Summary
Most restaurant companies do not have the right information to make smart pricing decisions. They need to understand the price sensitivity of every item on the menu. This involves using behavioral research more than the attitudinal research that most restaurant companies favor.
Analysis
There has been a lot of ink spilled recently on how to stay competitive in today’s tough economic environment. Most of the discussion is around controlling rising commodity prices and increasing traffic counts. We believe that controlling commodity costs to be nothing more than semantics, while increasing traffic counts is a viable revenue generating strategy. However, it leaves out the pricing side of the revenue equation which we think needs to be more professionally managed in today’s restaurant companies. When it comes to menu pricing, most restaurant companies show up to the gunfight with a knife.
First, here’s why we think controlling commodity costs is just semantics. A commodity is, by definition, a product that is only differentiated by price. Since there is no other differentiating factors, commodity prices settle into a “market price.” There is no “controlling” a market cost. You may be able to get certain volume discounts, but any other buyer with the same volume will get the same price. You can pass off the risk of fluctuating prices to your supplier or a third-party vendor, but they will need to be compensated for accepting that risk. You can take out the risk, but you cannot lower the cost below the market rate.
Let’s now talk revenue. For any business that sells a product, revenue equals the average price of the item sold times the number of items sold. Revenue equals price times quantity. In most restaurant companies, Marketing is responsible for quantity. This means guest counts. Your guest count is the product of the size of your audience times the average frequency of visitation. Those are two of the “levers” of restaurant revenue. You can increase the size of your guest base or you can increase the average frequency of visitation. Both are relatively expensive to do.
On the price side of the equation, you have the price per item charged multiplied by the number if items sold per guest. In good economic times, you should be working on selling more items per guest. This is one form of upselling. These are not good economic times. We are advising our clients to take a hard look at price per item. Here’s why: Not all menu items have the same price elasticity. For example, a hamburger might have a high price elasticity, meaning a 10% increase in price might lead to a greater than 20% decrease in hamburger revenue. A chicken sandwich might have a low price elasticity, meaning a 10% increase in price might only lead to a 5% decrease in revenue. Thus taking an equal price increase on the hamburger is going to lead to greater trades on your menu than would increasing price on the chicken.
Once you know the elasticities of every item on your menu, you would want to know the cross-elasticities of each product. That means if you raise prices on hamburgers and you sell less of them, what are you selling more of? If you sell more BBQ sandwiches, then you would want to increase the price on hamburgers only if you make more money on BBQ sandwiches. If you make less on BBQ sandwiches, then you wouldn’t want to take price on the hamburger.
The techniques for getting this type of information exists, however few restaurant companies take advantage of it. The time is now for professionally managing your revenue.
