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COST APPROACHES TO PRICING Prof. Dr. M. Selçuk Uslu Başkent Üniversitesi İİBF

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2 Mark Up Approaches To Pricing This method is one of the major methods used in pricing food and beverages. Mark up on cost covers all non product costs such as, labor, utilities, supplies, interest expense etc. This method is one of the major methods used in pricing food and beverages. Mark up on cost covers all non product costs such as, labor, utilities, supplies, interest expense etc. There are two versions of this method as ingredient mark up and prime ingredient mark up. There are two versions of this method as ingredient mark up and prime ingredient mark up.

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3 Four Steps in Ingredient Mark Up Approach 1) Determine the ingredient costs, 2) Determine the multiple to use in marking up the ingredient costs, 3) Multiply the ingredient costs by the multiple to get the desired price, 4) Determine whether the price seems reasonable based on the market.

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4 EXAMPLE: CHICKEN DINNER AND COSTS EXAMPLE: CHICKEN DINNER AND COSTS 1 Ingredient Cost ($) Chicken 2 pieces.59 Baked potato.19 Roll and butter.09 Vegetable.15 Salad with dressing.18 Coffee refills free.12 Total cost 1.32

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5 DETERMINATION OF MULTIPLE: Assume that the desired food cost percentage in the restaurant is 40%. In this case the multiple would be: Assume that the desired food cost percentage in the restaurant is 40%. In this case the multiple would be: 1 /.40 : 2.5, than the price of the chicken meal would be: 1 /.40 : 2.5, than the price of the chicken meal would be: 1.32 * 2.5: $3.3

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6 PRIME INGREDIENT APPROACH: This approach is similar to the ingredient mark up approach. Only difference is that the prime ingredient (chicken) is multiplied with the desired multiple. Assume that the desired multiple is 5.8. The price of the chicken meal would be: This approach is similar to the ingredient mark up approach. Only difference is that the prime ingredient (chicken) is multiplied with the desired multiple. Assume that the desired multiple is 5.8. The price of the chicken meal would be:.59 * 5.8 : $3.42

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7 PRICING ROOMS $1 per $1000 aproach: $1 per $1000 aproach: The above mentioned approach sets the price of a room at $1 for each $1000 of project cost per room. For example if the project cost of a room is $80000 then the price of the room wil be: $80000/$1000: $80 The above mentioned approach sets the price of a room at $1 for each $1000 of project cost per room. For example if the project cost of a room is $80000 then the price of the room wil be: $80000/$1000: $80

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8 Hubbart Formula in room pricing: 8 steps involved in Hubbart Formula: 8 steps involved in Hubbart Formula: 1. Calculate the desired profit by multiplying the desired rate of return (ROI) by the owners investment. 2. Calculate pretax profits by dividing desired profit (step 1) by 1 minus tax rate. 3. Calculate fixed charges and management fees. (depreciation, interest expense, property taxes,insurance, amortization,rent and management fees). 4. Calculate undistributed operating expenses. (administartive and general, data processing, human resources,transportation,marketing, property operation and maintenance, and energy costs. 5. Estimate non room operated income or losses. That is food & beverage, telephone, etc. income.

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9 Continued: 6. Calculate the required rooms department income. That is, step 2 + step 3 + step 4 + step Determine the rooms department revenue. That is step 6 + rooms department direct expenses of payroll and related expenses + other direct expenses. 8. Calculate the average room rate by dividing step 7 by rooms expected to be sold.

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10 EXAMPLE: Kaynak: (Schmidgall, 1997) The Harkins Hotel, a 200 room hotel, is projected to cost $ inclusive of land, building, equipment and furniture. An additional $ is needed for working capital: The hotel is financed with a loan of $ at 12% annual interest with the owners providing cash of $ The owners required rate of return on their investment is 15% annually. A 75% occupancy is estimated; thus rooms will be sold during the year (200 *.75 * 365)The income tax rate is estimated 40%. The Harkins Hotel, a 200 room hotel, is projected to cost $ inclusive of land, building, equipment and furniture. An additional $ is needed for working capital: The hotel is financed with a loan of $ at 12% annual interest with the owners providing cash of $ The owners required rate of return on their investment is 15% annually. A 75% occupancy is estimated; thus rooms will be sold during the year (200 *.75 * 365)The income tax rate is estimated 40%.

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11 Estimated additional expenses: Property taxes $ Property taxes $ Insurance Insurance Depreciation Depreciation Administrative & general Administrative & general Information systems Information systems Human resources Human resources Transportation Transportation Marketing expense Marketing expense Property oper. & mainten Property oper. & mainten Utility costs Utility costs

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12 Estimated other operated departments income or losses: Food $ Food $ Beverage Beverage Telephone (50 000) Telephone (50 000) Rentals & other income Rentals & other income Rooms department direct expenses are $10 per room sold. Rooms department direct expenses are $10 per room sold.

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13 ÇÖZÜM: Desired net income ( *.15) $ Pretax income ( / ) Interest expense ( *.12) Income before interest & taxes Dep., prop. Taxes & ins Income after undistr. Oper. Exp Undistr. Oper. Exp Required oper. Depart. Income Less:Food income (90 000) Beverage income (60 000) Rentals & other income ( ) Plus: Telephone department loss Rooms department income Rooms depar. Direct exp. ( * 10) Rooms revenue

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14 Continued: Required average room rate: / : $67.81 Required average room rate: / : $67.81 Calculation of single and double room rates: Calculation of single and double room rates: Usually double rooms are sold at a diferent price than the single rooms. Usually double rooms are sold at a diferent price than the single rooms. Assume that in Harkins Hotel a double occupancy rate is 40% and price difference with single is $10.

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15 Calculations: Doubles sold in one day:.40 * 200 *.75: 60 Doubles sold in one day:.40 * 200 *.75: 60 Singles sold in one day: 150 – 60: 90 Singles sold in one day: 150 – 60: 90 Let x be the single room rate, than; Let x be the single room rate, than; 90x + 60(x + 10) : * 150: $ x + 60(x + 10) : * 150: $63.81 Double room rate: : $73.81 Double room rate: : $73.81 Alternatively the double rate can be set as a percentage of the single rate. 15% mark up on single rate. The equation will be as follows: Alternatively the double rate can be set as a percentage of the single rate. 15% mark up on single rate. The equation will be as follows: 90x + 60x(1.15) : * 150: $ x + 60x(1.15) : * 150: $63.97 Double rate: * 1.15: $73.57 Double rate: * 1.15: $73.57

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16 Bottom-up Approach To Pricing Meals An approach like Hubbart Formula can be used to determine the average meal price. An approach like Hubbart Formula can be used to determine the average meal price. Example: Example: ItemAmountOther Owners investment $ Desired ROI: 12% Funds borrowed ınterest rate: 10% ınterest rate: 10% Tax rate 30% Fixed charges Annual Controllable exp annual Cost of food perc. 40% Seat turnover 2 times per day Days open 313 days

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17 Calculation: ItemCalculationAmount Desired net income *.12 $ Pretax profits / Interest * Total expenses and income $ Total food revenue /.60 $ Meals sold 313 * 100 * Average meal price / $ 18.22

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18 Dividing food revenue between lunch and dinner: Assume food revenue will be divided between lunch and dinner as 40% and 60% respectively. Luncheon seat turnover 1.25 and dinner seat turnover is.75. Assume food revenue will be divided between lunch and dinner as 40% and 60% respectively. Luncheon seat turnover 1.25 and dinner seat turnover is.75. Revenue per meal period: Revenue per meal period: Lunch: *.40: $ Lunch: *.40: $ Dinner: *.60: $ Dinner: *.60: $ Meals sold per meal: Meals sold per meal: Lunch: 100 * 313 * 1.25: Lunch: 100 * 313 * 1.25: Dinner: 100 * 313 *.75: Dinner: 100 * 313 *.75: Average meal prices: Lunch: /39125: $11.66 Average meal prices: Lunch: /39125: $11.66 Dinner: / 23475: $29.15 Dinner: / 23475: $29.15

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