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**Cost Control and the Menu—Determining Selling Prices and Product Mix**

4 Controlling Foodservice Costs OH 4-1

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**Chapter Learning Objectives**

Determine a selling price based on various markup methods. Explain how market forces affect menu prices. Explain how the menu product mix is used to determine the composite food cost of a menu. Explain how the menu helps with food cost control. Instructor’s Notes Indicate that these objectives (competencies) drive the information in the chapter and in this session. Ask the following question, “How do restaurant managers decide the prices they charge for their menu items?”

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**Menu Prices If they are too high; Sales suffer If they are too low;**

Profits suffer Instructor’s Notes Explain that a properly priced menu will help maximize sales because guests will feel they are getting true value for their money, and it will maximize the restaurant’s profits as well.

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**Menu Prices Should Be directly related to costs**

Help predict profitability Serve as a cost control tool Reflect realistic markups (the difference between a menu item’s cost and selling price) Instructor’s Notes Explain that managers can predict profitability if they create a pro forma income statement. Tell how experienced managers develop sales predictions.

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**Pro Forma Income Statement as Budget Standard**

Instructor’s Notes Explain that cost of food sales is a very large and important restaurant expense. Ask if the students think managers want to know the specific performance targets that will be used to evaluate their work. Provide examples of food cost percentages that are common in different industry segments.

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Menu Pricing Methods The Texas Restaurant Association (TRA) markup method The factor method The markup on cost method Instructor’s Notes Explain that there are several approaches to address menu pricing. Indicate that the best method to solve a management problem varies, based on the specific characteristics of the restaurant.

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**The Texas Restaurant Association (TRA) Markup Method**

Step 1 – Add target percentage values for labor, all other expenses (except food), and profit. Example Labor .25 All other expense (except food) + .30 Profit .10 Total .65 Instructor’s Notes Explain that the TRA method uses a formula that considers sales, costs, and profit.

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**The Texas Restaurant Association (TRA) Markup Method continued**

Step 2 – Subtract the total in Step 1 from 1.00. Example 1.00 Total from Step 1 – 0.65 Divisor 0.35 Instructor’s Notes Explain that the “1.00” in this formula can also be seen as “one dollar,” and that the .35 in this case can be seen as “35 cents per dollar” of sales. Explain that the “.35” in this example is named the “divisor.”

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**The Texas Restaurant Association (TRA) Markup Method continued**

Step 3 – Divide the standard portion cost of the item by the divisor to obtain the menu selling price. Menu item standard portion cost ÷ Divisor = Menu selling price $ ÷ $11.71 Instructor’s Notes Explain that this formula allows for easy changes to profit targets (increases or decreases in desired profit levels). Explain that this formula allows operators to vary the labor percentage assigned to a menu item.

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**The Texas Restaurant Association (TRA) Markup Method continued**

The Texas Restaurant Association’s menu pricing formula considers labor costs when determining selling prices. Instructor’s Notes Ask students to identify menu items with very high labor costs. Examples—entrees with complex sauces, some soups and salads, and labor-intensive specialty desserts. Explain that most restaurants round their menu prices because they do not like odd-cent prices.

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The Factor Method Determines menu prices based upon the standard (target) food cost percentage Involves a two-step process Instructor’s Notes Remind students that the standard or target food cost is established by management. Ask the following question, “If the target food cost for a restaurant rarely changes, why must managers continually recompute menu selling prices?” Answer: Because menu item food costs change frequently.

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**The Factor Method continued**

Step 1 – Calculate the appropriate factor using the following formula. 1.00 ÷ Standard food cost percentage = Factor ÷ 2.86 Instructor’s Notes Point out that this example assumes a 35 percent target food cost percentage. Ask students to mentally compute the factors for the following target cost percentages: 50% = 2 33.3% = 3 25% = 4 Make the statement, “If you know the factor and the menu item’s cost, you are ready for Step 2”.

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**The Factor Method continued**

Step 2 – Calculate the menu price using the following formula. Factor x Menu item cost = Selling price x $4.10 $11.73 Instructor’s Notes Point out that this example uses the factor calculated in Step 1 and assumes a menu item food cost of $4.10. Explain that a shortcoming of this method is that it does not directly take into account the labor cost required to make the menu items.

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**The Markup on Cost Method**

Is popular Is easy to use To calculate menu prices, use the following formula. Instructor’s Notes Point out that this example assumes a menu item cost of $4.10 and a target food cost percentage of 35 percent. Explain that each of the three methods are mathematically the same, so any variation in results is from rounding error. Menu item cost ÷ Standard food cost percentage = Selling price $ ÷ $11.71

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**Market Forces Affect Selling Prices**

Menu prices can be affected by a variety of external forces, including Competition Price-value relationship Instructor’s Notes Explain that competition affects pricing, especially in the quick-service restaurant (QSR) market. Example—the competition for $0.99 or $1.00 value-meal offerings popular with QSR restaurants. Explain that price-value perception is driven by service levels as well as food cost and quality.

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**Markups Affect Selling Prices**

Different menu items are typically marked up by different amounts. In general, the lower the menu item cost, the higher the markup (and the lower the food cost percentage). Instructor’s Notes Indicate that a cup of tea can be made for pennies, but is sold at a multiple of its cost that is very high (five to twenty times). Explain that, in some restaurants, steaks may not even be marked up two times their original cost.

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**Menu Product Mix Is Important**

Restaurants must achieve their standard (targeted) food cost percentage. If a restaurant exceeds its food cost standard, profits will likely decline. Menu items sell at a variety of cost percentages. Instructor’s Notes Explain that it is the guest choosing from alternative menu items, who significantly determines a restaurant’s weighted food cost percentage.

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**Menu Product Mix Is Important continued**

The average food cost percentage is determined by menu mix. Menu mix significantly determines a restaurant’s food cost percentage target. Instructor’s Notes Point out that it is the average food cost percentage that must meet the restaurant’s food cost percentage target. Ask students, “In what ways does the menu mix determine a restaurant’s food cost percentage target?”

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**Weighted Food Cost Percent**

Right way to determine weighted average unit cost Menu Item # Sold Unit Cost Total Cost Hamburger 20 $2.00 $40.00 Fries 5 $0.50 $2.50 Soda 10 $0.20 Total 35 $44.50 Instructor’s Notes Explain that, in this example, the weighted average cost of one menu item is $1.27. $44.50 ÷ 35 = $1.27

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**Weighted Food Cost Percent continued**

Wrong way to determine average unit cost Menu Item Unit Cost Hamburger $2.00 Fries $0.50 Soda $0.20 Total $2.75 Instructor’s Notes Explain that in this example the “unweighted” average cost of one menu item is $ 0.91. Make the following statement, “Weighted averages take into account how many of each item is sold, and unweighted averages do not consider the number of each item sold.” $2.75 ÷ 3 = $0.91

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Menu Product Mix It is not possible to add unweighted unit costs to determine average unit costs. It is not possible to add unweighted food cost percentages. A menu product mix spreadsheet helps determine the total (weighted) food cost percentage. Instructor’s Notes 1. Define “weighted” and “composite” food cost percentage.

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**Menu Product Mix Spreadsheet**

Lists the names of all menu items sold Lists the number of times each item has sold Identifies the unit item cost of each item Instructor’s Notes Explain that even those menu items that sell infrequently should be included on the spreadsheet.

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**Menu Product Mix Spreadsheet continued**

Lists each menu item’s selling price Identifies the total cost of each item (number sold x item cost) Lists the total sales achieved by each item (number sold x selling price) Instructor’s Notes Ask students to review Exhibits 4f and 4g on page 51 of the chapter. Explain that a spreadsheet program could be used to complete these computations. Tell students what they can do, or where they can go, to learn this important skill.

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**Menu Product Mix continued**

The items that guests select have a significant impact on a restaurant’s weighted food cost percentage. Instructor’s Notes Ask the following question, “Assume that a restaurant offered five items for sale, and each had a different food cost percentage. Assume also that 95% of the restaurant’s sales consisted of the sale of only one item. What impact would that have on the restaurant’s weighted food cost percentage?”

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**Menu Engineering Method of menu evaluation**

Considers contribution margin (selling price minus menu item food cost) Considers popularity (number of items sold) Instructor’s Notes Explain that menu engineering software exists to help with the calculations, but an understanding of the process is needed to analyze its results.

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**Monitoring Menu-Related Concerns**

Three factors must be considered and compared when analyzing food cost efficiency. Standard food cost percentage Weighted food cost percentage Actual food cost percentage Instructor’s Notes Make the following statement, “Understanding food cost really means understanding three distinct types of food costs. We will review them now.”

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**Monitoring Menu-Related Concerns continued**

Standard food cost percentage The expected food cost percentage based upon the approved operating budget or other benchmark. Calculation Total target food cost ÷ Total target food sales = Standard food cost percent Instructor’s Notes Explain that this is the food cost percentage identified earlier in the chapter for use in determining menu prices. It is the target food cost that the manager wishes to achieve.

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**Monitoring Menu-Related Concerns continued**

Weighted food cost percentage The percentage that results from the actual food sales Calculation Actual food cost for menu items sold ÷ Actual sales from menu items sold = Weighted food cost percent Instructor’s Notes Explain that this is the food cost percentage computed by using the menu product mix spreadsheet. It is heavily influenced by guests’ food choice selections.

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**Monitoring Menu-Related Concerns continued**

Actual food cost percentage Reported on the restaurant’s income statement Instructor’s Notes Remind students that a restaurant’s standard, weighted, and actual food cost percentages can be in-line and similar. However, differences in sales mixes between historic and actual guest choices along with product loss, waste, and theft typically result in some differences between these three food cost calculations.

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**Monitoring Menu Related Concerns continued**

Summary If the weighted percentage exceeds the standard percentage, take steps to manage sales activity. If the actual food cost percentage exceeds the weighted percentage, take steps to improve food controls. Instructor’s Notes Ask for examples of specific reasons why the actual food cost percentage might exceed that computed on a restaurant’s menu product mix spreadsheet. Answers—theft, inaccurate sales data, waste and loss, and nonreporting of sales.

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**How Would You Answer the Following Questions?**

A composite food cost percentage is a (weighted/unweighted) average. A menu product mix spreadsheet is designed to identify a restaurant’s composite food cost percentage. (True/False) The menu pricing method that considers target profit in its computation is the Factor method Markup on cost method Texas Restaurant Association (TRA) method Yield percent method Product mix has very little impact on the ability of a restaurant to achieve its standard food cost percentage. (True/False) Instructor’s Notes Answers Weighted True C False Note: indicate that the last part of this discussion will provide a review of definitions for the key terms used in the chapter.

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**Key Term Review Composite food cost percentage Factor method Markup**

Markup differentiation Markup on cost method Instructor’s Notes Composite food cost percentage—weighted average food cost percentage for all items sold; also called weighted food cost percentage Factor method—used to determine a menu item’s sales prices based simply on the basis of the standard food cost percentage Markup—the difference between the actual (food) cost of producing an item and its selling price listed on the menu Markup differentiation—relationship between cost of an item and its price after markup Markup on cost method—another method used to determine a menu item’s selling price based on the standard food cost percentage Note that there are additional key terms for this chapter.

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**Key Term Review continued**

Menu engineering Menu product mix Price-value relationship Pro forma income statement Texas Restaurant Association (TRA) markup method Instructor’s Notes Menu engineering—menu evaluation process that considers the contribution margin and popularity of each menu item Menu product mix—a detailed analysis that shows the quantities sold of each item, along with their selling prices and standard portion costs Price-value relationship—connection between the selling price of an item and its worth to the customer Pro forma income statement—income statement that is prepared before the fact Texas Restaurant Association (TRA) markup method—menu price calculation method that reflects the direct relationship between profit and selling price.

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**Chapter Learning Objectives— What Did You Learn?**

Determine a selling price based on various markup methods. Explain how market forces affect menu prices. Explain how the menu product mix is used to determine the composite food cost of a menu. Explain how the menu helps with food cost control. Instructor’s Notes Ask students to do a personal assessment of the extent to which they know the information or can perform the activity noted in each objective.

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