Determining Menu Prices

1. Determining Menu Prices 4 OH 4-1

2. Learning Objectives After completing this chapter, you should be able to: • Describe external and internal factors that influence menu pricing. • List and explain different menu pricing formulas. • Describe the menu product mix and menu engineering. • Explain the process used to identify food cost percentage problems. • Describe the process for determining menu modifications and price adjustments.

3. Menu Prices • If they are too high; Sales suffer • If they are too low; Profits suffer

4. Menu Prices Should • Be directly related to costs • Help predict profitability • Serve as a cost control tool • Reflect realistic markups (the difference between a menu item’s cost and selling price)

5. Pro Forma Income Statement as Budget Standard

6. Industry Standards • Restaurants typically run in the low to mid 30% • Italian - ~ 28% • Multi Unit - ~ 32% • American/Regional - ~35% • Steak - ~ 40% • Prime Cost = 65% (some industry professionals like to see this nearer to 55%)

7. Internal & External Factors Affect Pricing

8. Market Forces Affect Selling Prices Menu prices can be affected by a variety of external forces, including • Competition • Price-value relationship • Mark-Up Differentiation

9. Markups Affect Selling Prices • Different menu items are typically marked up by different amounts. • In general, the lower the menu item cost, the higher the markup (and the lower the food cost percentage).

10. Menu Pricing Methods • The Factor Method • Contribution Margin Method (CM) • Ratio Pricing Method • Prime Cost Method

11. The Factor Method • Determines menu prices based upon the standard (target) food cost percentage • Involves a two-step process

12. The Factor Method continued Step 1 – Calculate the appropriate factor using the following formula. Divide 100 percent by the Standard food cost percent.

13. The Factor Method continued Step 2 – Calculate the menu price using the following formula. Multiply the factor by the menu item cost.

14. Food cost % and associated factors

15. Contribution Margin Method • Contribution margin in the amount left over after the food cost is subtracted from the selling price • Contribution is the amount that pays for labor, rent, profit, etc. • A two step process is used for this method

16. Contribution Margin Method Step 1: Calculate the average CM per customer (Nonfood costs + Profits) ÷ # of customers = Avg CM/ cust. ($28,000 + $5,500) ÷ 10,000 = $3.35 Step 2: Determine selling price by adding the food cost to the CM $3.22 + $3.35 = $6.57 food cost CM selling price

17. Ratio Pricing Method • Managers must know 3 key components to use this method • Food costs • Labor costs • Target profit • This method required 3 steps

18. Ratio Pricing Method, continued • Step 1: Calculate the ratio of food cost to nonfood cost and profit (nonfood costs + profit) ÷ food costs = ratio • Step 2: Calculate the nonfood and profit requirements amount for the menu item food cost x ratio = non food costs and profit • Step 3: Add nonfood and profit requirement to menu item’s food cost food cost + non food cost + profit = selling price

19. Prime Cost Method • This method focuses on the direct labor involved in food preparation Direct labor + Food cost = Prime cost • Managers then determine a targeted prime cost percentage • Portion cost ÷ Prime cost % = selling price

20. Menu Product Mix Is Important • Restaurants must achieve their standard (targeted) food cost percentage. • If a restaurant exceeds its food cost standard, profits will likely decline. • Menu items sell at a variety of cost percentages.

21. Menu Product Mix Is Important continued • The average food cost percentage is determined by menu mix. • Menu mix significantly determines a restaurant’s food cost percentage target.

22. Composite Food Cost Percent • Wrong way to determine average food cost percent

23. Composite Food Cost Percent continued • Right way to determine is by weightedaverage food cost

24. Menu Product Mix • It is not possible to add unweighted unit costs to determine average unit costs. • It is not possible to add unweighted food cost percentages. • A menu product mix spreadsheet helps determine the total (weighted) food cost percentage.

25. Menu Product Mix Spreadsheet • Lists the names of all menu items sold • Lists the number of times each item has sold • Identifies the unit item cost of each item

26. Menu Product Mix Spreadsheet continued • Lists each menu item’s selling price • Identifies the total cost of each item (number sold x item cost) • Lists the total sales achieved by each item (number sold x selling price)

27. Menu Product Mix continued • The items that guests select have a significant impact on a restaurant’s weighted food cost percentage. • Menu Mix Popularity % is critical information

28. Menu Mix Popularity % • Ratio of portions sold for a given menu item to total portion sales for all menu items • Key element in forecasting sales • Critical in menu evaluation Popularity Index = Portion sales for itemx 100 Total portion sales of all menu items

29. Menu Item Popularity Index

30. Menu Engineering (Contribution Analysis) • Method of menu evaluation or analysis • Considers menu product mix • Considers contribution margin (selling price minus menu item food cost) • Considers popularity (number of items sold)

31. Menu Engineering

32. Menu Engineering

33. Menu Engineering

34. Menu Engineering

35. Menu Engineering

36. Menu Analysis High H/L H/H Popularity L/L L/H Low High Contribution Margin

37. Other Menu Analysis Methods • Miller Matrix • Same process but evaluate food cost and popularity • Weighted food cost is factor • Winners (similar to stars) = low food cost, high popularity • Goal to achieve sales mix with 60% of items in low food cost category • Cost Margin Analysis • Combination of Miller Matix and Contribution Analysis • Methodology includes evaluation of popularity, contribution margin and food cost • Primes (similar to stars) = low cost, high contribution

38. Menu Management Decisions • Must consider more than just sales dollars, item popularity, and contribution margins • Preparation and service costs • Restaurant’s image • Customers’ expectations

39. The Pareto Principle • A few of the top selling menu items account for a large majority of sales in a category. • Removing the two or three least popular items in a category will not likely reduce the total sales of items in the category.

40. Monitoring Menu-Related Concerns • Three factors must be considered and compared when analyzing food cost efficiency. • Standard food cost percentage • Composite food cost percentage • Actual food cost percentage

41. Monitoring Menu-Related Concerns continued • Standard food cost percentage • The expected food cost percentage based upon the approved operating budget or other benchmark. • Calculation

42. Monitoring Menu-Related Concerns continued • Composite (weighted) food cost percentage • The percentage that results from the actual food sales • Calculation

43. Monitoring Menu-Related Concerns continued • Actual food cost percentage • Reported on the restaurant’s income statement

44. Monitoring Menu Related Concerns continued • If the composite percentage exceeds the standard percentage, take steps to manage sales activity. Composite % ≥ Standard % • If the actual food cost percentage exceeds the composite percentage, take steps to improve food controls. Actual % ≥ Composite %

45. How Would You Answer the Following Questions? • A composite food cost percentage is a (weighted/unweighted) average. • A menu product mix spreadsheet is designed to identify a restaurant’s composite food cost percentage. (True/False) • The menu pricing method that considers target profit in its computation is the • Factor method • Markup on cost method • Texas Restaurant Association (TRA) method • Yield percent method • Product mix has very little impact on the ability of a restaurant to achieve its standard food cost percentage. (True/False)

46. Key Terms: Composite (potential) food cost percentage The weighted average food cost percentage for all items sold, weighted by the quantity of each item sold. Contribution margin (CM) The amount left over after the food cost of a menu item is subtracted from the menu selling price. Contribution margin method (pricing) Adding the contribution margin (CM) figure to the cost of a menu item to determine that item’s price. Demand-driven pricing The theory that an operation can set pricing based on demand for the product or service. Factor method (pricing) A popular formula used to determine menu prices based on the standard food cost percentage, also called simple markup or food cost percentage method. Food cost percentage method (pricing) A popular formula used to determine menu prices based on the standard food cost percentage. This method is also called simple markup or factor method.

47. Key Terms continued: Market-driven pricing Pricing that is determined by the market, which is usually regional. Market price A menu pricing strategy in which the price of a menu item changes based on the current market. Markup The difference between the actual cost of producing an item and the price listed on the menu. Markup differentiation Giving different markups to different categories of food, according to a range of expectations in the market. Menu engineering The process of analyzing the menu product mix, along with consideration of an item’s contribution margin and its popularity. Menu matrix The placement of menu items in different categories based on their popularity and profitability.

48. Key Terms continued: Menu product mix A detailed analysis that shows the quantities sold of each menu item, along with their selling prices and standard portion costs. Price–value relationship The connection between the selling price of an item and its worth to the customer. Prime cost method (pricing) A method that requires managers to determine the amount of direct labor spent in preparing an item; this number is added to the food cost to arrive at the prime cost. Q factor The quotient or cost of all other food items served with an entrée; the cost includes side dishes and garnishes as well as all complimentary items such as condiments, seasonings, coffee creamer, and sweetener. Ratio pricing method A ratio derived by taking the sum of all nonfood costs (including labor costs, other controllable costs, and noncontrollable costs), adding it to the target profit, and dividing the resulting number by the cost of food sold in dollars.

49. Key Terms continued: Value perception A customer’s opinion of a product’s value to him or her.