If you’ve ever paid, say, $14 for a cocktail, you might feel frustrated and ask why it is so expensive. But have you ever considered what goes into that price, or how the bar manager settled on it in the first place?
Believe it or not, there’s a strategic science behind pricing bar drinks rationally, and a big piece of it focuses on the drink’s CGS percentage.
What is CGS?
When determining the prices of a drink, a manager needs to think about the total cost of the ingredients in the drink. This is the Cost of Goods Sold. It could refer to the types of alcohol and other things (fruit or seltzer water) it takes to make your cocktail.
When pricing your drinks, you can manipulate the CGS percentage to achieve rational prices for your beverages. In turn, this will result in reasonable profit. Here’s how:
Step 1: Pretend you’re a manager and price your first drink. Let’s say you have Drink A that costs $2 and has a targeted CGS of 20 percent.
In order to get a possible selling price for this drink, you need to divide the cost by the CGS. Here’s what the equation looks like: $2 / 0.20 = $10
Now, you could sell Drink A for $10, but there are a few other factors to consider.
Step 2: Determine the price of a second drink. Let’s say Drink B costs $1 to make. If you apply the same 20 percent CGS, your drink will have a selling price of $5 based on the equation above.
Step 3: Consider the price gap. Considering these prices— Drink A costs $10 and Drink B costs $5— you might decide that you don’t want such a large gap.
Step 4: Consider how much each drink is yielding in gross profit. Gross profit is defined as the profit you make after deducting the amount it takes to make your product.
In this case, it took $2 to make Drink A. After deducting that, the $10 drink will result in an $8 gross profit. Drink B will result in just $4 (because it only took $1 to make).
Since you only have your customers in your establishment for a short amount of time, you don’t want to give them the opportunity to trade down and buy a cheaper item. It is important that all of your products yield a similar gross profit, so you might reconsider charging $10 for that first drink.
Step 5: Consider your contribution margin. A contribution margin is the amount of gross profit you make per drink.
In order to make up for the difference between both drinks, you might apply a higher CGS percentage (25 percent) to Drink A and a lower percentage (17 percent) to Drink B.
For Drink A, the new equation would look like this: $2 / 0.25 = $8
Since you’re keeping the original $2 cost figure, your selling price for this drink is now $8 instead of $10. For Drink B, you’ll lower the CGS (from 20 percent to 17 percent) to result in a selling price of $6 instead of $5.
By following these steps, your two drinks are now closer in price. Each time you sell Drink A, you make $6 (because you’re charging $8 and it costs $2 to make it in the first place). Drink B is now bringing in $5 in profit. In this scenario, if a customer trades up to the more expensive drink, you’re yielding more gross profit; But if they opt for the cheaper drink, you’re still making almost the same amount of money.
These ideas originally appeared in an article by Brian Warrener on Nightclub.com.
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