive pressure: Restaurant owners may be aware of the benefit of being close to the competition, as it forces you to maintain a certain standard and even improve, or you’ll lose clients.

Wrapping It Up

In conclusion, game theory has proven to be a useful tool for understanding business strategies, including those employed in the restaurant industry. Agglomeration, the tendency for restaurants to cluster together, can be explained through game theory. However, it is important for restaurant owners and managers to avoid reaching a Nash Equilibrium that may limit long-term success. By applying game theory principles, restaurant businesses can analyze their competition and develop effective strategies to stay ahead. This concept can be applied not only to staff, menus, and pricing but also to other areas of the business. Overall, game theory is a valuable tool for analyzing and improving business strategies in various industries.