One approach to pricing menus is budgeted cost percentage. For many within the industry there is a belief if you serve great food and deliver fabulous service that’s all you need do to magically achieve 33% food cost, or 25%, or perhaps 35%. Sadly this is an illusion.
Hitting a budgeted food cost won’t guarantee there will be enough money left over from the sale to pay for things like labour, rent, insurance, linens, small wares, uniforms, utilities, taxes, etc. Achieving a targeted cost percentage really means nothing. Not attaining a target doesn’t mean there is a problem. You could be selling a lot of high cost items that contribute more gross profit per sale.
Ask yourself which is better to sell 50 pies priced at £5 costing £1.20, or 50 portions of caviar priced at £40 that costs you £25?
Provided there isn’t a significant increase in your overheads serving caviar, your gross profit value wins every time. You don’t want to sell an item with a 24% cost with a £3.80 gross profit, it’s better to sell an item with the 62.5% cost and the £15 gross profit. You might find you are better off comparing the gross profits from each item rather than focusing on food costs. Clearly, if you have £15 in the till after a sale having paid your food costs (gross profit) you’re have more money to pay your overheads than if you had £3.80. Ultimately you will achieve a higher profit margin.
If you want to create prices to guarantee you’ll have enough money to pay your food and overhead costs you’ll need to consider these aspects:
- Market price elasticity – You need to know what your customers considers to be a fair price for your product service offering.
- Menu item rate – Despite the above statement inference to not price a menu item you should factor in
up to date cost of food for every item, on your menu.
- Desired gross profit – A number of factors need to be factored in for example how much does it cost you to serve every person you work for? Consider every expense of running your business, and include the profit you need to make.
How to price gross profit?
Elasticity of demand
Pricing must be under pinned by a great deal of common sense plus knowledge of the particular circumstances your operation markets its offering. While it’s not possible to accurately predict the change in demand if you change prices you need to have an awareness as to the consequence. You need to be mindful as to the implications of changing the price of one or two items. Ask yourself what cross-elasticity effect will this have on the menu as a whole? A benefit for one or two items may impact other items. Regardless of whether you use cost or gross profit percentages you must consider what the market is paying for a similar food product service. If your competitor is offering the same or similar offering and your price is significantly higher you will need to justify the added value. Your added value could be larger portions, locally verified sourced ingredients, better atmosphere, better location, parking, and live entertainment. Customers must feel the extra cost is worth the extra money. For example your staff may have a superior capability to develop customer rapport than your competitors. Tacit capabilities cannot be easily imitated. If customers value the implicit skills your staff members offer then your customers will be willing to pay a premium. More importantly you will be able to sustain your unique selling point and margin because your competitors cannot easily replicate such capabilities.
Menu item rate
To calculate menu item cost you must know how much each dish costs to make. To achieve and maintain your margin you must have up-to-date knowledge of your ingredient costs. Depending upon on your resources you can use Microsoft Excel spreadsheets or point of sale (POS) inventory program. If you decide to use POS software package be sure you understand how costing formulas are calculated and how much input is required by you. Some systems link to invoicing systems to automatically update your prices for you. However you decide to calculate your recipe costs do so regularly. Don’t leave it until you change the menu, you need up to the minute knowledge of your costs. If you are to achieve your financial objectives you need to understand how price ingredient fluctuations impact your margins.
Desired gross profit
When setting menu prices it’s critical you know how much it costs you to serve your customer. If you don’t know this figure you cannot know how much you need from each customer to pay your bills and make a profit. Most operations food costs run between 20-35%. The remaining 65% – 80% isn’t profit. You have other expenses to factor in and these need to be included in your pricing. Depending on your labour costs your food costs can be your largest business expense. If these and others costs aren’t covered you cannot know if you’ve made any money.
How to calculate required gross profit per person
The required gross profit per person is what you add to your recipe cost to attain a menu price. Gross profit per person is a fluid number because menu items have to be within a price point your market will pay. You may have to increase some items while decreasing other menu items. What’s important is you achieve an average gross profit per person to deliver enough gross profit to pay the bills. To calculate required gross profit refer to your financial (profits & loss [P&L] statement) and customer records. Ideally select months you achieved as many of your financial goals as possible. Calculate an average mean using the selected months. Referring to your P&L extract all your operating expenses for the year. Don’t include product costs. This is your overhead.
The formula is as follows: Total expenses for the year – product costs + ideal profit = Total required gross profit.
Once you know how much gross profit you require you have the first phase of your pricing model. It’s worth noting the figure is an historical figure. To price a menu item you need to factor in predicted inflation or deflation and or cost increases. Operating costs will fluctuate during the year so you should re-price your menu quarterly. Ideally ever three months. Generally if you add 5% cost increase to your total needed gross profit for the coming year you should cover increasing costs such as energy.
The formula is as follows: Total needed gross profit x cost plus increase (105%) = Total needed gross profit (adjusted for next year)
Having calculated your required gross profit you can go on to compute how much to charge each customer to cover all your expenses. I’m assuming you track the number of customers you serve if don’t start doing so now. If you don’t conservatively estimate the number of covers served over the previous year.
The formula is as follows: Total needed gross profit ÷ previous year customer count = Needed gross profit per customer
The gross profit figure is an historical number. Use this figure to calculate a target gross profit figure for the coming year i.e. what you need to charge each person to achieve this year’s profit. To realise the targeted profit figure you need to either meet or exceed the number of covers severed from the year before or you can exceed the gross profit average per customer.
The formula is as follows: Gross profit per customer x customers per year = Actual gross profit
If your actual gross profit is above your total needed gross profit per year and you are controlling your expenses you will surpass your budgeted profit figure.
Note budgeted food cost percentage isn’t part of the equation. What you have done is add menu item cost to the needed gross profit per customer to calculate the selling price.
A few factors to consider your needed gross profit per customer is computed using different sources in other words you don’t have to mark up every item by your
needed gross profit. Your needed gross profit figure is formulated by merging gross profit from everything a customer purchases. Everything you sell appetisers, entrees, mains, deserts, hot and cold beverages, alcohol all contribute to gross profit. Expressed another way if you required a £3.50 mark-up from 15,000 customers per year to make your total needed gross profit you’re have multiple ways to achieve your financial objective without having to mark-up every menu item by £3.50.
The next factor is your customer count. Let’s assume you must achieve a £3.50 gross profit from 15,000 customers to attain your total needed profit of £52,500 (£3.50 x 15000=£52,500). You can achieve your £52,500 goal by serving 15,000 customers or by serving more customers at a lower gross profit mark-up. Let’s suppose you double the number of covers served to 30,000. Theoretically a £1.75 mark-up would result in the same total gross profit (£1.75 x 30000 = £52,500).
Note, changing the number of covers may impact your overheads. Serving more people will increase some costs however not exponentially. Once your fixed costs are covered serving more customers increases your profit. Add your supplementary expenses to your yearend figures then recalculate you needed gross profit.
The method isn’t complicated but it does question convention. The advantage to this approach all costs of doing business are part of the equation you don’t have to guess what you need to do to make your required profit margin.
Try it out. If you need some help, don’t be shy call me.