11.3: Arriving at an item price
- Page ID
- 22117
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\(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)The old school menu pricing strategy was simple: you divided the cost of the ingredients by .33 and presto, you had your selling price. Times have changed and menu pricing can no longer be calculated using food cost alone. Numerous restaurants with low food cost percentages have gone out of business because the owners never considered their other expenses. There are no “guaranteed” ways to price your menu and assure profits, but there are formulas and strategies that you can use that will assist you. The method discussed here, takes into consideration not only your cost of food, but also your other variable and fixed expenses.
Quick Review - Income Statement
The more comfortable and knowledgeable you are with the makeup of your business’ sales and expense figures, the easier it will be to develop a menu pricing strategy and calculate your prices. Review a few definitions and terms associated with a typical income statement – and where you can obtain the information.
Income Statement. Shows your sales, cost of goods, gross profit, expenses and profit for a given period of time.
Revenue. (also known as Sales) Money earned from sale of food, beverages and other merchandise.
Cost of Goods Sold. The price paid for the food, beverages and other merchandise.
Gross Profit. The difference between the revenue received from your sales and the cost paid for the products sold.
Expenses. The cost of products or services used in operating a business – variable or fixed.
Variable Expenses. Change based on the number of guests that visit your operation or the amount of your sales these costs.
Fixed Expenses. These are the costs that do NOT change based on the number of guests or the amount of sales.
Occupancy Cost. Costs associated with the actual occupation of your physical structure, including rent, real estate taxes, interest on mortgage, and depreciation of a purchased building or structure.
Operating Expenses. The expenses incurred in running your business. Does NOT include your cost of goods. Lines 13 through 23 represent examples of operating expenses.
Operating Income. The Total Gross Profit minus the Total Operating Expense. This is your income or revenue before interest and income tax, and before paying any return or dividend to investors.
Income Statement (example)
Year Ending 20__
| Revenue Sales | % of TR | Source | ||
| 1 | Food Sales | $1,000,000 | 74.07% | From POS |
| 2 | Beverage Sales | $300,000 | 22.22% | From POS |
| 3 | Other Sales | $50,000 | 3.70% | From POS |
| 4 | Total Revenue (Sales) | $1,350,000 | 100.00% | Total of lines 1 to 3 |
| Costs of Goods Sold | ||||
| 5 | Food Cost | $330,000 | 33.00% | From Invoices |
| 6 | Beverage. Cost | $75,000 | 25.00% | From Invoices |
| 7 | Other Costs | $25,000 | 50.00% | From Invoices |
| 8 | Total Cost of Goods | $430,000 | 31.85% | Total of lines 5 - 8 |
| Gross Profit | ||||
| 9 | Food | $670,000 | 67.00% | Subtract line 5 from line 1 |
| 10 | Beverages | $225,000 | 75.00% | Subtract line 6 from line 2 |
| 11 | Other | $25,000 | 50.00% | Subtract line 7 from line 3 |
| 12 | Total Gross Profit | $920,000 | 68.15% | Subtract line 8 from line 4 |
| Operating Expenses | ||||
| 13 | Salaries & Wages | $364,500 | 27.00% | From Payroll |
| 14 | Employee Benefits | $80,190 | 5.94% | From Invoices |
| 15 | Occupancy Cost | $180,000 | 13.33% | From Invoices |
| 16 | Music & Entertainment | $20,000 | 1.48% | From Invoices |
| 17 | Advertising & marketing | $25,000 | 1.85% | From Invoices |
| 18 | Utilities | $50,000 | 3.70% | From Invoices |
| 19 | Depreciation | $25,000 | 1.85% | From Invoices |
| 20 | General & Administrative | $12,000 | 0.89% | From Invoices |
| 21 | Repairs & Maintenance | $25,000 | 1.85% | From Invoices |
| 22 | Other expenses | $10,000 | 0.74% | From Invoices |
| 23 | Total Operating Expense | $791,690 | 58.64% | Total of lined 13 – 22 |
| $128,310 | 9.50% | Subtract line 23 from line 12 | ||
Developing a Pricing Strategy
You need to start with a few basic pieces of information. Foremost, you need to know the cost of goods for each of your menu items. Standardized recipes as the best means of knowing your food cost. If you have standardized recipes, you will have all your food costs available already. If your standardized recipe file is not up to date with your current product costs, you will need to update your recipes. Include all of the items that are a part of the menu item’s service. These might include bread and butter, side dishes, condiments and a salad. Keep in mind that it is better to over-estimate your costs rather than under estimate them.
| Operating expenses | Total Exp. | Variable | % | Fixed | % |
|---|---|---|---|---|---|
| Salaries & Wages | $364,500 | $175,000 | 48.01% | $189,500 | 51.99% |
| Employee Benefits & Taxes | $80,190 | $50,000 | 62.35% | $30,190 | 37.65% |
| Occupancy Cost | $180,000 | $25,000 | 13.89% | $155,000 | 86.11% |
| Music & Entertainment | $20,000 | 0.00% | $20,000 | 100.00% | |
| Advertising & Marketing | $25,000 | 0.00% | $25,000 | 100.00% | |
| Utilities | $50,000 | $10,000 | 20.00% | $40,000 | 80.00% |
| Depreciation | $25,000 | 0.00% | $25,000 | 100.00% | |
| General & Administrative | $12,000 | $2,000 | 16.67% | $10,000 | 83.33% |
| Repairs & Maintenance | $25,000 | $10,000 | 40.00% | $15,000 | 60.00% |
| Total Expenses | $781,690 | $272,00 | 34.80% | $509,690 | 65.20% |
| Example | Formula | |
| Variable Expense % | 35% | For every dollar in revenue, this expense goes to variable expenses |
| Fixed Expense % | 65% | For every dollar in revenue, this expense goes to fixed expenses and profit |
Many operations have computerized their inventory and linked them with their recipes to provide up to date cost information. If you have not done this, consider it. There are several good commercially available software products on the market, which, after the initial setup, make this task a breeze.
You will need to do an analysis of your sales and the current selling price of each menu item. Your POS system should be able to provide this easily. A simple income statement, like the one shown will provide you with the rest of the numbers you will need.
Calculations
You can do the math by hand or on a computer spread sheet such as Excel or Lotus 123 to make it easier.
Step 1: From your income statement, make a list of your Fixed Expenses and your Variable Expenses. This usually requires some “estimation.” An expense item frequently fall into both categories
Step 2: Create a chart or spreadsheet similar to the one below. Begin the process by listing your menu items in column A. In column C, fill in your actual cost of the menu item from your recipe files. Columns D, E and F are formulas. Column D is calculates by dividing your item (recipe) cost by the selling price. Variable Expenses, column E, calculates by multiplying the selling price (column B) by the variable expense percentage calculated in Step 1. You calculate the Contribution to Fixed Expenses and Profit (column F) by first adding together your item cost (column C) and your variable cost (column E) and then subtracting these costs from (column B) the selling price.
| A | B | C | D | E | F |
| Menu Item Name | Selling Price | Item Cost | Food Cost % | Variable Expenses | Contribution to Fixed Expenses & Profit |
| Your Choice | From Recipe File | B/C | Variable Expenses % X B | B-(C+E) | |
| Pub Burger | $6.95 | $1.47 | 21.15% | $2.43 | $3.05 |
| Taco Salad | $7.50 | $1.95 | 26.00% | $2.63 | $2.93 |
| Grilled Salmon | $10.95 | $2.85 | 26.03% | $3.83 | $4.27 |
| Chicken Sandwich | $7.95 | $2.07 | 26.04% | $2.78 | $3.10 |
| Fajitas, Chicken | $9.95 | $2.59 | 26.03% | $3.48 | $3.88 |
| Fajitas, Beef | $9.95 | $2.59 | 26.03% | $3.48 | $3.88 |
| Fajitas, Vegetable | $9.95 | $2.59 | 26.03% | $3.48 | $3.88 |
| Sirloin, 12 oz. | $16.95 | $6.80 | 40.12% | $5.93 |
Step 3: Now you are ready to assume some “what ifs?” with our menu prices. Start by entering your current menu prices in column ‘B’. Look at the results. Column ‘D’ shows the Food Cost Percentage of the item. Column ‘E’ represents the amount necessary to pay for all of the other variable expenses. The last column, ‘F’, shows the amount the menu price left to put towards your fixed expenses and profit.
By analyzing the effect of raising or lowering your selling price of items, you can get a good idea of where your prices need to be. Remember, this may or may not be the amount that your guests are willing to pay. The fact that you have justification for the price does not mean that your customers will feel the same.
As recent as ten or fifteen years ago changing your menu was a major undertaking for most operations, and cost a lot of money to accomplish. With today’s desktop publishing technology and some forethought, you can update your menu quickly and easily with a trip to your neighborhood copy center. You may even be able to do the job in-house. Now, the restauranteur can address seasonal availability, changes in wholesale pricing or transportation costs, or simply item updating efficiently.
Consider choosing a menu format that allows flexibility. A nice cover with a printed insert or a design that allows you to make changes by substituting single pages will allow you to change and “tweak” your menu pricing and items gradually. Instead of making dramatic price changes once or twice a year, your menu can be adjustable to reflect your actual costs. You can make price adjustments subtly, take advantage of fluctuating commodity prices by featuring high profit items and turn your menu into a sales and profit-making tool.
Purchasing Functions
Regardless of restaurant operation size, someone must perform a certain number of purchasing functions. Purchasing functions are the tasks buyers must perform in order to obtain the right products and services, at the right price and time, from the right vendors. The owner or manager usually does the best they can under the circumstances. In some cases, owners and managers delegate a portion of their responsibilities by letting a supplier or a salesperson perform some activities for them. However, owner-managers should determine their own requirements and not allow others to do this. I am not implying that something unfortunate will occur if they enlist the help of a friendly salesperson, but, realistically, they must understand that the salesperson will be prone to enhancing his or her self-interest. In addition, the sales person may not have the owner or manager’s intimate knowledge of the operation, its goals, and standards.
Buyers usually perform a number of functions common to all hospitality operations. One survey of purchasing agents uncovered the following key purchasing responsibilities: (1) determine when to order, (2) control inventory levels, (3) establish quality standards, (4) determine specifications, (5) obtain competitive bids, (6) investigate vendors, (7) arrange financial terms, (8) oversee delivery, (9) negotiate refunds, (10) handle adjustments, (11) arrange for storage.
A study of large foodservice operations indicate that the important purchasing functions center on elements that are not so different from a small restaurant operation. Small operations typically perform: (1) recipe development, (2) menu development, (3) specification writing, (4) approval of buying sources, (5) designation of approved brands, (6) supplier evaluation, (7) negotiation with suppliers, (8) change of suppliers, (9) change of brands, (10) substitution of approved items, (11) approval of new products, (12) invoice approval, (13) invoice payment, and (14) order placement with suppliers.
The follow charts indicate the most common purchasing functions performed by the restaurant owner or manager, or, the person they designate to accomplish these tasks. Generally, the operation will perform more efficiently if one person has the task of following purchasing issues especially in the areas of costing, approving suppliers, and searching for new or equivalent products at affordable prices, and inspecting and maintaining product quality and obtainability.
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PREPURCHASE FUNCTIONS
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FORMAL PURCHASING
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INFORMAL PURCHASING
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Adapted from Food Purchasing Pointers for School Service
The restaurant operation has the choice of a ‘formal’ or ‘informal’ method of addressing the purchasing function. Remember that proper purchasing helps to eliminate waste, improve efficiency, and insure a quality product reaches the consumer. In addition, care and scrutiny regarding the purchasing function goes a long way in maintaining profitability.