I was talking with a potential client who works in the catering industry and I asked him how chefs costed their meals.  I was surprised when he replied that most chefs used a ‘one-third: one-third: one-third’ formula which was based on the ingredient costs of the dish.  So, if a burger’s ingredients cost £2.50, the menu price would be £7.50.

I was puzzled by this.  It was obvious that there was a wide range of class of restaurant; from fast food joints offering a basic meal for a couple of pounds through to fine dining three star restaurants.  Although there would be a variation in the cost of the ingredients between such premises, I doubted that the variation would allow all those premises to use a three to one ratio.  In particular, the ratio didn’t appear to appropriately cover the wide variation in fixed costs.  For example, the business rates for a prominent location in a city centre, as well as other property costs, would be far higher than a less prominent location in the suburbs.  Similarly, the salary of a highly qualified executive chef would be far higher than that of someone who operates a burger grill.

I did a bit of research and came across an article written for an American catering magazine which discussed restaurant costing and which provided examples of bad practice in the field of restaurant pricing.

First there was the restaurant who simply based their prices on those of a nearby competitor i.e. My competitor sells a pizza for $12 therefore I sell mine for £11.99.  This approach was not appropriate as there was no knowledge of the other businesses costs.  The assumption was that the business cost the same to run as its neighbour but that could be far from the truth.  It ignored factors such as the number of covers the restaurant could provide in an evening or the wastage rate experienced by that restaurant.  Surely a restaurateur would expect a certain percentage of the restaurants capacity not to be filled.

Restaurants are a service industry and said services have immediacy.  Once the service time has passed, the service can no longer be provided.  Such service industries should price their product in such a way that it accounts for quiet times when tables go unoccupied.

The second example was of a restaurant who priced their products based on the most expensive item on the plate i.e. a steak costs me $7 to cook and serve, therefore I add another $2 to cover the costs of vegetables and other items on the plate.  This calculation was criticised as without knowing the cost of every item on the plate, the true cost of producing the meal can never be known.  The business could be losing money hand over fist.

Finally there was the three to one costing method.  The article clearly stated that this was a common ‘rule of thumb’ in the catering sector but that it was deficient in two ways:

1. It led to  a target food cost that was an average and resulted in an unappealing pricing structure.  Some dishes would appear greatly over-priced whilst others would appear far too cheap.  It also prevented dishes being used as loss leaders.  Then there was the psychological element to pricing.  If other premises sold a burger for £1.50, and you were charging £3.50 for an equivalent product, there could be significant cognitive dissonance in the minds of consumers.
2. Not all restaurants are equal.  High volume, low-priced restaurants, such as McDonald’s, have a food cost which is a higher percentage of their total costs than fine dining ‘destination’ restaurants.

Then there is how marketers view price.  To marketing strategists price is not simply a source of income generation.  Prices are not simply a financial tool designed to generate income; they are an important element in the marketing mix which is used to attract target customer segments and to differentiate the business from its competitors.  If pricing goods and services was simply a matter of finance, there would only ever be a narrow range of prices in any market.

When looking at price calculation, marketers look beyond accountancy and look at the expectations of target customers.  Factors such as the indented marketing strategy, competition, ability to explain prices, the value to the customer and the price/quality relationship will be taken into account when calculating prices.

Tools such as Value Chain Analysis can be used to ascertain where customers see value in a businesses goods and services and budgets can be allocated accordingly.  For example, Heston Blumenthal may see great customer value in researching and developing novel cooking methods; Raymond Blanc may see value in sourcing the highest quality ingredients; whilst Gordon Ramsay looks for the most prominent restaurant locations and is therefore willing to invest in high rental properties.  Joe’s Café will probably look to buy ingredients at the best possible price.

When statistics are produced for business failure rates, catering businesses are usually highly ranked.  One survey I have seen shows the rate of catering business failure at 15% in any year; that’s three times the average of 5% in the economy as a whole.

Perhaps one reason that catering businesses are so likely to fail is their unscientific approach to costing their product and their ignorance of the use of pricing as an element of a marketing mix.