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Monday, September 01, 2014

A Margin of Safety for Restaurateurs

In an earlier post, High Food Cost Due to Inflation, I recommended an across the board increase in menu prices. During the month of August, I received several calls and emails asking how big the suggested increase should be for most restaurants.

Anyone considering an across the board menu price increase should first conduct a thorough competitor analysis. If you find your competition has already raised prices, you should go ahead with the increase.

Every menu has a unique cost composition. I can only speak to general market conditions. Two key components of gross profit have shot higher in 2014. The impact on labor costs of the Affordable Care Act has been estimated at between 1% and 2% by operators here in the Mid-Atlantic. Food Costs have risen 7.5% in the protein category.

If your food cost percentage was 30% before the 2014 cost increase, your current percentage would be around 32.25% (30% * 107.5%). We can also add 1.5% to your labor cost. If your cost before the ACA was 30%, we can estimate a new labor cost of 31.5%. In order to achieve a profit of 40% after cost of sales and direct labor, we would raise menu prices by 3.75%.

The ACA will continue to cause general price levels to increase as employers provide employees with the mandated health care coverage. I'd recommend additional menu price increases on a quarterly or semi-annual basis to cover the additional costs. A 1% quarterly increase would provide a 6.75% increase in a 12 month period. My previous range for the increase was between 3% and 10%.

Restaurants Continue To Struggle With High Protein Costs

The market prices for beef, pork and chicken remained high this summer.  In the most competitive markets, restaurant operators have had a tough time building higher costs into their menu prices.  Consumers continue to carefully manage how they spend their discretionary income.  These consumers see the higher food prices when they shop in the grocery stores.

Restaurants need to take a long term view and develop a strategy to deal with the challenging environment.  I remember when McDonald's first came to our area in Upstate NY around 50 years ago.  You could purchase a meal for $0.40.  This meal consisted of a hamburger, a order of fries (similar to today's small portion) and a soft drink.  For shake lovers, the meal cost rose to $0.50.

If you visit a McDonald's today, you may find a similar meal for $3.00.  They have a separate dollar menu in many locations.  This is an increase of $2.60 in 50 years.  The average annual increase is around 4.1%.

How long has your operation been in business?  If you saved your original menu and check average information, it would be a great exercise to compare today's prices with your oldest menu.  Create a spreadsheet and enter the years in column A.  Label column B "Meal Cost".  Column C "Growth" will have 1.041 in every cell.  Column D should be labeled "New Cost".

Columns B and D will be filled with calculated values.

Cell B2 will have the price of a meal in your first year of business (or the first year you kept solid records).  Cell D2 will have a formula as follows:  =B2*C2.  Cell B3 will have a simple formula as follows:  =D2.  You can copy the formula in B3 all the way down.  Repeat this with cell D2.

The final value in column D will yield the cost of a meal this year if you steadily raised prices 4.1% each year for every year you have been in business.

I ran a catering operation in my sophomore year of college.  The sale prices for whole chickens back in the 1970's was $0.29 per pound.  Today, I can buy chickens for around $0.99 per pound on sale.  These sale prices are tough to find for fryers and broilers.  The $1.49 per pound every day chicken prices do reflect a 4.1% growth rate.

Restaurant operators can increase profits steadily, over a long time period, by implementing a slow growth policy for menu prices.  A 4.1% growth is roughly a 1% increase each quarter.  Today's high protein costs provide cover for restaurants who need to increase prices by a much higher percentage.  Make sure you know your competition thoroughly before implementing any large price increase.

Restaurant Data Pros

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