Setting prices is arguably the most complicated part of creating a menu and starting a business. If your menu prices are too high, you’ll drive customers to your competitors. If you price too low, you miss out on potential profit and can even end up operating at a loss. To get the price just right, you have to consider a myriad of factors, including the cost of ingredients, who your competitors are, and how much your customers are willing to spend. And because these factors are constantly evolving, it’s important to reassess your prices on a regular basis.
Cost-based pricing
To start, you need to know how much you intend to spend on each menu item’s ingredients, so calculating plate cost is an intuitive way to start. The plate cost is the amount you spend on raw ingredients to prepare an item, which is calculated by breaking down each ingredient to its unit cost, then multiplying that cost by the amount used in each serving. This process can get pretty tedious, but as long as you keep track of the recipe breakdown, it will be much easier to recalculate it every once in a while to figure out how the cost has changed.
Your ingredients are, of course, not the only expenses that need to be built into your menu prices; you also need to account for operating costs such as labor and rent. Those numbers are much more difficult to break down in terms of a single dish, so you will need to look more broadly at your profit-and-loss statements (P&L)—that is, you need to determine your average monthly spending, your average monthly sales, and your monthly profit goal in order to figure out your maximum allowable food cost percentage. This calculation determines the portion of revenue that you can spend on ingredients before you start eating into your profit margins.
Some experts in the industry estimate that food cost is typically 28-32% of sales, with fine-dining establishments on the lower end and value-oriented establishments on the higher end. Let’s say you’re selling a burger: The basic food cost would include the patty, bun, tomato, lettuce, gherkin, seasoning, sauces, and cooking oil. If this came to $1.86, and your food cost percentage is 32%, then you would divide 1.86 by 0.32 to get a cost of $5.81. This is the minimum you can charge if you want to hit your profit goal.
Competition-based pricing
Once you have that baseline, it’s useful to consider your competition. Gather a few burger prices in the neighborhood and draw out a range with the lowest price, the highest price, and the average price. On one side, you have a Big Mac that is selling at the local McDonalds for $5.29. On the other side, you have a wagyu burger from a classy steak restaurant that is selling for $26. When you factor in a few other restaurants in the neighborhood, you find that the average price for a burger is $12.
You don’t want to just pick a point along the spectrum; instead, you want to use these numbers to narrow down the range that appropriately matches the value you offer to your customers. If you are selling an experience as well as a quality burger, you can compete in the $12-26 range. If you just want to offer a great deal, you will probably have to pull the reins on your pricing a bit to prevent your thriftier clientele from ordering a Big Mac instead. Keep in mind, though, that customers often perceive higher prices as meaning better quality, so if the local Mickey D’s sells its burger for $5.29, you could even push your price up to $7 to signal that your burger is of higher quality.
In either case, you are going to have to check on the other burger-sellers on the block from time to time. If they bump up their prices, for example, you will have to decide if you want to maintain your price point in order to position yourself as the more affordable option or if you want to increase the price to prevent customers from seeing you as the cheaper option.
Value-based pricing
To really narrow it down, you need to paint a picture of your customer. How old is your clientele? Do they have disposable income to spend, or are they just trying to make ends meet? Do they have a variety of options for dinner or are they limited to what is available in a sleepy shopping center? The answers to these questions will help you determine not only what your customer can pay but also how much they are willing to pay.
You might notice when you travel that airport restaurants often have exorbitantly priced menus. Their unique location maintains a captive audience with few options, which in turn, means that hungry travelers will be much more willing to pay for an overpriced burger than they would if they had more options. That being said, there is an upper limit to this demand—even hungry travelers might pass on a $41 burger. They make that determination based on an unconscious judgment system called the perception of fairness.
However imprecise, the customer’s perception of price fairness is a significant determinant when your customer is deciding where to go for their next meal as well as when they are deciding whether to return to your establishment. “When we see a price difference, we tend to have that question of whether it’s better or not and whether we are able to justify the price difference,” says Chaoqun Chen, an assistant professor of marketing at the Cox School of Business. Customers may think that a $26 burger is fair if they are being served a sophisticated pinot noir alongside it, but they may gawk at the price of a $12 burger if they are picking it up at a counter and eating it under fluorescent lights. Keep this marketing strategy in mind when setting your menu prices.
To determine whether customers will perceive your prices as fair, think of how you would feel if you were the person scanning the menu—would you see the $15 price tag and think about how much money you would save if you just got the salad, or would you think it would be money well spent to take a bite out of the thick, cheese-smothered burger that just got delivered to your neighbor’s table? If you’re struggling to think objectively, ask your servers! Experienced servers are attuned to their customers’ preferences and will likely be able to tell you if the price is right.
Continual Price Optimization
After all that, you might think you've finished the job, but building a menu that is fairly priced is just the beginning. According to a survey of 96 businesses, those that continuously adjusted their prices over time were exponentially more successful than those that only reviewed their menu pricing on an annual basis.
If your food costs go up or the minimum wage increases, your prices may need to increase to reflect that. If the fish dish on the menu hasn’t sold as well and you have a glut in the fridge, consider lowering the price and push it as a special. And of course, if your competitors change their prices, you may want to do the same.