Interested in becoming a restaurant owner? If you’ve worked in the restaurant industry, you know it’s a tricky business. You need to know a little bit about everything — interior design, quality control, customer service, cuisine, management, and marketing. However, one of the most challenging aspects of becoming a successful restaurateur is finding ways to stretch the almighty dollar.
How do you put together a menu that is both appealing and cost-effective? For many, the dream of running a restaurant is about the food and the customer experience. That’s what they love and what they want to share with their clientele. But, it’s important for a restaurant owner to be profitable in order to sustain the business.
The profit in a restaurant business comes from many places, such as managing food costs effectively. But, designing your menu prices appropriately also plays an important role. You need to know how to price your food items in such a way that aligns with your target customer demographics, but also keeps your restaurant running well into the future.
WHY THE MENU IS A BIG PRIORITY
Running a business — any business — requires that you sell your product for more than your cost to make a profit. Running a restaurant is no different. If you want to be lucrative and thrive in the long run, you must have proper restaurant menu pricing.
Your food pricing strategy feeds into other areas of the business, too. It is an essential part of attracting customers to your restaurant. If your menu is too pricey, you may discourage potential customers. If it’s too inexpensive, potential customers may ask why — “Why are the prices so low? Does this mean that the food quality is poor?”
You must balance customer expectations to your restaurant’s profitability. It’s not easy, but your menu is the key.
MENU PSYCHOLOGY AND MENU PRICING STRATEGY
Psychology plays an important role in creating a menu for your restaurant. Menu psychology refers to how the restaurant’s menu influences your guests’ willingness to frequent your business. It is as much engineering as it is psychology. You need to ensure you make a reasonable profit on each menu item, without overpricing.
UNDERSTANDING FOOD COST PERCENTAGE
First, create a formula that allows you to price your items quickly, but efficiently. That starts with understanding your food cost percentages. Food cost percentage refers to the amount of money you spend on your food inventory related to how much the food generates in revenue. The formula creates a percentage that gives you a clear perspective on cost versus revenue.
The formula for food cost percentage is total food cost/total food sales. To calculate your total cost, you want to add the amount of your starting food inventory with food inventory purchases, then subtract your ending inventory.
Let’s say your restaurant starts with food inventory valued at $15,000. Then, over a year, you add an additional $200,000 in food inventory. By year’s end, you have $10,000 of food inventory left. Your total cost would be $205,000 [($15,000 + $200,000) – $10,000].
Now, we’ll divide your total cost ($205,000) by your total food sales for the year. If you generate $350,000 worth of food sales that year, your food cost percentage would be 58% [($205,000 / $350,000) * 100].
A 58% food cost percentage is exceptionally good. A profitable restaurant will average from 28 to 35%.
You can use food cost percentages to help you make adjustments to menu prices. A percentage of 58 might tell you that if you lowered your menu prices even a little, you could do more business.
IDEAL MENU PRICE
To calculate your ideal menu item price, you need to determine how much it costs you to make the dish. Then, you’ll divide the cost by your ideal food cost percentage.
For example, let’s say it costs you $5.00 to make nachos. To calculate your menu price:
- Raw cost for nachos = $5.00
- Ideal food cost percentage = 30%
- $5.00 / (.30) = $16.66
If you originally had your nachos priced for $30, you may consider lowering the price of your nachos to grow demand for this menu item and increase profit. You want your restaurant to make money, but if you price your menu items higher than the average, you may lose to your competition. A price-conscious customer looking for nachos is more likely to favor a restaurant with average prices, rather than more expensive items.
The key to success for any restaurant is loyal customers. Overpricing your menu will mean they may come once, but they may not return.
GROSS PROFIT MARGIN
Calculating gross profit margin tells you how much the restaurant actually makes for every dollar spent. This is another effective way to price your menu profitably.
The formula for gross profit margin is revenue (total food sales) – the cost of goods sold (total food cost) / revenue (total food sales). The sweet spot for gross profit margins is around 70% for many restaurants. In other words, you want the restaurant to keep 70 cents of every dollar earned.
If your total food sales are $350,000 and your cost of goods sold is $205,000, then your gross profit margin would be 41% [($350,000 – $205,000) / ($350,000)]. This is where you may see flaws in your pricing. The restaurant gross profit margin should be closer to 70%.
You need to bring your revenue up to get there, which might mean lowering your menu prices to draw in more business. Even though you make less per menu item, your lower prices may create customer loyalty — a returning clientele base, rather than one-time visits.
Gross profit margin is an excellent way to gauge your menu prices even before you open the door. It gives you something to target when pricing your menu. If you want to see a gross profit margin of 70%, you can figure out how much you need to make in sales to get there.
You can also use your ideal gross profit margin to price menu items individually, too. However, you’ll need to experiment a bit. Let’s say your goal is a 70% gross profit margin. You need to know how much it costs you to make a particular menu item. Then, we’ll work with this formula: Ideal gross profit margin (70%) = (Menu Price – Raw Food Cost)/Menu Price.
If it costs you $4 to make a particular food item, let’s see what happens when we price the menu at $8. (8-4) / (8) = 5 or 50%. How about $11? 63%. This is where you’ll need to experiment and bring your math skills to work. To get to a 70% gross profit margin, you’ll need to price this menu item at $13.50.
OTHER THINGS TO CONSIDER WHEN DEVELOPING YOUR MENU
Food cost percentage and gross profit margin are good ways to see if your menu is set up for success once you see some numbers. They can also give you some insight on menu pricing before you open, but they are not the only things you need to consider.
The cost of running a restaurant goes beyond just how much you pay for your food inventory. Staff is a vital asset to any restaurant, but also an expensive one. It is not just about hourly wage or salary, either. You must consider benefits, overtime, payroll taxes, and paid time off, as well.
Labor is the primary cost you must consider when pricing your menu. You want to calculate the percentage of your sales that go toward paying for staff. To calculate your prime cost, take the total labor cost and add it to your cost of goods sold.
Cost of Goods Sold (CoGS)
The cost of goods sold is your beginning food inventory plus any purchased inventory, less what you have left. If you started with $5,000 in food inventory then added an additional $3,000 dollars, you had $8,000 inventory. If at the end of the month, you have $2,000 dollars left, your cost of goods sold is $6,000 dollars. That is how much it costs you in food inventory for the set time period. In this case, a month.
Prime Cost Formula
You take your CoGS and add it to your labor costs to calculate the prime cost. If your CoGS is $6,000 and your labor costs were $500, then your prime cost would be $6,500. If you sold $15,600 dollars in food for the month, your prime cost is 42%.
- Prime cost = CoGS + labor
- $6,000 + $500 = $6,500
- Prime cost percentage is prime cost / total sales
- $6,500 / $15,600 = 42%
If you have other operating costs such as rent, food waste, and utilities, factor those into your labor costs to get an accurate prime cost.
The restaurant industry is highly competitive. If you run a seafood restaurant, and you are the only one in town, you have a little more flexibility. If you are one of 10 in the city, then you have to pay attention to what your competition is doing.
Check out the menu prices of your largest competitors. You might go online or even have a meal there to see what they offer. Compare your food item prices to theirs. If you see significant discrepancies, you might need to reconsider your pricing.
If that’s not possible, then look for ways to stand out in the crowd. Maybe they are corporate restaurants. In that case, you can buy all your food locally and incorporate this into your marketing and communications strategy.
Menu Pricing Balance
You also need to balance your menu prices, too. Are you selling your entrees for $20 but your appetizers for $30? That doesn’t really add up, unless your appetizers are structured family-style. But, does this balance with your customer demographics? Maybe, you’ll add a family-style section to your menu and reprice from there.
In this example, if the appetizers cost more to make than the entrees, look for other ways to recoup that expense, like add-ons for sauces or reducing portion sizes.
Finally, put some thought into the type of restaurant you want to run. Your goal should always be to stand out. You don’t want to be just another burger joint in a sea of burger joints. Figure out what will make you unique. If the town has 50 burger joints but no seafood restaurants, then you might want to be the first.
Running a restaurant may be your dream, but it is also a business, and you need to treat it like one. For every restaurant owner, that starts with understanding how operating costs affect menu pricing.
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