What Should That Burger Cost?
When we build a high impact pricing strategy for a restaurant business, the goal is to optimize overall long-term profitability. As I’ve written before, we find that a 2% effective change in pricing can influence EBITDA by 25%. This means optimizing your restaurant pricing can yield significant cash flow and valuation increases. The right pricing strategy increases overall returns by improving the complex interplay between guest count, menu design and ticket size so overall price goes up without hurting volume.
Plain vanilla price increases (increase every menu item by 5%) or cost-based pricing (e.g. cost of labor + 40%) don’t achieve long term returns restaurant investors are looking for. Instead, operators need to create a menu architecture that grows overall revenues without cannibalizing high margin items, while attracting new customers you wouldn’t get otherwise.
Four-Stage Strategic Pricing Process for Restaurants
In our restaurant pricing engagements we progress through a four-stage process:
Step 1: Measure price elasticity and develop a price optimization model. What items should be taken up? By how much?
Step 2: Assess the industry landscape. Changes in the Food Away From Home Index and overall industry and store-level market conditions.
Step 3: Benchmark against key competitors. How many competitors, at what value point, etc.
Step 4: Implement the new pricing strategy and measure success, feeding the results back into the model for further iteration.
Utilizing Data and Models to Achieve Optimal Restaurant Pricing
The restaurant industry is very rich in data, including POS, economic indicators, competitor benchmarks, customer surveys, loyalty programs, social media, etc. Loyalty data, including restaurant loyalty cards and mobile app purchasing data, is becoming a powerful source of pricing information. Average wages by store and geographic location, household income of the restaurant’s customers, nearby home values, drive-through customer demographics, etc. are all potential sources of insight as to whether there is price flexibility that can be exploited to generate higher returns.
Abundant data offers tremendous upside, but it takes expertise and the right pricing model to capture, aggregate and derive insights from the data. Most restaurants never achieve this on their own, because management is too busy running the business and lacks the right software and financial experts trained in econometrics and big data.
Below is an example of a pricing model we use with our clients to align their business and pricing strategy. This is one of the client-facing “KPI tree” views that shows the interrelationships between price, volume and profitability.
Many restaurants use a cost-based pricing approach more than they realize. When minimum wage goes up many restauranteurs resort to the peanut butter spread approach to pricing, applying a fixed percentage increase to all items then adjusting price points. Even worse, many do this all at one time rather than spread the increases out incrementally over time. This is essentially one level up from not having a pricing strategy at all. Simply tacking on a fixed percentage markup on top of server minimum wages and glasses of wine might increase top-line revenues, but it often drives down guest counts. This can negatively affect the restaurant’s long-term profitability.
A more sophisticated approach that captures multiple data sources and measures price vs. overall profitability is needed to drive restaurant value.
Essential Pricing Analyses for Restaurants
We’ve developed a series of analyses we consider essential for uncovering strategic pricing opportunities in the food service industry. These analyses have been battle-tested and perfected across hundreds of pricing engagements, including many well-known franchises and restaurant groups.
Value Map Analysis
The goal of the Value Map Analysis is to determine where a restaurant is “value advantaged” vs. “value disadvantaged”. This is achieved by benchmarking key price-to-value indicators of the subject restaurant versus the industry and competitors in the local market. Areas of value advantage can be pursued through increased pricing, whereas value disadvantages can be reflected in lower pricing or improving those areas of the business in other ways.
Menu Optimization Analysis
Menu Optimization is an iterative modeling exercise that analyzes price vs. volume effects of every item the restaurant offers. This uncovers direct price-volume relationships, as well as substitution effects and the effects of combinations and bundles. The goal is to understand the full impact of price and the interrelationships within the menu that drive profitability and optimum guest counts. This reveals where a restaurant should increase, decrease or maintain prices to drive maximum ROI.
Store Tiering Analysis
Multi-location restaurants should be priced differently according to the local conditions in which they operate. A Store Tiering analysis helps identify which restaurants should be priced differently (higher or lower) to maximize value across the group.
An important part of a Store Tiering analysis is the 4Cs (Customer, Competition, Costs, Conditions). These are the core areas we analyze at each restaurant unit, and across the whole system, to uncover pricing opportunities. We generally find less price sensitivity in stores where there are high volume counts (Customers), few nearby competitors (Competition), higher wages (Costs) and higher property values (Conditions).
We recently completed a 600-unit Store Tiering analysis which involved thousands of data points and millions of relationships. Part of this effort was analyzing the number of competitors for each restaurant location within 1000 feet and one mile with GPS and satellite mapping. We found that most locations with no competitors within 1000 feet could increase prices aggressively without losing volume (although this is affected by many other factors on a per-location basis). The Store Tiering analysis uncovered this one factor (among many other value points we uncovered) and was responsible for $3+ million in additional revenue.
Fair Price Think Twice
Whenever we undertake a pricing engagement we always conduct consumer research. This is done to complement the POS and industry data that is highly valuable but has some limitations.
Customer research helps us uncover key strategic price points (price thresholds) that the customer has with respect to different items in the menu. This is highly valuable and unique information that only customers can provide.
To do this we use a methodology called “Fair Price/Think Twice”. This approach helps identify pricing opportunities and threats. For example, we found with one client that the Fair Price Think Twice indicator showed there was ample opportunity to increase Burger prices but that they were already over a key threshold for Chicken. By fine tuning their pricing to respond to these opportunities the client was able to substantially grow profits.
A Key Restaurant Pricing Trend to Watch
The explosion of mobile app commerce offers new opportunities to restaurant investors and operators. No longer does a restaurant have to rely solely on foot / drive-through traffic, reservation counts and tables turned to generate profits.
Mobile apps not only extend the reach of your kitchen and brand, but collect a vast amount of data that can be leveraged to optimize price and ROI. This includes order data, price variability by time of day and/or demand, delivery fee pricing, loyalty rewards / discounts / special offers, geolocation data, and much more. This trend is certainly one to watch and we’ve seen strong yields from utilizing mobile data in our pricing strategy engagements.