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Photograph by: Karolina Garbowska/Pexels
A Guide to Pricing Strategy
When setting prices, understanding what constitutes a price rather than relying on the standard food cost formula of: Price = Food Cost of Item / Ideal Food Cost Percentage is essential because it often does not adequately account for all of a business’ costs. To understand pricing it is important to start from an economic standpoint of supply and demand. That is, the ideal price of a good is at the intersection of the supply and demand curves. This means price is the maximum a consumer is willing to pay for the good (demand) while simultaneously being the minimum which the producer is willing to accept in order to stay in business (supply). To calculate price means that two factors need to be taken into account, the consumer’s perspective and the producer's perspective.
Consumer’s perspective (Demand Curve)
Understanding the consumer’s perspective is done through a market analysis. This will help determine the general pricing structure of a menu. In this analysis:
Build a comparison set also known as a Comp Set
In this analysis look at similar bars and restaurants to see what they are offering and at what price.
Perform a Strengths, Weaknesses, Opportunities and Threats analysis (SWOT) of each company in the comp set.
This will help identify if the comp set companies have an “accurate” pricing model from a consumer perspective.
• Strengths are internal, positive attributes of the company that are within the company's control.
• Weaknesses are negative factors that detract from the company's strengths. These are elements of the business which need to be improved on to make the firm competitive.
• Opportunities are external factors in the business environment that are likely to contribute to success.
• Threats are potential external factors of which the company cannot control their occurrence. Response strategies should be in place if the threat should occur.
• For more on pricing strategy visit hawaiibevguide.com/business-strategy
Create a price point of the goods and services provided based upon the results of the two analyses.
Price ranges are more ideal than singular prices because some menu items may be more expensive to produce than other menu items, however they are typically all within the consumer’s tolerance of being similar in price.
Some general price ranges are:
$5-$7, $7-$10, $10-$12, $12-$15 or $15+
Build a comparison set also known as a Comp Set
In this analysis look at similar bars and restaurants to see what they are offering and at what price.
Perform a Strengths, Weaknesses, Opportunities and Threats analysis (SWOT) of each company in the comp set.
This will help identify if the comp set companies have an “accurate” pricing model from a consumer perspective.
• Strengths are internal, positive attributes of the company that are within the company's control.
• Weaknesses are negative factors that detract from the company's strengths. These are elements of the business which need to be improved on to make the firm competitive.
• Opportunities are external factors in the business environment that are likely to contribute to success.
• Threats are potential external factors of which the company cannot control their occurrence. Response strategies should be in place if the threat should occur.
• For more on pricing strategy visit hawaiibevguide.com/business-strategy
Create a price point of the goods and services provided based upon the results of the two analyses.
Price ranges are more ideal than singular prices because some menu items may be more expensive to produce than other menu items, however they are typically all within the consumer’s tolerance of being similar in price.
Some general price ranges are:
$5-$7, $7-$10, $10-$12, $12-$15 or $15+
Producer's Perspective (Supply Curve)
The general strategy behind the price of a menu item is to include fixed cost, variable cost and profits while keeping the price at-tractive to the consumer. That is:
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Price = Fixed Cost + Variable Cost + Desired Profit
We are building a tool on hawaiibevguide.com/business-strategy that will help calculate costs based upon the following equations. 1. Calculate Fixed Costs Fixed costs are the costs that do not change regardless of how many units are sold. A common error in many indus-tries is not adequately accounting for fixed costs, which leads to many business closure. The fixed cost of a single sale is responsible for covering is dependent on the number of total units sold. For example: • If fixed costs are $10,000 and there are 1000 items sold at the same price, then each item will need to cover $10 worth of fixed costs ($10,000/1000) • If fixed costs are $10,000 and there are 2000 items sold at the same price, then each item will need to cover $5 worth of fixed costs ($10,000/2000) • Typically fixed costs include: • Rent, which is typically the largest line item. • Utilities like electricity and internet can be considered fixed costs. Electricity is either covered in common area maintenance (CAM) or the additional energy draw for using the dishwasher and other variable usage appli-ances is minimal compared to the energy costs from always-on appliances like refrigeration, HVAC and lights. |
Insurance, license fees and other administrative costs.
Glassware, plates, utensils etc. are typically tied to the number of seats and not the number of dishes served. Disposable elements like takeout cups are variable costs. Labor may be considered a fixed cost if the number of employees generally remains the same regardless of how busy the establishment is. Labor can also be a variable cost if more employees are added as sales increase. Restaurants can use the estimated percentage of revenue from the bar program versus the estimated percentage of revenue from the food program to allocate a percentage of the fixed cost to each menu item. For example: If 40% of revenue comes from beverage sales and 60% from the food sales, and fixed costs are $10,000, then 40% of fixed costs ($4000) can be allocated to costs the bar sales should cover and 60% ($6,000) are fixed costs food sales should cover. 2. Estimate the number of units sold per period (most likely per month)
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3. Calculate Variable Costs
Variable costs are the costs that increase for every additional unit sold.
Cost per unit of Ingredient A = (Total Ingredient cost/ quantity of ingredient used per unit sold) /price. Where:
Cost per portion is the variable cost of the ingredients. |
To calculate the labor cost per unit:
Q Factor, represents the additional costs required for the service experience. These are variable costs including items like table side condiments and napkins. Q factor is typically more applicable to food service than beverage service. 4. Profit A percentage of the cost of a menu item will be profit. That is the return on investing money into all the fixed and variable costs. It is ideal to allocate a portion of the overall cost to profit. How much of the overall cost should be allocated to profit is personal preference. One approach is to have profit be in excess of 8-10% as that is the average return on investment in an S&P 500 Index fund that is passively managed (no buying or selling except for the initial purchase and the final sale). When the Standard Food Cost Formula can be used The standard food cost formula can be used when revenue and fixed costs are known and predictable. This situation allows for fixed costs to be calculated as a percentage of profit. To calculate price: Price = Food Cost of Item / Food Cost Percentage Where Food Cost Percentage = 1 - [(Fixed Costs /Gross Revenue) + Profit] *Food Cost Percentage is calculated to find the percentage of fixed costs/profit in relation to overall sales. Example: If: Gross Revenue = $10,000 Fixed Costs = $6,000 Desired profit = 15% = 0.15 Variable Cost = $2 Food Cost Percentage = 1 - [($6,000/$10,000) +.15] = 1 - [0.6+0.15] = 0.25 Food Cost / Food Cost Percentage = Price $2 / 0.25 = $8.00 |
Labor cost should be accounted for in the price of an item.
This can be calculated into the price or at least should be a footnote if labor will be treated as a fixed cost. Labor cost should be taken into account because an item that takes 20 minutes to produce requires more paid labor than that which takes 5 minutes to produce (both including prep time), even if the ingredients cost is the same, therefore the 20 minute production time item should cost more, or at least be accounted for in some capacity.
This can be calculated into the price or at least should be a footnote if labor will be treated as a fixed cost. Labor cost should be taken into account because an item that takes 20 minutes to produce requires more paid labor than that which takes 5 minutes to produce (both including prep time), even if the ingredients cost is the same, therefore the 20 minute production time item should cost more, or at least be accounted for in some capacity.
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