By The Numbers:
Pricing Yourself Out of Competition
by Aaron DeFeo
Before you consider raising your prices, consider your business model and the business model of your competition.
Liquor and food cost is perhaps the single most important business variable that affects most hospitality businesses these days. Bar and kitchen managers are already obsessed with, and in some ways subservient to, both of these because their owners have mandated that certain percentages be met and lowered on a monthly and quarterly basis. And with the economy taking a steady plunge, all eyes are squarely upon falling revenues and rising costs.
So in a hostile monetary environment like American casual dining and entertainment, it’s easy to fall prey to the temptation to raise prices across the board. Food, for one, has increased so sharply due to farm production and gasoline costs that chefs have been faced with raising their menu prices every month, as opposed to one or twice a year, and many of them have had no choice. The price of eggs, for instance, has almost doubled per dozen over the past year, and so egg-intensive dishes must therefore be adjusted accordingly.
But with liquor-as always-the formula is not always as complex. When a manager costs out a chicken sandwich, he or she takes into account the cost of the bread, chicken breast, ounce cost on any sauces that come on the sandwich, and the produce involved (tomatoes, lettuce, onion etc.) It is fairly simply that in order to stay in business, the restaurant must make at least a 50% margin on this sandwich, and even that does not lend much profitability. The labor involved with serving that sandwich can sometimes eat the profits alive between a busser, server, cook, and dishwasher. Liquor, however, yields the highest margin of any service industry product because of its relatively cheap expense per unit, and because it can be served with a low labor cost and a low cost of mixers (or none at all.) And while liquor prices, like food, have crept ever so steadily higher over the last two years, minimal price increases and smart ordering practices can negate many of the ill effects caused by economic woes.
In a panic, bar managers looking at their rising pour costs and cost of goods analyses will often find themselves raising prices to make up this difference. Worse yet, they are doing it not because they fully understand the benefit that the increased prices have-they are doing it because that’s what everyone else is doing. A bar manager might stumble into a popular bar down the road from his own establishment and notice that an Absolut and tonic water fetches a hefty sum of $7.00, while he charges a mere $4.00. Instantly, he wonders in the back of his mind whose price structure is foolish. Is $7.00 too high, or is $4.00 an inadvertent error of judgment that is costing hundreds of dollars per month? Let’s say for the sake of argument the bar manager decides, upon arriving at work on Monday, to change his price on Absolut to match that of his competition. Within two weeks he notices a better margin on his Absolut products, but he also notices a 20% decline in Absolut sales. It may be difficult to determine whether this is an anomaly or a direct reflection of the customer’s unwillingness to pay $7.00 for that particular product.
In most cases, four specific considerations must be made when adjusting pricing on alcoholic beverages: cost of goods increase, market average, clientele demographic, and overall value. Many managers focus squarely on the first two but eschew the others. The last two, clientele demographic and overall value, might just be the most crucial to the success of all aspects of the business. Great managers focus more of their attention on gauging guest reaction as a starting point to making decisions.
I will use Absolut as the example. Between ’07 and ’08, the price per bottle on Absolut in Arizona for on-premise distribution went up $2.28 a bottle, or $.07 an ounce (10%). Assuming that a business sold an average of four cases of Absolut a month, the bar would experience a loss of $110 a month, or about 4 ¼ bottles. Over the course of the year this is over four cases, and no manager worth their salt can stomach losing four cases, if they think about it. So the price must increase.
But by how much, and does it really have to? An increase of $0.25 per drink will yield, on 25 pours per bottle, an extra $6.25 per bottle… more than enough to cover the COS. And after factoring in “shrinkage”-the common industry term for spills and theft-it seems as though this would be perfectly appropriate. But is it really feasible to raise the price on ALL items? Aren’t there items in high demand that, at a higher price, might steer bargain hunters away from your establishment and into the open doors of your competitor, who charges $0.50 less than you do?
In this respect, it IS important to know your competition’s pricing structure, but at the same time so many factors exist to consider. If your business is a neighborhood pub that caters primarily to a following of local regulars and you are comparing your prices to those of an upscale nightclub, you are missing the point. That nightclub has overhead costs to consider far beyond your own, and also caters to a clientele that feels financially comfortable enough to pay $7.00 for that shot of Absolut because, in a way, they are also paying for the atmosphere. To the nightclub’s customers there is still overall value. Your regulars, however, who are used to paying that $4.00 might grumble, and your fringe customers who vacillate between nearby bars and your establishment may choose to go elsewhere. By knowing your clientele and what they drink, you might come to the conclusion that the Absolut drinkers at your bar will drink at your bar no matter how expensive Absolut is, and they will continue to order it.
This scenario begs the question, “How much of an increase can I get away with?” At my bar, I was concerned that increasing the price of Absolut by $1.00 would have a negative effect. In reality, sales of Absolut stayed almost exactly the same, and I conquered the cost of goods on that particular product because my customer base does not primarily consume Absolut.
A perfect example of how this customer/bar dynamic works is the sales of canned beer. Tucson houses a thriving downtown artist’s scene, and their drink of choice is primarily Pabst Blue Ribbon served in cans. Although the price per can of Pabst Blue Ribbon has gone up 25 percent, and is the second most popular item sold at my bar, raising the price ($1.50) would not be prudent because many of my competing establishments sell it for the same price, if not lower (in some cases as low as one dollar!). Raising the price from $1.50 to $2.00 would create a hysterical reaction, as many customers already complain that they receive the same beer thirty percent cheaper down the road. However, I charge slightly more for many of my other products, so the hit that I take on PBR doesn’t shake my costs from the ground up.
In the end, all prices must go up. But by raising prices at the appropriate times-and for the appropriate reasons-you will avoid seeing a backlash from your clientele and your ledgers will stay safely in the black.