COST APPROACHES TO PRICING

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

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. There are two versions of this method as “ingredient mark up” and “prime ingredient mark up”.

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

EXAMPLE: CHICKEN DINNER AND COSTS1
Ingredient Cost (\$) • Chicken 2 pieces Baked potato Roll and butter Vegetable Salad with dressing Coffee refills free Total cost 1. Kaynak:Raymond S. Schmidgall, Managerial Accounting For The Hospitality Industry, 4th. Ed., Educational Institute, Lansing, 1997, s. 243.

DETERMINATION OF MULTIPLE:
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: 1.32 * 2.5: \$3.3

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: .59 * 5.8 : \$3.42

PRICING ROOMS \$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

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

Continued: 6. Calculate the required rooms department income. That is, step 2 + step 3 + step 4 + step 5. 7. 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.

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%.

Property taxes \$ Insurance Depreciation Administrative & general Information systems Human resources Transportation Marketing expense Property oper. & mainten Utility costs

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

ÇÖZÜM: Desired net income (2 500 000 * .15) \$ 375 000
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

Continued: Required average room rate: 3 712 500 / 54 750: \$67.81
Calculation of single and double room rates: 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.

Calculations: Doubles sold in one day: .40 * 200 * .75: 60
Singles sold in one day: 150 – 60: 90 Let x be the single room rate, than; 90x + 60(x + 10) : * 150: \$63.81 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: 90x + 60x(1.15) : * 150: \$63.97 Double rate: * 1.15: \$73.57

Bottom-up Approach To Pricing Meals
Item Amount Other Owner’s investment \$ Desired ROI: 12% Funds borrowed 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 An approach like Hubbart Formula can be used to determine the average meal price. Example:

Calculation: Item Calculation Amount Desired net income 200 000 * .12
\$ Pretax profits / .70 34286 Interest * .10 50 000 Total expenses and income \$ Total food revenue / .60 \$ Meals sold 313 * 100 * 2 62 600 Average meal price / \$

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. Revenue per meal period: Lunch: * .40: \$ Dinner: * .60: \$ Meals sold per meal: Lunch: 100 * 313 * 1.25: Dinner: 100 * 313 * .75: Average meal prices: Lunch: /39125: \$11.66 Dinner: / 23475: \$29.15

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