While having a passion for food and hospitality is an important part of running a restaurant, you need a lot more than just passion to make it in today’s challenging economy. Successful restaurateurs have business savvy and use data, rather than intuition, to make important business decisions.
Especially when it comes to pricing a menu.
Food is a restaurant’s main moneymaker. The revenue generated by selling food has to cover many business expenses, including rent, payroll, inventory, utilities, insurance and technology. Pricing menu items properly, so that they cover these costs and lead to a profit, is a crucial part of running a financially viable restaurant.
So how do profitable restaurants set their menu prices? Successful restaurateurs don’t base prices on a hunch. Instead, they take things like food cost percentage, profit margins, and competition into account.
Fortunately, you don’t need a business degree to set your menu prices properly. All it takes is some number crunching and data from your POS system to get it right.
In this guide to restaurant menu pricing you’ll learn:
- How to price menu items based on ideal food cost percentage
- Restaurant pricing strategies based on gross profit margin
- Other factors to consider in your restaurant menu pricing strategies
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How to price a menu based on ideal food cost percentage
First, we’re going to show you menu pricing strategies based on your restaurant’s ideal food cost percentage. So what’s a food cost percentage?
A food cost percentage is how much your restaurant spends on food inventory related to how much money this food generates the business (revenue), expressed as a percentage.
Calculate inventory costs over time by figuring out how much the inventory you started with costs, and add the cost of any additional inventory to that figure. Next, subtract the cost of the inventory that you’re left with at the end of the time period you’re examining. Finally, divide this number by the revenue your restaurant generated during that time.
Let’s unpack that formula with an example.
An example of how to calculate food cost percentage
Johnny owns Johnny’s Burger Bar and wants to know his restaurant’s food cost percentage over the last year. The formula for food cost percentage is:
Johnny refers to his POS system to find the value of the food inventory that he started with at the beginning of last year. That number is $12,000.
He then calculates how much his restaurant spent on inventory over the last year. According to his POS, Johnny’s Burger Bar spent $120,000 on inventory purchases last year.
At the end of the year, the restaurant had $10,000 left in remaining inventory.
According to POS reports, Johnny’s Burger Bar generated $305,000 in food sales last year.
Let’s take those figures and plug them into the formula:
According to our calculations, Johnny’s Burger Bar’s food costs percentage over the past year was 40%. This means that for every $1 of revenue generated, 40 cents was spent on food inventory.
Now that you know what food cost percentage is, you need to learn about the ideal food cost percentage.
Ideal food cost percentage is the sweet spot of food cost percentage that restaurateurs try to maintain to run financially viable businesses. To run a profitable restaurant, most owners and operators keep food costs between 28 and 35% of revenue.
Let’s say Johnny’s Burger Bar wants to bring their food cost percentage down to 30%. How would they need to change their burger price? Use the following formula to find out and set the right menu price.
As we had previously calculated, Johnny’s Burger Bar’s overall food cost percentage is 40%, which is higher than the ideal 28-35% industry benchmark. Johnny wants to price his menu items properly in order to bring his food cost percentage down to a more manageable 30%.
He wants to start by setting a new price for his signature burger. The burger costs him $3.60 per serving to make, and he currently charges $9 for it, which represents a 40% food cost percentage.
How much should he charge for his burger to bring his food cost percentage down to 30%? That’s where using the ideal menu item price formula comes in handy.
Johnny should charge $12 for his signature burger in order to lower his food cost percentage for that item to 30%.
How to determine restaurant menu prices based on gross profit margin
Another data-based way to profitably price menu items is to base it on gross profit margin.
Gross profit margin formula
The ideal gross profit margin is 70%, which means that for every $1 of revenue your restaurant makes, 30 cents goes into the cost of making the meal and 70 cents are gross profit.
Let’s revisit Johnny’s Burger Bar to illustrate how to use this formula to set menu prices.
Johnny wants to know what his gross profit margin is. His total sales last year were $305,000, and he spent $122,000 on inventory that went into these sales.
Using the formula above, calculating for gross profit margin looks like this:
Johnny’s Burger Bar’s gross profit margin as a percentage is 60%, meaning that for every $100 a guest spends at their establishment, $60 is gross profit that can be used to pay for fixed and variable operating expenses.
You can reverse engineer this formula to figure out how much revenue you need to generate in order to get a 70% profit margin, which is the ideal figure.
Solve for revenue so that you can find how much you need to sell, with your current menu costs, in order to get the margins you want.
Back to Johnny’s Burger Bar…
Johnny’s COGS are fixed at $122,000 and he wants a gross profit margin of 70%.
Johnny’s Burger Bar needs to generate $406,666 in annual revenue in order to reach a 70% gross profit margin if food costs are fixed at $122,000.
Johnny can now revisit the ideal menu item price formula to calculate how to price individual items on his menu to help him reach his annual revenue goal.
Pricing food shouldn’t be a guessing game. Crunch the numbers to set menu prices that will sustain your business.
Different menu pricing strategies for restaurants
There’s no one size fits all approach when it comes to pricing and restaurants have many strategies they can choose to turn a profit. Here are a few commonly used menu pricing strategies in the restaurant industry:
With cost-plus pricing, restaurants focus on costs of production. This involves calculating the cost of producing each menu item and adding a predetermined profit margin to arrive at the selling price. The costs include everything that goes into making the dish as well as other costs like rent, bills and staff wages. This ensures that the restaurant covers its costs and keeps a consistent profit margin.
In this type of pricing, decisions are based on perceived value. Restaurants set prices based on factors such as quality, ambiance and unique features. Restaurants that emphasize high-quality ingredients or exceptional dining experiences often use this strategy. Pricing might not be as clear cut as the cost-plus pricing, because features such as an original ambiance are less clear to quantify, but should still be reflected in the final price.
Market penetration pricing
Restaurants that are just starting out might use this strategy to compete with existing restaurants. Market penetration pricing attracts customers by setting lower prices than competitors. The goal is to gain loyalty and generate repeat business.
This strategy is often used by high-end or luxury fine dining restaurants. These restaurants set higher prices because of the quality and superior dining experience, but also to add an element of exclusivity. Customers are willing to pay extra for the perceived quality, ambiance and exceptional service that these restaurants offer.
Bundle pricing involves creating deals and packages at the purchase of multiple menu items. Many restaurants use other pricing strategies but offer some bundle pricing within theri menu. For example, if a sandwich shop offers a lunch deal where you can add a soup or salad to your sandwich with a drink at a reduced price, this means they’re employing a bundle pricing strategy. Customers will often spend more when they see they will be receiving a higher value in a convenient package.
With dynamic pricing, menu item price will vary with the demand. Dynamic pricing involves adjusting prices based on demand, time of day or other factors. For example, restaurants may offer higher prices during peak hours or charge premium prices for special events or holidays.
The restaurant pricing strategy for any given restaurant will depend on many factors such as : target audience, geographic area, competition, brand positioning and overall objectives. Many restaurants can also end up using a combination of strategies or customize any given strategy to their restaurant’s unique needs.
What to consider in your restaurant menu pricing strategy
Unfortunately, you can’t set prices on ideal food cost percentage and gross profit margin alone. Here are six other factors to take into account while setting menu prices.
- Prime costs
- Market tendencies
- Menu design
Your restaurant doesn’t operate in a vacuum, so you have to consider your competition when setting menu prices. What do similar restaurants in your area charge for their dishes?
It’s difficult to get away with charging much more than what others in your area charge because the competition’s pricing of food sets an anchor for what you can charge.
If after doing calculations you realize that you have to charge much more than your competition for items, look for ways to differentiate yourself so that you don’t seem like competition. Highlight the quality of ingredients or local sourcing, for example.
2. Prime costs
Ideal food cost percentage and gross profit margins take prime costs into consideration. Prime costs combine the costs of goods sold with the cost of labor.
If you price your menu items within the ideal ranges, but find that you can’t pay the bills, consider repricing at higher or lower ends of those ideal percentages in order to encompass all of your expenses: labor, rent, utilities, etc.
Your menu prices must be balanced. This means that you shouldn’t have $4 sandwiches on the menu alongside $20 salads.
Yes, premium ingredients will cost more, but if you charge much more for a premium ingredient and give the lesser ingredients away for much less, it devalues the whole business model. Make sure prices are similar for similar items.
You can balance this out by upcharging for add-ons like Chipotle does for guacamole.
4. Market tendencies
Some goods are premium items that you can get away with charging a lot more for them, even if they don’t cost you a lot to make.
For example, avocado toast is a trendy food item that many restaurants charge upwards of $15 for, even if they cost less than $2 to make. Study food trends and see if any of them fit your concept.
5. Menu design
Menu design plays an important role in how much you can charge for items. You can charge more for items depending on how you engineer your menu.
Follow these menu engineering principles, grouping menu items into plowhorses, stars, duds and puzzles. That’ll help you know which items you should feature prominently on your menu and which items should be obscured on your menu or eliminated altogether.
Final thoughts on restaurant pricing strategy
Being business savvy is an important part of running a financially viable restaurant. Rather than guessing how much you should charge for items, or just basing it on what your competition is charging, you need to look at your menu costs and margins in order to make data-driven pricing decisions.
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