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Managing the profitability game in restaurant business

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Revenues are the life blood of businesses and restaurants are no different. As the saying goes, if there is no top line (revenues) to speak of, it is highly likely that there will be no bottom line (profits) to delight in. Restaurants are inherently lower in their price points compared to say the accommodations industry (hotel guest rooms) and thus have to work harder to achieve their revenues. This, as we will see, is easier said than done.

Managing the profitability game in restaurant business
Restaurants are inherently lower in their price points compared to say the accommodations industry (hotel guest rooms) and thus have to work harder to achieve their revenues

As in any business too, revenues are a hybrid of seesawing prices and volume. A restaurant has to decide early on whether it will take the price approach or opt for volume. Truth be told, it will be a mix of both price and volume that will determine a restaurant’s revenues. But here I am talking about the strategic approach. Are you going to put up your prices because you have high value and demand menu items which you believe will command those kind of prices? Or will you drive volume? It is important to remember that a price leadership approach at some point of time will reach what is known in business as a price resistance point. This is when the perception of value from the menu item has gone below the level of price that the customer is willing to pay. This is a crucial point of time because of the connotations it has to value. Whatever price point you are aiming at, an erosion in value is a self-destructive situation to be in.

The Volume Game

The other side of the revenue see-saw is volume, that is business volume. This is the meal covers served in a restaurant. Volume always has an umbilical cord connection to capacity. By capacity, I mean the seating capacity of a restaurant outlet. Capacity is central to a stake holder’s point of view. They view restaurant seating capacity as their asset investment to be managed effectively. If a restaurant operates regularly on or around the half way to capacity mark (say daily food covers served are at 150 compared to its seating capacity of 300), stake holders consider that a waste of the other half of their investment in the restaurant. This reinforces the point that volume is very crucial in a restaurant revenue and profit performance.

Mastering Fixed and Variable Expense Behaviours

In our earlier discussion, we emphasized the importance of volume. Why is this? It is simply because a restaurant’s profit performance (given a certain level of revenues) will depend upon how well it manages the twin types of restaurant expense behaviour – fixed and variable. Fixed expenses are those which do not change with business volume. They are expenses which will be incurred even if no covers are served in a restaurant. This is one reason achieving a minimum business volume or covers served is critical in covering such fixed costs. Having covered fixed costs, variable costs are those that change with business volume. In other words, the higher the volume of business, the higher these variable costs. For example, the more covers served, the more operating supplies will be consumed. It is evident thus that restaurant profitability hinges on an efficient combination of fixed and variable expenses. As a general rule, fixed costs must not be high compared to the revenues achieved. This is linked to the powerful concept of break even.

The Unsung Heroes of the

One cannot talk about variable costs of a restaurant without a reference to the role a procurement function plays in the control of those costs. For example, food and beverage costs, which are one of the biggest type of variable costs of a restaurant, owe their efficiency a great deal to the procurement function. A focused procurement function will ensure well negotiated food and beverage prices helping the restaurant bottom line a great deal by reducing unit costs. I have always maintained that the procurement function is the unsung hero of the food service industry. Procurement professionals work silently behind the operation but their contribution is in no measure smaller than others. A powerful menu engineering process that is in place owes that power mainly to competitive prices broadly negotiated by the procurement function of the restaurant.

Squeezed Margins

Restaurants thus often work on squeezed margins. This is particularly true if you consider that food and beverage costs account for between 35 per cent and 40 per cent of revenues. Add to that labour costs, which can be anywhere between 25 per cent all the way to 40 per cent of revenues. This simply means that just these two items can account for 60 per cent to 80 per cent of restaurant revenues leaving squeezed margins. Under the circumstances it is paramount that a restaurant operates closer to its seating capacity. A higher break-even level (a result of lower business volume) means lower profitability, which results in poor return on the stake holder investment.

The Owner Take

So, is there a way out of what seems like daunting odds. Yes, indeed. A restaurant profitability is buoyed by strong volume performance (and edging closer to the seating capacity), combined with a value for money menu choice and a price to match that can mean covering fixed costs at a low level of volume operation and then leveraging variable costs to boost bottom line. If you get this right, your restaurant can achieve sustained revenue and profit performance, something that will make your owners smile all the way to the bank.