RMIT FOHO

CONTENT

1. INTRODUCTION.............................................................................................................2

2. PRICING METHODS......................................................................................................4
2.1 FACTORING METHOD.................................................................................................... 4
2.2 PRIME COST METHOD................................................................................................... 4
2.3 GROSS MARGIN METHOD.............................................................................................. 4
2.4 MARKET PRICE METHOD.............................................................................................. 5
2.5 VOLUME - RISKS – PROFIT METHOD.............................................................................5
3. EXERCISES......................................................................................................................5
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1. Introduction
The determination of menu prices in food and beverage
operations has traditionally been a rather unsophisticated
process. Often based on the restaurateur's gut feeling, prices
have been pulled out of the air rather than having been based on
knowledge of product costs and market acceptability. With the
exception of a few large food service and hotel chains, the
pricing process has been an impulsive and haphazard activity.

Of the five P's of the marketing mix (product, place, people,

promotion, and price), pricing is by far the easiest to change.
This facility has frequently led to erratic price changes in an
attempt to remedy a wide array of marketing and operational
problems unrelated to price.

All pricing criteria can be classified into three broad categories,

which we can refer to as the three "C's". They are:

Costs: all costs incurred in producing and serving the

product, including direct food cost and all overhead costs (rent,
taxes, maintenance, etc.) involved in running the restaurant.

Competition: the price of competing products in the market.

Customers: the price sensitivity of the target market.

Based upon the three points above, there is, at least

theoretically, a single optimum price, which will produce the
greatest amount of profit. This price is graphically depicted at
point A below. Point B is the amount of profit realised when the
product is sold at price A.

PROFIT B

A PRICE

If the product is sold at a price below A, it may generate more

revenue than at point A, but because of a lower profit margin on
each unit sold, total profit is less. At price above A, the profit
margins are increased but demand for the product decreases,
thus producing a lower total profit.
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This relationship between price and profit can be seen in the

following example. Consider a menu item, which has a total
product cost of € 10.-:

Menu price € 12.- € 15.- € 18.-

Product cost - € 10.- - € 10.- - € 10.-

Gross profit € 2.- € 5.- € 8.-

Number sold * 100 * 50 * 30

TOTAL PROFIT € 200.- € 250.- € 240.-

In the example above, it can be seen that profit is maximised at

a price of about € 15.-; that is the point that is represented as
point A on the previous graph.

It is important to realise that increasing revenue does not

necessarily mean increasing profit. In the example above, the
menu price of € 12.- produces the greatest revenue (€ 12.- *
1000 = € 1200.-).

However, at a price of € 15.-, greater profit is realised, even if

total revenue is less (€ 15.- * 50 = € 750.-). To further explain
this point, let us take an extreme example. If the proprietor of a
large steak house in a major city were to offer a 200-gram beef
filet for € 5.-, he might be able to fill his restaurant from
morning until night, seven days a week. It is obvious that
regardless of how much revenue he could generate, it would be
impossible to make a profit.
RMIT FOHO

2. Pricing methods
The pricing of menu items so as to maximise profit cannot be
based on mathematical calculations alone. Restaurant customers
are human beings with their own ideas, prejudices and
preconceptions concerning the value of menu items. Consumer
purchase behaviour is often illogical and ignores the absolute
value of a particular menu offering. An understanding of the
major psychological factors affecting customer price evaluation
can assist food service managers in maximising profits.

For all pricing methods, the logical starting point is the standard
portion cost. There are three types of methods:

 methods based essentially upon calculations according to

overall percentages applied to individual items

 methods based essentially upon how much the market is

willing to pay for a given item

 methods based upon how perishable the products are

Among these methods, five of them deserve a closer look.

2.1 Factoring method

The multiplying factor is obtained by dividing 100% (revenue)
by the food cost %. To set the sales price, each standard portion
cost is then multiplied by the factor obtained.

2.2 Prime cost method

The cost, therefore the sales price of each item takes into
account the direct labour cost to produce and serve the item.
This is added to the standard portion cost (prime cost) of the
item and to an even share of overheads and profit.
This share is calculated by dividing total overheads and profit
margin by the number of portions sold (past statements).

2.3 Gross margin method

A method designed to determine a specific amount of money
(gross margin) that is provided by each customer.
The overall food cost being deducted from the revenue, this
gross margin is then divided by the number of portions sold
(past statements).
RMIT FOHO

2.4 Market price method

The sales price is determined by a study showing how much the

guests are willing to pay for a given item.
Overall expenses and profit margin are divided by the total
number of portions sold (past statement). The result is then
deducted from the set price. The remaining amount being what
is available to purchase the ingredients (standard portion cost).

2.5 Volume - risks – profit method

A profit margin percentage is set according to how perishable

the product is. The more perishable and the higher the volume
of product purchased is, the higher the risk of wastage.
Therefore, a higher profit margin should be achieved to cover
this risk.

3. Exercises
Using the three methods explained above, calculate the sales
price of these two items:

Factoring Prime cost Gross margin

Beef tenderloin Wellington
Number of portions sold 2'000
Revenue 50'000.-
Cost of goods according to 140.-
standard recipe for 10 portions
Standard portion cost
Cost of labour to produce 10
portions: 11/2 hour at 36.- /hour
Prime cost
Salaries 30% (1/3 kitchen, 2/3
other)
Food cost 40%
Other variable costs 10%
Other fixed costs 10%
Profit margin 10%
Multiplier
Gross margin per portion sold
Sales price
RMIT FOHO

Factoring Prime cost Gross margin

Chicken liver pâté
Number of portions sold 2'000
Revenue 50'000.-
Cost of goods according to 22.50.-
standard recipe for 10 portions
Standard portion cost
Cost of labour to produce 10
portions: 20 minutes at
36.- /hour
Prime cost
Salaries 30% (1/3 kitchen, 2/3
other)
Food cost 40%
Other variable costs 10%
Other fixed costs 10%
Profit margin 10%
Multiplier
Gross margin per portion sold
Sales price

 Using the fourth method, determine how much money is

available for the standard portion cost if:

Beef tenderloin Wellington has a maximum market price

of 30.- per portion.

Chicken liver paté has a maximum market price of 7.50

per portion.

 Using the fifth method, determine the sales price if:

The profit margin of Beef tenderloin Wellington is set at

18% because of its high risk of waste.

The profit margin of chicken liver paté is set at 7%

because of its lower risk of waste.