Menu items can cost customers 40% more at peak hours as Uber-like surge pricing hits food delivery

• The food-tech startup Sauce allows restaurants to use dynamic pricing to raise delivery prices.
• Sauce is backed by the venture capitalist Kevin Novak, who created surge pricing for Uber.

The venture capitalist Kevin Novak, an early data scientist at Uber, invented surge pricing for the ride-hailing giant.

Novak, the founder and managing partner of Rackhouse Venture Capital, is once again touting the benefits of supply-and-demand pricing. Only this time, he's not coding. He is a seed investor in Sauce, a dynamic-pricing startup that uses machine learning to adjust menu prices on delivery orders.

The timing is right for the industry.

Raising menu prices to offset delivery fees and rising labor and supply-chain costs is becoming standard practice at chains like Chipotle and McDonald's. In October, money spent on food away from home, which includes restaurants, rose 8.6% over last year, according to the Consumer Price Index. Chipotle said pricing on delivery orders was up 13% in the third quarter, year over year.

But "blanket price increases are no longer the best strategy" to combat rising costs, Colin Webb, the cofounder and CEO of Sauce, told Insider.

Founded in 2020, Sauce's AI-powered software can suggest different online menu prices for different times of the day based on a restaurant's historical and real-time delivery-ordering patterns.

"We actually will recommend strategies that both increase and decrease prices, and restaurants are able to choose their preference or build their own strategies from scratch," Webb told Insider.

In some cases, "we've seen restaurants during a peak time raise their price 40%," he said.

'We are trying to make sure that we are not getting our margin heavily eroded'

Webb said restaurants are taking a closer look at dynamic pricing as they face inflationary pressures and a possible recession in 2023.

Sauce works with "hundreds" of restaurants and has "grown over 700% this year," the MIT graduate said, declining to give a specific number of clients.

The fast-casual chain Piada Italian Street Food has been using Sauce since June. A case study released by Sauce this month found that the 49-unit chain has doubled profit margins and improved its takeout operations using the dynamic-pricing model.

"From our end, we are trying to make sure that we are not getting our margin heavily eroded by the third-party fees," Jason Profitt, the director of technology at Piada, said in the case study.

In a follow-up interview with Insider, Profitt said Piada gave Sauce access to its order history. That allowed Sauce's machine-learning tech to "effectively train their AI" to know when to raise prices and by how much.

Piada gave Sauce a 10% cap on markups.

"Supply-and-demand pricing allows us to keep that markup lower during periods of slow volume, and it will increase it during the higher volume," Profitt said.

Piada said it also took advantage of Sauce's ability to adjust pricing differently on the same menu items on a store-by-store basis, where supply and demand vary in each market.

Piada couldn't do that when it made "static" markups using its online-ordering platform Olo, Profitt told Insider.

When Piada marked up delivery prices through Olo, Profitt said there was the potential to "drive away our DoorDash guests" at lower-volume stores.

Webb said Sauce's tech has evolved this year to be more flexible based on restaurant feedback. The startup's technology is automated, but operators can also manually control the pricing recommended by Sauce.

"We have restaurants who change prices and have different pricing on the weekends versus the weekdays," Webb told Insider.

'It's kind of like paying to skip the line'

Andrew Charles, an analyst at Cowen, said in a November 21 note that the restaurant industry has experienced record increases in menu pricing this year, but "there has been limited instances of consumer pushback to elevated industry pricing."

Webb said diners, so far, haven't complained about paying higher prices for the convenience of on-demand delivery during peak hours.

"It's kind of like paying to skip the line," he said.

On customer-feedback surveys, Piada's Profitt said diners aren't balking, either. In fact, they have "talked about the price being reasonable" for third-party deliveries, he said.

Novak, whose VC firm Rackhouse invested in Sauce last year, said price-lowering features are often overlooked when discussing dynamic pricing.

"I think dynamic pricing being contemplated with prices going up, it's sort of a false correlation. Many times, you know, I think there's an opportunity for consumers to save," Novak said.

Sherri Kimes, a professor emeritus at Cornell's Hotel School, echoed Novak, saying dynamic pricing can give consumers "some control" over how they spend their money. For example, demand pricing in the airline industry allows consumers to buy tickets on cheaper travel days of the week.

Still, she said most consumers don't like surge pricing.

"Research has shown that customers view changing prices based solely on demand is unfair," Kimes wrote in a recent editorial column for QSR Magazine.

For restaurants, dynamic pricing is still worth a shot.

"Don't be afraid to experiment," she wrote. "With digital menus, it's simple enough to just try it and see what happens."