Restaurant Profit Margin-6 Secrets Nobody told you
Do you know why Restaurant Contribution Margin is superior to Restaurant Profit Margin?
Two business concepts often confused with one another are Restaurant Contribution Margin and Restaurant Profit Margin.
If you mistook one for the other, the result could well be decrease in overall restaurant profit.
So, how to increase restaurant profit margin?
In this blog post, we unearth six secrets of achieving incremental restaurant profit margins.
- Secret 1 - The Sales Mix
- Secret 2 - The Seat Capacity
- Secret 3 - The Buffet
- Secret 4 - Table Turnover Ratio
- Secret 5 - Restaurant Contribution Margin
- Secret 6 - Meal Period Analysis
Let us dive into the first secret right away.
SECRET 1: SALES MIX
The first secret of incremental restaurant profit is the Sales Mix.
What is that you ask?
Restaurant Sales Mix is the foundation on which restaurant revenue is generated.
Profit concepts between a hotel and a restaurant are broadly similar. However, they are not the same.
A restaurant’s profit margin model is different from a hotel’s.
The former has to deal with higher direct variable costs per unit than the latter.
The foundation of restaurant profitability can be found in its Sales Mix.
The foundation of restaurant profitability can be found in its Sales Mix.
What is a Sales Mix?
A Sales Mix is the combination of products and services that a restaurant offers.
Note the word “combination.”
It is not simply the total number of menu items that are on offer.
It is how each menu item combines with others that is key.
So, what is the difference between total number of menu items and combination of menu items?
I will explain this shortly.
However, before that, let us note similarity between the hotel (predominantly rooms department) and restaurant profit models.
Hotel room revenue is generated on the foundation of market segments while restaurants depend on sales mix for their revenue.
In fact, in one department of food and beverage revenue, market segments play an important role.
Sales Mix is not merely the foundation of revenue generation but is also the fulcrum for restaurant profit.
In later parts of this blog post, we will examine how a restaurant profit margin is significantly influenced by a well thought out sales mix.
This should be in sync with customer expectations and tastes as well.
Restaurant Sales Mix
So, what are the components of a restaurant Sales Mix?
There are three components – Menu item Mix, Meal Period Mix and Market Segments.
Menu Item Mix is the foundational component considering that a restaurant’s primary offering is about menu items.
You could say that the menu item is the smallest product offered.
This mix is about how many different combination of menu items that is on offer within a food and beverage category.
Meal Period Mix, while still dealing with menu items per se (other than the concept of buffet), categorizes menu items based on different meal periods in a day.
The most popular meal periods are breakfast, lunch, afternoon tea, dinner and supper.
Each meal period is at a different time of the day.
The third major component of Market Segments is mainly related to the Banquet or Catering function of a restaurant.
It targets the profile of a catering customer into market segments like local group, local individual and so on.
A restaurant may or may not have this component.
The primary purpose of the components of the Sales Mix is to classify menu items (the smallest offering) into various customer target profiles and use those profiles to tailor offerings.
The profile of a customer coming in for breakfast is often different from lunch or dinner.
Secret 2: SEAT CAPACITY
One of the most critical elements of a restaurant revenue generation strategy is the Seat Capacity of the restaurant.
Knowing the maximum number of seats in a restaurant is critical to keeping the restaurant full over different meal periods.
Knowing the maximum number of seats in a restaurant is critical to keeping the restaurant full over different meal periods.
Again, seat capacity plays a different part for each meal period.
More so if some of the meal periods have a buffet offering.
Buffets are fully discussed shortly in this post.
Seat Capacity plays a huge part in a restaurant profit margin.
It plays as important a part as Rooms Available for the profitability of the rooms department.
The current volume of covers served by a restaurant is always compared with the Seat Capacity.
At the time of designing and conceptualizing the restaurant and the seat capacity, it is important that demand estimates be accurate.
It may mean the difference between a largely empty restaurant (too high Seat Capacity) or one that is always full (too low Seat Capacity).
This has repercussions for the stakeholder return in investment.
Secret 3: THE BUFFET
The next secret is that of the powerful concept of a Buffet spread which is central to optimizing sales mix in a restaurant.
This is a popular approach adopted by hotel restaurants.
We will see how this approach boosts restaurant profit margin.
The Buffet Philosophy
No Restaurant Sales Mix analysis is complete without an analysis into whether menu items are a-la-carte dishes or a buffet spread.
A-La-Carte dishes are single menu items sold separately.
In a traditional menu list, each menu item priced separately is thus an a-la-carte menu item.
The most popular and common offerings of restaurants are individual menu items or a-la-carte items.
Hotel restaurants often offer a buffet spread apart from a-la-carte orders.
A buffet spread is a bundle offering which brings together the following generic menu items (also available a-la-carte):
- salad
- soup
- entree
- dessert
The above is a generic buffet composition for lunch or dinner.
There can be more items added to the above depending upon the selling strategy. But these can be considered basic.
Buffet Spread
Rationale for Buffet
Why are buffet spreads offered?
The most obvious reason for a buffet spread is ease of access to the customer or guest.
A guest can pick up any item on the buffet that they like.
Quick turnaround, visual attraction, more choices, unlimited quantity are other reasons.
A powerful phenomenon is at work in buffets relating to Restaurant Sales Mix.
Buffet Power in Restaurant Revenue
A buffet which is well conceived of and priced attractively is a major contributor of revenue in a Sales Mix.
A buffet which is well conceived of and priced attractively is a major contributor of revenue in a Sales Mix.
Let me give you an example of what this means.
ILLUSTRATION
Let us consider a Lunch Buffet in a All Day Dining Restaurant (Coffee Shop)
Items included are: salad, soup, entree, dessert.
Individual prices of a-la-carte items included in buffet:
- salad $3.50
- soup $4.50
- entree $11.75
- dessert $4.75
- Total of a la carte items (without taxes): $24.50
Now, assume that the buffet spread is priced at $20 (without taxes).
Let us list the advantages of this strategy:
- Saving - Most obvious one is the saving of $4.50 (this amounts to 18% discount based on a la carte total and more than 20% based on the buffet price)
- More Sales Quantity - Instead of selling the salad, soup, entree, dessert individually, in one shot, all items have been sold through a buffet offering. This has (as said before) powerful implications for the Sales Mix.
- Consumption - Not all guests who choose buffet spreads consume every part of the meal.
- Some may just have the entree and dessert or the soup, entree and dessert and similar combinations which do not include all the items. This has implications too.
- The most immediate effect is that revenue contributions are higher when a buffet is sold than when individual a-la-carte items are sold. Simply put, revenues are higher with buffets sold.
- Apart from this increased revenue, there is a strong impact on margins.
- Manning - With a buffet laid out, the restaurant outlet can operate with less number of service employees. This reduces payroll costs and boosts restaurant profit margin
- Breakages - With a buffet laid out, there is less movement in and out, of the operating equipment (plates, dishes, chinaware, glassware and so forth) between restaurant and the kitchen. This brings down breakage, increasing profit margin of the restaurant.
It is quite obvious that a Sales Mix that shows individual a-la-carte items sold (not all of them all the time) is less effective than a buffet sold.
As said before, the buffet works like a bundle.
Let us use the bundle metaphor in the related food processing industry.
The McDonald’s Meal Combo model
McDonald’s is a fast food outlet serving pre-portioned and processed food.
This is different from a hotel restaurant outlet (primarily the all day dining restaurant).
However, the Sales Mix principle involved in the Meal combos is similar to the buffet spreads offered in hotel restaurants.
By selling Fries and a Soft Drink bundled into a Meal combo with the entree that is the Burger, McDonald’s has successfully boosted revenue contribution by optimizing their Sales Mix.
Buffet Power and Contribution Margin
The increased revenue contribution from a buffet sales mix compared to individual a-la-carte items is clear from the above comparison.
But that is not the only benefit.
When the buffet is sold as a bundle, the additional variable costs for the revenue achieved are lower thereby increasing profit margins.
Buffet Power in Restaurant Profit Margin
The most powerful implication on Sales Mix of the buffet spread offering is that more buffets sold in a particular meal period result in a higher restaurant profit margin.
This is owing to a better contribution margin than when compared to individual items on a-la-carte basis.
Secret 4: TABLE TURNOVER RATIO
The next secret is a phenomenon that affects all parts of a restaurant revenue and profit strategy.
This is the concept of a table turnover ratio.
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.
A Table Turnover ratio is a great KPI (Key Performance Indicator) which is used extensively for restaurant revenue budgeting and forecasting.
WATCH this video for understanding the power of a Restaurant Table Turnover Ratio.
And now on to probably the most significant secret of incremental restaurant revenue and profit.
In this secret, we will look at how sales mix delivers incremental revenue and more importantly a sustainable restaurant profit margin through the phenomenon of Contribution Margin.
We will, along the way, address the pricing concept of average check and other profit related elements.
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Secret 5: RESTAURANT CONTRIBUTION MARGIN
Contribution Margin is a powerful principle that will allow you to optimize both hotel and restaurant profit.
What is Contribution Margin?
Contribution Margin is simply Revenue minus (-) Variable Costs.
Contribution Margin is based on the principle of: the extent of contribution a revenue item makes to total profit.
It recognizes that to earn revenue, both fixed and variable costs will be incurred.
However, a change in revenue or sales quantity will only affect the variable costs.
Fixed costs remain unchanged irrespective of sales or revenue quantities.
Let us illustrate this with an example:
ILLUSTRATION
Type of Restaurant: 24 Hour All Day Dining / Coffee Shop
Restaurant Seat Capacity: 200
Table Turnover: (February 2018) – 3 times turnover (Refer to Secret #4 on Table Turnover)
Turnover: (March 2018) 5 times turnover
Average Check: $25 (February & March 2018)
Service Charge: NIL
Variable Costs Per Cover: $2.50
FNB Revenue: (200 x 3 x 28) x 25 = $420,000
In the above example, the Contribution Margin will be calculated as:
February 2018
(200 x 3 x 28) x $25 = $420,000 F&B Revenue
Variable Costs: (200 x 3 x 28) x $2.5 = $42,000 Variable Costs
Contribution Margin = F&B Revenue – Variable Costs so,
$420,000 – $42,000 = $378,000
Contribution Margin
Food & Beverage Cover
Food and Beverage Cover is one of the two basic ingredients of revenues (the other is Average Check).
The Food and Beverage Cover can also be called the quantity element of revenues (the Average Check is called the price element).
The Food and Beverage Cover can also be called the quantity element of revenues (the Average Check is called the price element).
Food and Beverage Cover calculation is closely linked to guest patronage, number of guests consuming meal, number of meals being consumed and so forth.
In simple terms, it normally represents number of guests who have had a meal during a meal period.
So, you could say that number of guests is equal to number of covers.
There are some exceptions and some situations to be considered in the calculation.
Normally, it is the practice of every hotel or hotel group/chain to have their own definition of a Food and Beverage Cover.
All of them though follow the above principle in some way or other with some variation.
Remember the following formula:
Restaurant Revenue = Food & Beverage Covers X Food & Beverage Average Check
Average Check
The Average Check is one of the two basic ingredients of revenue (the other is Covers).
The Average Check can also be called the price element of revenue (the Covers are called the quantity element).
This is made clear by the following formula:
Restaurant Revenue = Food & Beverage Covers X Food & Beverage Average Check
What does the Average Check represent?
The Average Check represents the average of all the menu items of food and beverage that were sold during the period for which it is calculated.
In other words, all a la carte and buffet menu items over all meal periods and market segments are totaled in quantity (Covers).
They are then multiplied by the price (Average Check) to arrive at Food and Beverage Revenue.
The Average Check is influenced by the Sales Mix which has gone into the Food and Beverage Revenue.
On to the last secret which is significant in any restaurant revenue and profit strategy.
Secret 6: MEAL PERIOD ANALYSIS
Why is it critical to know and analyze meal periods?
There are two paths to restaurant revenue growth.
The first one is Table Turnover which we saw in Secret #4 of this post.
The second path is Meal Period Analysis.
This is closely related to the table turnover ratio seen in Secret #4.
In fact, we can go as far to say that the optimum path to restaurant revenue growth is a combination of both these factors.
But what then is meal period analysis?
It is a study of data and information on what contribution each meal period in a hotel or resort’s restaurant outlets is making.
It is a study of data and information on what contribution each meal period in a hotel or resort’s restaurant outlets is making.
This depends first on the type of outlet.
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 an All Day Dining Restaurant type (also called a Coffee Shop).
Having understood factors which affect table turnover and meal period analysis, how then are these considered powerful operationally as well as from a point of view of financial analysis tools?
How do these actually contribute to restaurant revenue growth?
As we saw earlier in the post, revenue contribution in restaurants is made by two key elements – food and beverage covers (number of guests) and the average food & beverage check.
These are also known as the quantity (or volume) and price contributions. The formula, if you remember is:
Restaurant Revenue = Food & Beverage Covers X Average Food & Beverage Check
When the above formula is applied for each meal period, they become the building blocks of a revenue estimate.
However, this revenue estimate is on the assumption that each guest or cover is based on a turnover of one.
If we are to assume different table turnover ratios for different restaurant types and meal periods, then we need to multiply the earlier revenue estimate with this ratio to arrive at the final revenue estimate.
For example, taking the earlier formula further:
Restaurant Revenue = Food & Beverage Covers X Table Turnover Ratio X Average Food & Beverage Check
An alternate way of calculating restaurant revenue is:
Restaurant Revenue = Restaurant Seating Capacity X Table Turnover Ratio X Average Food & Beverage Check.
One important aspect to remember in using Table Turnover ratio is that the ratio must be accurately applied.
When applied to full seating capacity, the factor will be less than when computed based on covers.
So, the approach is to estimate revenue assuming table turnover ratio is 1.
Then you multiply actual cover count (or seating capacity) with the table turnover factor (number of times a table is turned over) to arrive at the final estimate.
This is why table turnover and meal periods in tandem are such powerful elements of budgeting or forecasting restaurant revenue.
New Hotel Revenue Projection
Another area of financial analysis where table turnover and meal period are used together is for new hotel revenue projections.
This is done by actually applying table turnover ratio to the full capacity of the restaurant.
Moreover, table turnover can be generically used to determine other factors like manning requirements, supplies etc.,
Restaurant Contribution Margin vs Restaurant Profit Margin
In the beginning of this post, I asked a question:
Do you know why Restaurant Contribution Margin is superior to Restaurant Profit Margin?
Let me address that now.
Contribution Margin deducts only Variable Expenses from revenue for its calculation.
Restaurant Profit Margin deducts Total Expenses (both Variable and Fixed) from revenue for its calculation.
Why does that make Contribution Margin superior, you ask?
All in good time.
When a restaurant sales quantity (covers served) increases, it brings with it only Variable Expenses.
Fixed Expenses do not accompany it simply because they do not move with sales quantity movements.
In other words, incremental revenues because of increase in sales quantity only have Variable Expenses increasing.
Since, Contribution Margin deducts only Variable Expenses from revenue for its calculation, it is a reflection of how much profit is affected.
If you are looking for a metric that tells you how much bottom line is increasing or decreasing with movements in sales quantity, Contribution Margin is the way to go.
Departmental Profit, by deducting Total Expenses from revenue is not able to give you that one level deeper analysis of what is happening to profit when sales quantity is increasing or decreasing.
This is the reason why a Restaurant Contribution Margin is superior to Restaurant Profit Margin.
Strategies you can apply right now
Go back to your hotel or restaurant Income Statement.
See how Contribution Margin for a current period compares to the previous period. Compare with Restaurant Profit Margin.
Use the Table Turnover Ratio to find out how well you are utilizing the restaurant seat capacity asset.
Select meal periods where you think you can push up sales quantity to boost revenue and contribution margin.
Be aware of price resistance challenges when you embark on increasing prices.
As a general rule, price changes should only be made when actual and/or perceived value has become better for the customer.
When value (even perceived value) falls below price, you may lose the customer forever.
What is your strategy going forward?
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Your Takeaways
What were the takeaways for you from the blog post? And from the video?
Are you leveraging your Sales Mix in your restaurant to improve Contribution Margin?
What is your average restaurant profit margin?
What topics would you like to see as future blog posts?
Tell us in the comments section below.
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