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 needed 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 gross profit ÷ 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, chains 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. If you need some help, give me a call.

Brandon O’Dell
O’Dell Restaurant Consulting
www.bodellconsulting.com
blog.bodellconsulting.com
brandon@bodellconsulting.com
Office: (888) 571-9068

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About bodellconsulting

Food service consultant and owner/operator of a home chef service in Kansas City and Wichita

Posted on June 26, 2008, in Articles and tagged , , , , , , , , , , , , , , , . Bookmark the permalink. 16 Comments.

  1. I like the posting.
    I am a grad of a famed culinary school. And I can give you some glimpse as to why lots of students fresh out of school have the thought process that the percentage is the only number to look at and not the big picture.
    At my alamater, they, and in great detail, explaind that percenatages are a tool, not the end all or be all.
    However, when they go to their jobs during and after school, students are only hearing the % and not getting the full picture.
    Thus, they beleive that the % is the only tool to judge profitability. When lots of graduates get there first job after college, they are constantly being asked about the numbers and when they only know the food cost and labor percentages what elese are they to beleive?
    Later, when they have their own places or are out into positions that require a greater detail of thought, they do not understand because 10 years earlier no one took the time to explain it to them or they were not paying attention in class that day.

  2. Thanks for the reply and the insight. Ideally, students would come out of school into the real world prepared to properly price their menu the right way, and never fall into the trap that is inadvertantly set for them.

    As an employer, I’ve had my feathers ruffled by more than one “fresh from culinary school” student proclaiming, “thats not how we learned in school”, but in the case of pricing, most owners are doing it wrong already. It would do them a great service to have throngs of wet-behind-the-ear students telling them how wrong their pricing methods are.

    In the real world though, most recent grads don’t have the opportunity to affect change at that level. Still though, I would like to see them educated with proper pricing practices that prepare them for an industry that is “doing it wrong”.

  3. As another grad from a renowned school, I couldn’t agree more with some exception. The institute I attended focused primarily on teaching people to cook profitably. I feel, in certain classroom settings, it was tried to explain to us that there was no magic number that keeps restaurants alive..that each concept would have different requirements for each line of their P&L. Unfortunately things like fixed cost, depreciation, occupation, and etc were given about a day under the impression that the future chefs of the world would have to be concerned with two things…food cost and labor cost, and would have clear direction from the GM or accounting office on what they needed to do on their part.

    It was actually the industry that got me thinking about food cost percent as an end all be all. Interestingly enough, my step father, who is in charge of a very large resort and a very effective manager complained that his food cost was an etc %. I said “what SHOULD it be,” and he said a 26. I asked why and he said, “Because that’s what they want us to run…that’s our budget.”

    I reiterated the question, “No, not what do you WANT it to be..based on the menu mix you are SELLING, what SHOULD the food cost be.” He had no idea.

    This is an unfortunate trend in our industry because without focusing on on theoretical food cost to actual food cost gap, we have no idea of we are making mistakes or simply selling higher dollar cost items. We, then, have no inclination to revisit our pricing or marketing strategy.

    And how I wish I could get the folks in my corporate office to focus less on the food cost percent and more on the line of all lines for a restaurant GM in my opinion..total controllable income. My theory is..if I as a restaurant operator can flow more money to the line I control than my peers, even with a higher food and labor cost, I’m doing something right, and to focus on trimming my schedule or production costs, I might jeopardize my income by decreased service or quality. Thoughts?

  4. Right on target Mike.

    This focus on costs is hurting many concepts in the long run. Successful contract food and beverage management companies like Compass Group set up bonus programs for their general managers based only on profit, then they give their managers the education to understand what it takes to profit.

    I have my own bonus structure I modeled after their philosophy, that I share with restaurant owners. It is based strictly on the bottom line. In any business, every attempt at controlling cost or driving revenue is an effort to earn a larger profit. That needs to be the end goal of any manager, not cost percentages or sales figures that by themselves don’t mean much.

    Some independent restaurant owners I know have created bonus models for their chefs based on hitting theoretic food costs instead of budgeted food costs. While I still advise bonusing based on profit exclusively, and using theoretic and actual food cost comparisons as a tool to manage profit, bonus structures based on theoretic to actual cost accuracy are a great improvement over bonusing based on budgeted costs.

  5. Interesting point, and I could see it’s effectiveness in independent concepts where, generally, the management is more invested than in corporate chain.

    I, personally, like the bonus structure I’m in. Bonus on food cost gap, or the difference between actual and theoretical, and certain sections of guest surveys. We do have a merit increase for profit, but here is why I think that’s dangerous:

    In the beginning, we bonused on sales increase and flow through over the previous year. In a slowing market, sales increase is a lofty goal, but trimming T.C.I. isn’t. For managers that aren’t as invested, this simply means trim labor to substandard levels, don’t purchase the items needed for crew to effectively do their job, don’t pay for extra cleaning, and duct tape maintenance issues, all of which hurt long term profitability. I feel bonusing on profit alone is dangerous as it encourages management to cut costs where they may be needed.

    One of the reasons I’m loving this blog and commenting, however, is education. I would like to venture into the world of consulting focusing primarily on controlling food cost, so I would welcome any rebuttals that may help me view things differently.

    FYI, I am having my current management team, who know how to do what I tell them but understand very little of the food cost intricacies, browse through this blog as there are several times, in reading your posts, I have found myself saying, “Yes, yes! That’s exactly what I’ve been trying to say!”

    Thank you, keep up the good work!

    Ps. Basing bonus on hitting a budgeted food cost is just silly and leads to frustration as the person eligible rarely receives the bonus because there is no way to track where they should be.

    Also, in your spreadsheets and analysis, do you look at things on a menu item basis, or ingredient basis? I dramatically improved food cost gap in my unit by analyzing each individual items food cost gap and going after the highest dollar losses…from about a 4% gap to a 1.5% currently…a savings of about $500 a week.

  6. Basing bonuses on sales increase and cash flow over the previous year is separate altogether than bonusing strictly on profit.

    As you point out, bonusing on increases leaves the managers nowwhere to cut that doesn’t affect quality. There are many factors affecting sales, etc that are out of the control of the managers. A good example would be the present day economy. If managers are getting bonused based on profit comparisons instead of flat profit, and sales are flat or lower due to something out of their control, their only avenue for creating more profit is through cutting needed expenses, and as you point out, this can hurt long term profitability.

    When the focus of the bonusing is completely on profit, without being affected by comparisons to other periods, and staff is properly educated as to how profit is made, their only incentive is to make more money for the restaurant not just in the short term, but in the long term. Afterall, they are getting the next quarter’s bonus based on profit too, just it doesn’t do any good to rob Peter to pay Paul.

    When viewing food costs, it’s important to look at everything from menu item costs to ingredient costs. A properly set up inventory and recipe spreadsheet system allows owners and chefs to see how the cost of individual ingredients flows through the entire system. I link together spreadsheets so individual inventory item price increases are carried through every other spreadsheet. Owners and chefs can see how price increases affect their gross profit on individual items, overall profit, cost percentages, etc. It doesn’t do much good to concentrate on only one aspect of cost control.

    Another major consideration in menu profitability is the frequency of menu price increases. Many, if not most, operations wait 1 year or longer to raise prices. They then use larger increases that are more noticed by their customers instead of doing smaller, more frequent price increases. A quick example of the financial advantage of frequent price increases is on the front page of my blog http://blog.bodellconsulting.com/2008/10/30/quick-tips-update-your-menu-often/.

    The disadvantages I see to bonusing based simply on cost accuracy between theoretic and real food costs is that it ignores the rest of the financial picture. It removes the incentive to control the other 70% of the financial picture. Some restaurant that use this model also use sales bonuses for FOH staff, and effectively create a rift between their back of house and front of house, because they have set separate goals. In the food business, it is tough enough to get BOH and FOH staff working together without creating a bonus system that makes them work against each other.

  7. Love the input, and thank you for taking the time to have a dialogue!

    I see all of your points, and they are valid. Unfortunately, I am in a corporate chain so have little control over how the bonus is determined, how often we increase menu prices (although we regularly increase) etc.

    But, this is great information should I get the opportunity to coach operators in the future.

    Do you ever offer advice on how one might break into the field of consulting?

  8. Consulting isn’t really a field you can just start up in and expect to make it from the get-go. You start doing consulting work while you are working for someone else, or while you have another business that provides more steady income.

    I would suggest finding your specialty. Don’t try to be all things to all people, as you will often get approached for projects you are not qualified for. It’s important to realize your limitations and not try to be an expert on something you’re less experienced with.

  9. MasterChef Consulting

    Great Stuff….So many owners/chefs that I meet do not know exactly what their food cost is…let alone what their gross profit is on a specific menu item. Tools that we use such as accurate recipe costing sheets and standard recipe sheets for the cooks do not exist in many operations. The answer that is often heard is that “I do not have time”. I also use Excel based spread sheets and Excel based recipe cost sheets
    to keep on top of menu pricing. A very large percentage of recipe costing sheets that I am shown are not current. I am responsible for the success of my operation and learned a long time ago that it was not always ok to do something a certain way because “that’s the way it was always done”. Sometimes I wonder how much time is spent in school on the importantence of maintaining accurate records of recipes and menu item cost. Great article.

  10. Great advice all…as a management consultant with many restaurant clients in the U.S. and Canada, too few owners want to take the time to do plate costing and portion controls let alone waste/inventory controls…and one constant fault they make is thinking cost mark up is done by multiplying the food cost by the % vs. dividing by the reciprocal…you leave money on the table the first way!

  11. Hi,
    I know this article has some age to it by now but I was curious if you had any advice for a figuring out total needed gross profit for a restaurant that is getting ready to open?? Thanks so much.

  12. Reblogged this on O'Dell Restaurant Consulting's Blog and commented:

    Bringing this article back around. It’s a good read.

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  14. Spot on. Catering schools, corporates have their agenda and rightly so but students employees should learn to read between the lines to really understand what agenda is right for the job and their development. Excellent real world advice.

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