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HFT 3431

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  1. HFT 3431 Chapter 8 Cost Approaches to Pricing

  2. Pricing Questions • Which Costs Are Relevant in the Pricing Decision? • What Is the Common Weakness of Informal Pricing Methods? • What Are Common Cost Methods of Pricing Rooms?

  3. Pricing Questions • What Are Common Methods of Pricing Food and Beverages? • How May Profitability and Popularity Be Considered in Setting Food Prices?

  4. Pricing Questions • Will Departmental Revenue Maximization Result in Revenue Maximization for the Hospitality Firm?

  5. Pricing Questions • What Is Integrated Pricing? • What Is Price Elasticity of Demand?

  6. Price Elasticity of Demand • Measures How Sensitive Demand Is to Changes in Price • Either Elastic or Inelastic

  7. Price Elasticity of Demand • Computed by Dividing % Change in Quantity Demanded by Base Quantity BY % Change in Price by Base Price (Q2 - Q1) / Q1 (P2 - P1) / P1

  8. Price Elasticity of Demand • Assume Hotel Sells 1,000 rooms @ $30 • Changes Price to $33 and sells 950 (950 - 1,000)/1,000 (33 - 30)/30 = - 0.05 / 0.10 = -0.50 Inelastic

  9. Price Elasticity of Demand • If between 1 and -1 Inelastic (Demand Is Insensitive to Price Changes) • An increase in price is offset by a smaller decrease in demand • Normally results in more profits with a price increase • An decrease in price is offset by a smaller increase in demand • Normally results in less profits with a price decrease

  10. Price Elasticity of Demand • If Greater Than 1 or -1 Elastic (Demand Is Sensitive to Price Changes) • An increase in price is offset with a higher decrease in demand • Normally results in less profits with a price increase • An decrease in price is offset with a higher increase in demand • Normally results in more profits with a price decrease (up to a point)

  11. Price Elasticity of Demand • Competition, Uniqueness Affect Elasticity • When Change Prices, Test for Elasticity

  12. Informal Pricing Methods • Competitive • Intuitive • Psychological • Trial and Error • Follow The Leader

  13. Informal Pricing MethodsFour Modifying Factors • Consider First: • Historical Price Changes • Guest Perceptions (Price/value) • Competition • Modify by Rounding

  14. Mark Up Approaches • Ingredient Mark Up • Determine Ingredient Costs • Determine Multiple to Use • Multiply Costs by Multiplier • Adjust Using Qualitative Factors

  15. Multiplier • 1 / Desired Food Cost Percentage • Example 1 / 40% = 2.5

  16. Alternative to Multiplier • Divide Costs By Desired Food Cost Percentage • Example $3.00 Cost / 40% = $7.50 Selling Price

  17. Ingredient Mark Up Approach • If total ingredients cost $1.32 and you have a 40% desired Food Cost • Multiplier = 1/0.4 = 2.5 • Suggested Price = $1.32 * 2.5 = $3.30 • Would suggest rounding to $3.50

  18. Mark Up Approaches • Prime Ingredient Mark Up • Determine Prime Ingredient Cost • Some Versions Add in a Fixed Dollar Amount for Other Ingredients

  19. Mark Up Approaches • Prime Ingredient Mark Up(Continued) • Determine Multiple to Use - Higher Than Mark up (Arbitrary) • Multiply Costs by Multiplier • Adjust Using Qualitative Factors

  20. Prime Ingredient Mark Up Approach • If Prime Ingredients cost $0.59 and you have a Prime Multiplier of 7.8 • Suggested Price = $0.59 * 7.8 = $4.60 • Would suggest rounding to $4.75 • Note, the Prime Multiplier is based on history or industry standards there is not a formula for it. It is usually higher than the ingredient multiplier

  21. Rooms Pricing Traditional Method • $1 Per $1,000 Cost Per Room • Doesn’t Consider Current Value • Doesn’t Consider Other Services • Assumes 70%occupancy • Assumes Profitable Food and Beverage

  22. Rooms Pricing Traditional Method • If $100,000,000 to build a 5,000 room hotel = 100,000,000 / 5,000 = 20,000 per room = 20,000 per room / $1,000 = $20.00 per room rate

  23. Rooms PricingHubbart Formula • “Bottoms Up” • Start With Profit • Determine Pretax Profit

  24. Rooms PricingHubbart Formula • Add in Fixed Charges • Add in Undistributed Operating Costs • Estimate Non Room Income (Loss) • Sum Is Rooms Department Income

  25. Rooms PricingHubbart Formula • Rooms Revenue Equals Rooms Income Plus Rooms Department Costs • ADR = Room Revenue / Rooms to Be Sold • See page 371 for example

  26. ADR to Single and Double Rates • (Singles Sold * Single Rate) + (Doubles Sold * (Single Rate + Price Differential)) = Average Rate * Rooms Sold • Solve for Each Rate

  27. Rate Calculation • Assume 200 room hotel with occupancy of 75% and double occupancy of 40% with ADR or 67.81 (doubles are $10 more than singles • Sell (.75 * 200) 150 rooms per day 90 singles 60 doubles

  28. Rate Calculation • Let X = Single Room Rate • 90x + 60(x + 10) = 67.81 * 150 • 90x + 60x + 600 = 10,171.50 • 150x = 9,571.50 • x = 63.81 Single Rate x + 10 = 73.81 Double Rate

  29. Yield Management Increasing the Rooms Revenue

  30. Yield Management • Take the Guess Work out of Your Rooms Inventory • The Business of Selecting the Most Profitable Reservations • Yield Management Is the Process of maximizing the total revenues, rather than selling more rooms

  31. Why Yield Management ? • Increase Room Revenues • Improve Total Corporate Profitability • Enter New Markets With Strategic Pricing • Identify and Respond More Quickly to Changing Market Trends • Manage Distribution Channels More Effectively

  32. What We Gain Is: • Assume 100 room hotel and you can sell either to business or group: • Business - ADR = $80 • Business books 1 week out, and have 40 business guests already booked and can book 55 more in the next 3 weeks • Group - ADR = $55 • Groups books 3 week out • It is 4/1/02 and a group wants to book 20 rooms for 4/21-11/02

  33. What We Gain Is: • Option 1 Accept the Group Group Rooms 20 * $55.00 = $1,100 Business Rooms 80 * $80 = $6,400 Total $7,500 • Option 2 - Reject the Group Business Rooms 95 * $80 =$7,600 • Since only $100 difference look at the overall revenue that will be generated from each option (ie food and bev)

  34. Menu Engineering A Tool to Increase Food and Beverage Profits

  35. Breaking Out of the Box • Is It Really Important to Sell Each Guest a Selection From Each Part of the Menu? • Is Food Cost Percentage the Best Measurement of Performance?

  36. Breaking Out of the Box • Can We Determine the Exact Labor Cost for Each Item Sold on the Menu? • Should Selling Prices Be Determined on a Consistent Mark-up Basis?

  37. Selling the Entire Menu • Drives up Check Average and That Is Good • Additional Points of Service Reduces Seat Turnover • Waiting Time for Table May Cause Loss of Customer

  38. Selling the Entire Menu • Would You Rather Serve a Dessert at a Cost of $2 for $5 or an Entrée at a Cost of $4 for $10?

  39. Food Cost Percentage • Ratio of Cost of Goods Sold to Sales • Gross Profit Is Sales Minus Cost of Goods Sold • Objective Is to Increase Gross Profit

  40. Food Cost Percentage • Do You Deposit Percentages or Dollars? • Item “A” Costs $4 and Sells for $12 or 33% • Item “B” Costs $8 and Sells for $20 or 40% • Which One Would You Rather Serve (All Other Things Being Equal)?

  41. Labor Cost • Labor Is a Mixed Cost - a Fixed Component and a Variable Component • Customer Demand Is Variable on a Daily Basis • Daily Labor Is Scheduled Based on Forecasts Which Inherently Are Imprecise

  42. Labor Cost • Therefore, Exact Labor Cost Quantification on a Per Item Basis Is Impossible to Compute • Can Rank Labor Cost Per Item (High or Low Relative to the Items in the Mix)

  43. Menu Engineering • Smith and Kasavana • Analyzes Popularity and Contribution Margin • Two by Two Matrix • Classified Items As Stars, Dogs, Puzzles, or Plowhorses

  44. Popularity • Item Is Popular If Individual Item’s Sales Mix Exceeds 70% of the Average Popularity • Average Popularity = (100% / Number of Items) * (70%)

  45. Popularity Example • 10 Items • Average Popularity = (100% / 10) * (70%) = 7% • If Individual Sales Mix Is > 7%, The item has HIGH Popularity • If Individual Sales Mix Is < 7%, The item has LOW Popularity

  46. Contribution Margin • Selling Price Minus Variable Costs or Gross Profit • Compute for Each Item

  47. Weighted Average Contribution Margin Calculation • Compute Individual Contribution Margin • Multiply Item Contribution Margin by Number of Item Sales • Result Is Total Contribution Margin

  48. Weighted Average Contribution Margin Calculation • Divide Total Contribution Margin by Number of Sales • Result Is Weighted Average Contribution Margin

  49. Contribution Margin • Compare Against Weighted Average Contribution Margin for Menu Section Engineered • If Item CM Is > WACM - Label “HIGH” • If Item CM Is < WACM - Label “LOW”

  50. Classifications • Star - High Popularity & High CM • Continue promoting item • Plow Horse - High Popularity & Low CM • Re-price the item to increase CM • Puzzles - High CM & Low Popularity • Promote the item to increase popularity • Dogs - Low CM & Low Popularity • - Drop the item from the menu

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