Contribution Margin Magic in Menu Engineering Analysis

Ever heard of Contribution Margin?

Are all best sellers or popular menu items in a restaurant also profitable?

If you had not asked this question for your restaurant, you have just lost an opportunity.

An opportunity to leverage the power of menu engineering analysis to achieve highest restaurant profit.

You would want that wouldn't you?

I will show you in this blog post ways to discover which popular menu items are also profitable.

So that you can maximize your restaurant profit margins consistently.

Sound good?

Let's dive in.

This Blog Post will cover:

This is Part 2 of the 2 part blog post series on restaurant menu engineering analysis. Click below for Part 1 if you missed it for a better understanding of this Part 2.

Menu Item Revenue and Contribution Margin

Menu Item Mix in Menu Engineering Analysis

Here are some typical ways, menu items feature in restaurants as part of a Menu Item Mix.

Buffet [for this blog post we will assume that all menu items are a la carte]

For an in depth look at how buffet operates in a restaurant, read this blog post I have written on restaurant profit.

A la Carte

Your Menu Item Mix is a key element of achieving highest restaurant revenue and profit.

Your Menu Item Mix is the combination of different items or categories of your menu that contribute to your food and beverage revenue.

Your Menu Item Mix may have the following combinations:

• Food and Beverage (separately and together)
• Buffet and A la Carte - Breakfast, Lunch and Dinner [Refer to blog post on restaurant profit margin]
• Individual and Group [Refer to blog post on restaurant profit margin].

Food

The simplest example of a menu item mix will be different combinations of menu items which relate to just food.

These could be:

• salad,
• soup,
• entree,
• dessert

as items of food.

Beverage

Similar to the Food menu item mix, the Beverage menu item mix will be the different combinations of menu items which relate to just beverage.

Beverage could be:

• soft drinks,
• juices,
• wines,
• spirts and so forth.

Food and Beverage

The most common combination of a Menu Item Mix in a food and beverage operation is that of food menu items and beverage menu items.

For example, a soup, entree, dessert (food items) and a drink (beverage item).

Why is this combination important?

Food Revenue normally accounts for 75% or more of the Food and Beverage Revenue in your restaurant.

It could be 75% in your restaurant and say 85% in another.

If Food Revenue accounted for 75% of Food and Beverage Revenue, then Beverage Revenue accounts for the balance 25%.

Did you notice that Food Revenue can thus be 3 times that of Beverage Revenue?

In other words, selling one Food Menu item is like selling 3 Beverage Menu items!

So, why don’t we just sell Food items?

Good question.

The answer to that will be discussed in detail in another blog post on profit flow through.

Contribution Margin and Food & Beverage Menu Items

For the moment, know that:

• not only are beverage costs lower than that of food
• but it also makes sense to sell BOTH Food and Beverage items in your Menu Item Mix.

Why does it make sense to sell BOTH Food and Beverage items in your Menu Item Mix?

This is because of an important principle that operates in the hotel as well as restaurant business.

It applies in different degrees to all other businesses too.

This principle is known as the Contribution Margin.

Cost Point

As said earlier, Menu Item Mix is not just the quantity and price elements of the revenue.

The real power of the Menu Item Mix is:

• when, apart from the Sales Quantity and Price (which become Sales or Revenue in dollar terms),
• we bring in costs and contribution margin too.

We will look at an illustration shortly to show significance of contribution margin.

This will emphasize that a Menu Item Mix is not just revenue.

That costs and contribution margin play a big part too.

Contribution Margin Magic in Menu Engineering Analysis

Contribution Margin is a powerful principle that will allow you to focus on and optimize restaurant profit.

What is Contribution Margin?

Calculation

Contribution Margin is simply Food & Beverage Revenue minus (-) Variable Costs.

Contribution Margin is based on the following principle:

How much of contribution does a menu item revenue make to the total Profit?

In other words, if a menu item contributes to $100 of revenue, how much of that $100 would translate to profit?

It recognizes that to earn revenue, two types of expenses will be incurred:

• fixed expenses and
• variable expenses

However, a change in revenue or sales quantity will normally only affect the variable costs.

What do we mean by that?

We mean that when sales quantity and/or revenue changes, only expenses which are related to earning that revenue will also change.

For example, if you remember, in Part 1 of this 2 part blog post series, we discussed how as soon as a menu item is prepared and served to a customer, the restaurant incurs food cost.

That food cost in the variable expense we are talking about.

Fixed expenses remain unchanged irrespective of sales or revenue quantities.

Let us illustrate this with an example:

Example

Type of Restaurant: 24 Hour All Day Dining / Coffee ShopRestaurant

Seat Capacity: 200

Table Turnover: (February 2021) - 3 times turnover [Refer to the blog post on restaurant profit margin for an explanation of Table Turnover]

Table Turnover: (March 2021) 5 times turnover

Average Check: $25 (February & March 2021)

Service Charge: NIL

Variable Expenses Per Cover: $2.50

FNB Revenue will be calculate as follows from the above:

200 [Seat Capacity] x 3 [Table Turnover] x 28 [No of days in Feb]) x 25 [Average Check] = $420,000

In the above example, Contribution Margin will be calculated as:

February 2021

200 x 3 x 28 x $25 = $420,000 FNB Revenue

Variable Expenses: 200 x 3 x 28 x $2.5 [Variable Expenses per Cover] = $42,000

Contribution Margin = FNB Revenue - Variable Costs so,

$420,000 - $42,000 = $378,000

March 2021

200 x 5 x 28 x $25 = $775,000 FNB Revenue

Variable Expenses: 200 x 5 x 28 x $2.5 [Variable Expenses per Cover] = $70,000

Contribution Margin = FNB Revenue - Variable Costs so,

$775,000 - $70,000 = $705,000

Increase in FNB Revenue Feb Vs Mar 2021 - $355,000 [85% Increase in FNB Revenue]

Increase in Contribution Margin Feb Vs Mar 2021 - $327,000 [87% Increase in Contribution Margin]

Notice how the Contribution Margin in Mar 21 has jumped by 87% when revenue has gone up by 85%.

That is mainly due to the higher Table Turnover [5 Vs 3] in Mar 21 compared to February 21.

If you wish to enhance the Contribution Margin in your restaurant, boost Table Turnover!

Did you also notice also that Variable Expenses per Cover were the same in Feb and Mar 21.

This is normally the case.

Variable Expenses per Cover remain constant (mostly) while Variable Expenses themselves change all the time.

Let us look at a Flow Chart of Steps.

On How to Use Contribution Margin in a Menu Item Mix to Achieve Highest Restaurant Profit.

Leveraging Contribution Margin - a Flow Chart of Steps

STEP 1: Start with Revenue

STEP 2: Find out Revenue Contributors

Revenue Contributors are Covers and Average Check

STEP 3: Determine how Covers and Check move with the Menu Item Mix

STEP 4: Analyze information over this period versus previous period

STEP 5: Detect patterns, trends in both Covers and Average Check

STEP 6: Re-align Menu Items Mix to those that contribute to higher profit

STEP 7: Optimize Menu Item Mix [Go back to Part 1 of this blog post series and watch the video on how to do this - Boost, Review and Replace Strategies]]

As you saw from the above illustration, contribution margin is critical to the path of highest revenue and profit.

However it all begins with a solid menu engineering analysis.

Do you know the best sellers from the laggards in your restaurant menu items?

That is the first question you need to ask yourself.

Revisit Part 1 of this blog post to understand how (if you missed that post).

Next, it is critical that you use the menu engineering analysis process to manage two elements:

• menu item popularity and
• menu item profitability

And now let us move on to some specific measures which will tell you whether your contribution margin strategy is working or not.

Contribution Margin and Key Performance Indicators You Must Watch

In this application of menu engineering analysis magic, you will take a close look at some of the powerful triggers to restaurant profit.

These are your Key Performance Indicators (KPIs).

These KPIs allow you to measure and monitor your performance and course correct where necessary.

They show you how your Contribution Margin is performing and how to tweak that to achieve highest profit.

You could say that KPIs empower you to attack the cause of any performance strength or shortcoming and then address them for optimum effect.

Let us deal with these KPIs one by one.

REVENUE PER SEAT

Revenue is the starting point for any business activity which wants to earn profit.

Revenue generation happens when you use assets in the operation.

The single most critical asset in a restaurant operation is the Seating Capacity.

Restaurant outlets are divided into sections, sections consist of tables and tables have seats.

It is the total of these seats that goes by the term Seating Capacity.

Seating Capacity is the maximum number of guests who can be seated at any one time.

It is the highest level of revenue capacity.

If a restaurant outlet has a seating capacity of 200, it thus has a maximum point.

Thus the calculation for Seating Capacity is:

Maximum Number of Seats in a Restaurant Outlet

COVERS SERVED

An empty seat in a restaurant adds nothing to the revenue.

So, knowing the capacity of seats in a restaurant is important.

However, it is only when a guest is seated and is served, that a revenue process starts.

Covers served however are a bit more complex than just having a seat.

It is normally the responsibility of the manager to determine and define what a cover served is.

For example, if you serve coffee to a guest, is that a cover served?

What about when 5 guests at a table order 7 different menu items or categories (soup, salad, entree, dessert, beverage and so forth)?

These are critical questions that need to be answered before a standardized definition of a Cover Served can be arrived at.

This is because getting this wrong would distort the average check calculation (see later in this section).

Covers served can be considered the quantity element of the revenue generation process, the other part is the Average Check.

You learned this briefly in Part 1 of this 2 part blog post series.

Thus the calculation for Covers Served is:

Standardized (per management definition) unit of a menu item served in a Restaurant Outlet

AVERAGE CHECK

Even once a cover is served, revenue will not follow unless there is a price attached to the menu item served.

Price when averaged out among all the covers served will become what is known as Average Check.

Just like different menu items and item categories have different prices, when all these prices are applied to quantities in which they are served (covers served), you arrive at revenue.

Thus the calculation for Average Check is:

Average of all the prices of different menu items served to guests.

However, the above calculation becomes clear when we apply the revenue formula which is:

Covers Served X Average Check = Food and Beverage Revenue

Pricing is at the heart of revenue generation.

Price of a menu item must be set carefully after considering direct expenses of preparation of food and a profit margin.

This is technically the way an item should be priced.

However, often it will become necessary to make the price more competitive.

To do this price may barely include a profit margin.

The real power of the pricing strategy is realized when a menu item is of such value to the guest that they demand it again and again which results in more covers served.

It is a misconception to think that we can price a menu item whichever way we think and the guest will buy it.

First comes value perceived by the guest and then only profit will follow.

The above formula can also be stated as below:

Food and beverage Revenue / Covers Served = Average Check

In the above formula if we now bring in Seating Capacity, you can see that Covers Served has an upper limit - number of seats in the restaurant at any one time.

Given this limitation, it is even more important that the pricing is right.

Two related KPIs to the above are:

• Table Turnover and
• Meal Period Analysis

Both address the limitation of seating capacity to a great extent.

Table Turnover Ratio is a simple ratio which measures the number of times a table in a restaurant is turned over during a particular meal period.

In effect, how many number of times the same table in a restaurant is sold.

Obviously a high turnover ratio means higher incremental revenue for the restaurant.

Meal period analysis requires accurate identification of specific meal periods that are applicable to each of a hotel or resort’s restaurant outlets.

Generically, the standard meal periods for a city hotel are breakfast, lunch, snack, dinner, supper although this is more applicable to a Coffee Shop.

Read the blog post on restaurant profit margin to know more about meal periods.

REVENUE PER SEAT AVAILABLE

Earlier, you learned about Seating Capacity in a restaurant outlet.

You learned that there is an upper limit to the number of covers that can be served within meal period because of the number of seats available.

You also saw how table turnover allows you to measure how many times you have used a table to sell during a meal period.

But the key measure for a restaurant outlet as far as utilization of capacity is concerned is Revenue Per Seat Available.

The calculation for this is:

Total Food & Beverage Revenues / Seating Capacity

This ratio will also indirectly tell you how many times a seat has been used for earning revenue.

It is a powerful KPI.

REVENUE PER SQUARE FOOT

Often a question arises whether a food and beverage facility (more particularly banquet function space) can earn more revenues by treating it as real estate space and renting or leading it out.

This is compared to holding events and earn food and beverage revenue.

Even if that strategy is not actually pursued, there is a KPI that measures what revenues you earn currently from your banquet function rooms by holding events.

That is Revenue Per Square Foot.

The calculation is:

Total Banquet FOOD AND BEVERAGE Revenue / Total square Foot of Space of Function Rooms

The above KPI can then be compared to the rentals that you may get by leading it renting that space.

Of course, costs of renovating and preparing the space for such leading and so forth also need to be considered in the comparison.

Many times this comparison leads to a rethink of the function room space and it's earning capacity.

However, it must be remembered that if the banquet function room space is part of a hotel's key facility offerings, it may have to remain that way.

REVENUE / PAYROLL COSTS PER EMPLOYEE

The above two KPIs are often used together to determine how much of a gap exists between revenue earned by and cost of payroll for an employee.

These two KPIs will give an indication whether you are over staffed, your payroll costs are too high (or too low as well) and whether productivity levels are good.

It is a generalized KPI and must be used with care.

Employees cannot be hired or fired just based on this KPI.

So, there you are.

An end to end solution beginning from the menu engineering analysis and ending with higher contribution margin and profit.

This is Part 2 of the 2 part blog post series on restaurant menu engineering analysis. Click for Part 1 if you missed it for a better understanding of this Part 2.

Want to experience for yourself how a Menu Engineering Analysis works for a restaurant?

DOWNLOAD the Microsoft Excel Worksheet with:

• Scenarios,
• Strategies and
• Tips

on how to conduct a powerful Menu Engineering Analysis.

With real menu items, prices, costs and profitability measurement.

Action Steps You Can Take Right Now

As you saw from the illustration, contribution margin is critical to the path of highest revenue and profit.

However it all begins with a solid menu engineering analysis.

Here are the steps you can take right now for your restaurant.

STEP 1: Start with Revenue

STEP 2: Find out Revenue Contributors

Revenue Contributors are Covers and Average Check

STEP 3: Determine how Covers and Check move with the Menu Item Mix

STEP 4: Analyze information over this period versus previous period

STEP 5: Detect patterns, trends in both Covers and Average Check

STEP 6: Re-align Menu Items Mix to those that contribute to higher profit

STEP 7: Optimize Menu Item Mix [Go back to Part 1 of this blog post series and watch the video on how to do this - Boost, Review and Replace Strategies]]

Your Key Takeaways

So, what did you think of Contribution Margin?

Are you utilizing its power and magic in your restaurant?

What are your strategies on achieving highest restaurant profit?

Leave your comments below. I will be keen on knowing your thoughts

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