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Thursday, July 21, 2011

Higher Food Costs Can Lead To Higher Profits

As commodity prices have leveled recently, we have consumers modifying their food purchases due to much higher prices for many staples.  The financial press has featured plenty of articles on the high prices for gold, oil, corn and other key commodities.  Many restaurant chains have increased their menu prices to offset the higher cost of goods sold.

In the short term, savvy restaurant managers can boost profit through strategic menu engineering analysis.  Imagine your food purchases are 5% higher for the same sales level.  If you raise selling prices by 5%, you can cover the higher cost of sales and increase profits by holding overhead and labor costs low.  With a check average of $18 and a 33% food cost, your cost of sales is $6 and your gross profit is $12.  Raising the $18 by 5%, you would expect a check average of $18.90.  The cost of sales would go to $6.30 in the same 5% rise.  Your gross profit would increase by $0.60.

In terms of the original $18 check average, this $0.60 is an additional 3.3% of gross margin.


Kurt Woloch said...

This is a fine theory... however, that price increase may lead to customers slightly tending to lower-cost food, which in turn would lower the check average again (probably not below $18, but still a portion of the $0,90 increase). In addition so that, some customers may choose not to visit your restaurant as often anymore or even switch to a competitor entirely because you've become more expensive in general. This wouldn't reduce your check average, but your overall profit. If, by factoring in these losses, your total profit will not rise, you've probably reached the limit of practically possible price increases at this time. If your total profit even goes down because of this, you might consider taking back the price increases...

Joe Dunbar said...

When would you raise prices in this environment?

On a routine basis? Never? When prices of food go down? or When prices of food go up?

Normally, I prefer regular price increases to stay in line with price increases. Since restaurants have been absorbing higher costs for so long, I think the 5% increase is warranted for many locations.

However, if you prefer routine, regular increases, any additional increase for higher seasonal prices would be risky.

Kurt Woloch said...

Well... if you ask me that... since I'm a control freak, I would ask myself if I should raise prices every time a key expense goes up... either prices of key ingredients, or labor costs, or utility / rent cost. But I wouldn't raise them over a fixed percentage across the board, but rather I'd keep a spreadsheet or database with all the expenses for each menu item (labor / food cost etc.). I'd also take a look at the competition's prices for similar items, which are factored into my prices to a certain degree (assuming that's the price the customers are willing to pay). Now changing some of the numbers would yield new prices for all of the items, and then I would estimate if it pays off to do this (because there's a cost associated with reprinting menus, teaching price changes to the servers and such). If so, I would raise to the rounded new prices. That could take a year from the last change or less than that, depending on how fast my costs raise... or I'd do it if there are seasonal changes to the menu and it would have to reprinted anyway.

Joe Dunbar said...

I'm more inclined to increase prices (in a stable economic environment) every year at the bare minimum. If possible, prices should change 3 times a year (more gradual).

We agree regarding the across the board method. I'm against it.

The original post was directed to the owners who have been eating the higher costs for well over 2 years.

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