Pricing food - Why you're doing it wrong and how to fix it

One thing I'll never forgive formal culinary schools for, is teaching new impressionable would-be chefs to use a budgeted cost percentage to price food menus. Chain restaurants share an equal responsibility for perpetuating this bad practice by focusing their managers on food cost percentages without letting them in on the secret that the cost percentage is a management tool, not a pricing tool.

Though most culinary programs teach many different methods for pricing food, every culinary student seems to emerge from the Culinary Institute of America or Le Cordon Bleu believing in the world of restaurants, all they have to do to be profitable is serve great food and deliver a 33% food cost, or is it 25%, or 35% or 30% or 19%? The truth is, hitting a budgeted food cost does nothing to guarantee there will be enough money left over from the sale to pay for things like labor, rent, insurance, linens, smallwares, uniforms, utilities, taxes, etc, etc, etc. Hitting that cost percentage really means nothing. Further, not hitting it only means, "I should give things a closer look." It doesn't mean there is a problem. On the contrary, a high food cost could mean you've been selling a lot of high cost items that contribute more gross profit per sale. Are you going to make more money selling 50 hamburgers priced at $6 that cost $1.50, or 50 lobsters priced at $30 that cost $15? As long as there isn't a significant increase in the overhead of serving the lobster, gross profit dollars win every time. You don't want to sell the item with the 25% cost and $4.50 gross profit, you want to sell the item with the 50% cost and the $15 gross profit. Rather than comparing the food costs, you should be comparing the gross profits from each item. Obviously, if you have $15 left over from the sale after paying for food (gross profit) compared to $4.50, you're going to have a lot more money to pay your overhead and turn a profit.

If you want to create prices in your restaurant that guarantee you'll have enough dollars left over after paying for food, you'll need to make three important considerations:
  1. Market price point - What does your market consider a fair price for the food you are preparing, served in the atmosphere you offer?
  2. Menu item cost - I know I said you shouldn't use cost percentages. That doesn't mean you don't include the cost of the food into the price. You need to keep up-to-date recipe dollar costs for every item on your menu, and use those costs to figure into your pricing.
  3. Needed gross profit - What does every person who walks through your door cost you to serve? You have a lot more costs to cover than just food. That's just a fraction of the picture. You must consider every expense of running your business when pricing menu items, including the profit you need to make.
I guess now the question is, "How do I price by gross profit?".

I'm glad you asked.

Market Price Point

You can't throw prices out there, whether based on cost percentages or gross profit, without considering what your market is already paying for those products elsewhere. Just like your potential customers, you must consider what other operations are charging for the same type of food, or even the same dishes, that you are offering. If you are going to charge more for the same dish than your competitor down the street, you have to be able to justify your price with added value. Added value could be larger portions, more exotic ingredients, better atmosphere, better location, live entertainment or something else. It could also be the promise and delivery of a unique selling point that your competition doesn't have.

Whatever your prices, they must offer value to your customers. If your customers don't feel your food is worth what you're charging, you won't have enough of them to make money no matter your pricing method.

Menu Item Cost

How much does each menu item cost you to make? Ingredient costs go up all the time. When is the last time you updated your menu item costs? Without knowing exactly what a menu item costs you to make, and how many dollars you need to add on to the price to pay for the ingredients, you can't possibly come up with prices you KNOW are going to make you money.

The easiest way to track recipe costs (menu item costs) in my opinion is with Microsoft Excel spreadsheets. While there are many commercial food costing and inventory programs out there that will help you cost out your items, many use costing formulas based on valuation methods I don't endorse, or require too much input to keep prices up-to-date. Some do have the capability of linking directly to broadline vendor's invoicing systems to update prices automatically, but most smaller vendors don't have this capabibility and you're still left doing a lot of extra manual input. For my money, there is nothing simpler, less time consuming and easier to use than Excel spreadsheets. That doesn't mean you shouldn't use other inventory and costing tools. Any effort you make toward calculating recipe costs and inventory is going to pay off. Even the more expensive softwares will make you money in the end.

Don't make the mistake of getting lazy with your recipe cost tracking. Many operators only price out menu items when they're making a menu change (which are normally too few are far between). Between changes, they don't see how the cost of ingredients is impacting certain menu items, and without that information they don't have the urgency to make the necessary pricing changes needed when they are needed.

Needed Gross Profit

This is the most important consideration in setting menu prices. You must know what your guests cost you to serve. Without knowing what they cost you to serve, you can't know how much money you need from each of them to pay all your bills and make a profit.

Look at your financial picture this way. Your food costs make up anywhere from 20-35% of your financial picture in most restaurants. Depending on your labor costs, your food cost could be the largest expense of running your business, and it needs consideration when forming menu prices. BUT...... What about the other 65-80% of your financial picture? It's not all profit. Most of that picture is expenses other than food cost, and if you're lucky a little profit left over. Doesn't it go to reason that you have to include those costs in your pricing? Of course it does. Without knowing those costs are covered, you can't know you'll make money.

Before you can know how to add gross profit into a menu price, you have to know how to calculate it. Here are some explanations to try and illustrate how to calculate a needed gross profit per person. The needed gross profit per person is what you add to your recipe cost to arrive at a menu price. Unlike the menu price, the needed gross profit per person is a fluid number. Since it is important to keep menu items within the price point of your market, you will likely have to increase the gross profit you add to some items, while decreasing it on other items. It's only important that the end result gives you an average gross profit per person that delivers enough gross profit to pay the bills.

You can start to calculate your needed gross profit by looking at your financials and customer count records. It's best to use financials from months where you achieved as many of your financial goals as possible to establish your needed gross profit numbers. You can use an average of all months by using a year-end profit and loss statement. From your P&L, you need to find how much all your operating expenses for the year were without including product costs. This is your overhead. To this, you'll add the ideal profit you should have made during that time period.

Total expenses for year - product costs + ideal profit = Total needed gross profit

Once you know how much gross profit you would have needed to collect during the last year to make the profit you should have made, you have the beginnings of your pricing method. Before we go any further, you need to take into consideration any inflation or cost increases you can assume for the following year. Operating costs will always go up, and you need to price for those cost increases. If you're smart, you'll re-price your menu every 3-4 months to make sure those costs are covered, but that is another article. To be on the safe side, I add a 5% cost increase into the total needed gross profit to come up with a target for the next year. With the ever increasing cost of gas, you could either add in a higher buffer, or do what I suggest and evaluate your pricing every 3 to 4 months. It's much better to do regular, small increases to some menu items than annual large increases to all of them.

Total need gross profit x cost plus increase (105%) = Total needed gross profit (adjusted for next year)

Now that you have your new needed gross profit, it is very easy to figure out how much of it you'll need to collect from each person to cover all your expenses. That is, assuming you track how many people come into your restaurant. If you don't, you need to start doing it now, and you'll need to estimate how many covers you did for the previous year. Estimate low to be on the safe side.

To find out how much you need to collect from each person, simply divide your total neeeded gross profit for the upcoming year by your total customer count for the last year.

Total needed customer count ÷ previous year customer count = Needed gross profit per customer

This number is simply the amount of gross profit you would have had to collect from each of last year's customers to achieve your financial goals for the upcoming year. What this gives you, is a target gross profit to collect from every person this year to achieve profit. That profit will be achieved if you can meet or exceed your customer counts from the year before, or you can exceed the gross profit average per customer.

Gross profit per customer x customers per year = Actual gross profit

If you can exceed your total needed gross profit per year with your actual gross profit, and you do a good job of controlling your expenses, you will exceed the profit you budgeted for.

Remember in all this that your budgeted food cost percentage hasn't entered into the equation once. You are adding the actual cost of your menu items to the needed gross profit per customer to come up with a selling price. That's all it takes.

There are a few other things to consider though. Your needed gross profit per customer is collected from a few different sources. You don't have to mark up every menu item by your needed gross profit. Your needed gross profit per customer is collected by combining gross profits from everything a customer buys. The markup on entrees, appetizers, desserts, soft beverages, alcohol and merchandise all contribute to gross profit. If you need $7 in markup from 30,000 customers per year to make your total needed gross profit, you have many different avenues to get it from and don't have to mark up every menu item by $7.

Another factor that majorly affects these averages is your customer count.

If you've determined that you need $7 gross profit from each of 30,000 customers that walks through your door to reach your total needed gross profit, then you can also reach that number ($210,000) by serving more customers at a lower gross profit markup. If you could double your covers to 60,000, you could theoretically collect $3.50 in markup from each to collect the same total gross profit. Whenever considering cover changes however, you must also consider how serving more people will change your overhead. If you serve twice as many people, some of your expenses will also increase. They WILL NOT however, increase exponentially. Additional customers are always cheaper to serve than your primary customers, as they are the ones you are covering your fixed costs with. Add your additional expenses to your year end numbers and start over calculating your needed gross profit.



I hope I've laid out this method in a way that you can understand it. While it isn't complicated, it does go against the principles being taught in classrooms and kitchens all over the country. If you have followed along well though, you can see how this pricing method takes into consideration every cost of doing business, and leaves no guessing as to what you need to do to make money. This method of more effective planning could do a world of good for your profitability. Try it out.

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Tags: consultant, consulting, cost, development, food, gross, menu, percentage, prices, pricing, More…profit, restaurant

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Comment by Don L. Stull on July 2, 2008 at 5:06am
Have you been looking at my weekly reports? When liquor costs hit 25%, it was after I had to point out the dollars they were loosing in order for them to take action. Three times. After busting one girl, for theft she was told to sin no more and I was given the reason that she brings in more than she steals.??? But I get off the point. The new menu (which is still too large) is now in place and going strong and I believe I'm getting fired today. I've already been told that I won't be getting any of the 6% savings I helped them attain (as promised). I've been warned to expect the economy to be the reason but I know they've got what they want from me and I am gone. I shouldn't have been trusting and had a contract. Nine months wasted. Sorry for venting. I plan on a couple of discussions to deconstruct my experiences in a helpful manner for others.
Comment by Don L. Stull on July 1, 2008 at 5:09pm
Thanks, again, Brandon for laying this out in such a succinct manner. I've patched together several of your posts in an attempt to put all of this into one article and all I had to do was wait. And I've had plenty of time to wait while working for the meatheads that I work for now.

The real use for food cost percentages is in comparison with ideal food cost numbers. The guys I work for now are happy with a 40% food cost even after I showed them the ideal number with the product mix should be 34%. They are so old school that they remain happy running 40%. I'd really like to say more but then I would be off topic. Please keep the good things coming to remind me there is intelligent life left.

Non-Operator
Comment by Brandon O'Dell on July 1, 2008 at 11:52am
That's it!

Non-Operator
Comment by Brandon O'Dell on July 1, 2008 at 8:11am
Thanks a lot Joe. I enjoy your blog too. I look up to both you and Jeffrey as a "young up-n-comer".

Non-Operator
Comment by Brandon O'Dell on July 1, 2008 at 7:10am
I do segment menu analysis' into categories. Not trying to sound coy, but that's nothing new to me. I'm just trying to keep this post on-point.

You're example illustration is well-taken. There are many variables to any issue we could discuss here, ESPECIALLY pricing, and the other management tactics that affect those pricing decisions. Fixing the pricing issue and creating a system to sell higher gross profit, higher cost items could adversely affect profitability if another issue, like budgeting based on a labor percentage, isn't addressed. I think I read and commented on an article about the issue on your blog once Joe.

Addressing this problem in particular with a restaurant sometimes makes it hard to stay focused on the task at hand during a job. Peeling back any one layer tends to reveal cracks in other layers that need to also be addressed.

Non-Operator
Comment by Brandon O'Dell on July 1, 2008 at 6:31am
Gross profit calculations could be segmented to death. When you're digging to find the cause of a problem, it's important to have as much information as possible, but going into the minor details of the issue isn't really the focus of this piece. It's more of an introduction and validation of gross profit pricing versus pricing by budgeted cost percentages. I think there are still a lot of arguements that need to be made first to get people in policy making positions in both independent and chain restaurant thinking differently, before we start overloading them with the details of the process making it sound more complicated than it is.

I don't disagree that gross profit averages have to consider the gross profit os everything you sell from any menu segment it comes from, of course they do. But, lets condition people to jump high enough to get over the first hurdle before we send them tripping over all of them, problably resulting in a crash 'n burn. Lol.

Non-Operator
Comment by Brandon O'Dell on June 30, 2008 at 6:39pm
I like to use the whole needed gross profit as the target Joe, with labor and everything else included. I try to teach operators to focus on
gross profit (per customer) x customer counts = total gross profit necessary

The teaching challenge isn't in showing how to find the target gross profit per customer, but in breaking the gross profit out among profit centers (i.e. food, soft beverages, bar, mechandise) to establish pricing. The benefit to me though, is that fixing gross profit margins is a LOT easier than trying to balance a budgeted cost percentage through pricing.
Comment by Tracy McMahon on June 30, 2008 at 11:16am
Hi Brandon. Excellent post. I agree completely but I often have trouble getting these points across. This post will really help me be able to explain these concepts more effectively--thanks for sharing.

Non-Operator
Comment by Brandon O'Dell on June 30, 2008 at 9:21am
Thanks Daniel. The hard part is reprogramming everyone else around you, isn't it?

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