Revenue Contribution and Pricing
A common question that often comes up during restaurant pricing performance discussions is: What is contributing to the profit increase or decrease?
Before we talk about profits, we first need to discuss revenues. Revenue Contribution has three major factors: capacity, business volume and price. For instance, in the case of restaurant revenues, these are represented by: Seats Available, Covers Served and Average Check.
Capacity is related to the original owner investment. In the case of the restaurant, it is your total seats available. Your covers served shows at what level of business volume compared to this seats available you are currently operating. Your Average Check shows the average of menu item prices which your customers have paid at the cover volume you are operating. It is customary to look at these three factors when you are looking at restaurant revenue contribution.
Revenue Per Available Seat (REVPAS)
Having talked about revenue contribution, a consistently faced dilemma of a restaurant operation is the virtual see saw battle between price and volume as contributories to revenue performance. Revenue per Available Seat (REVPAS) takes a balanced approach considering both price and volume. However, from the REVPAS computation, it is important to determine how much of the contribution is being made by price and how much by volume. From the bottom line perspective it is generally felt that a consistently increasing price point is the quick way to bottom line success. However, in reality, price points cannot be going up all the time. At some point, it will meet with resistance. It is prudent thus to follow a strategy which uses volume to complement the price points. In fact, many restauranteurs subscribe to the opinion of first building up volume (known as butts in seats) and then tweaking price gradually (commensurate with perceived value) to improve bottom line performance.
Balancing price and volume consistently to optimize profits is easier said than done. The moment an extra chunk of business through menu items is offered at a lower price point, many restaurant managers tend to panic without really understanding what it does to the bottom line. The adage goes (and is true in almost all scenarios) that other things being equal, a lower priced seat occupied is better than a vacant seat from a bottom line perspective.
Pricing for Profits
A consistent misconception among restauranteurs is that pricing for profits means operating at the highest price level within your competitive set. This is as far from the truth as anything. Pricing for profits is an approach which takes into account how well your pricing strategy deals with one of the most common phenomenon in restaurants or any form of business – price resistance.
Price resistance is a price point where customers feel the need to look elsewhere. This may be caused by two critical factors – first, there may be a perception of value not being commensurate or second, your price may have become over stated with or without direct relation to value. The first factor is more damaging than the second although both tend to have an impact on business. Customers are constantly looking for a value proposition from businesses which can simply be stated as the ratio between benefits and costs. When your restaurant as a product provides benefits far outweighing the costs (price in most cases), the customer sees value and patronizes your business. Ensuring thus that benefits are ahead of the price being charged is key. The second factor is merely a level where the customer feels the price is more than he or she can consider paying. In this instance, there may or may not be connotations of reduced value. In a majority of circumstances, when value is perceived to be eroded, price resistance will take over. In other words, Average Check which is the representation of price may not necessarily indicate the best path to sustained profits. What then could be the better approach? Enter the comprehensiveness of a REVPAS approach.
REVPAS Vs Average Check
What is REVPAS? It is Revenue per Available Seat. Instead of dividing restaurant revenue by covers served, you divide by seat capacity.
Why is RevPAS a better index to look at than just Average Check which is the representation of the price factor? This is because RevPAS takes into account the seat capacity of the restaurant. and is thus a big picture measure of performance. In other words, REVPAS is a reflection of the capacity utilization of your restaurant.
There is another critical element to this entire REVPAS direction. Owners and stakeholders are assessing how you are performing compared to the capacity or seats available. If your restaurant seat capacity is 200 and you are doing 100 covers per day, your capacity utilization is 50%. REVPAS tells you how close you are to the seats available at your current restaurant business volume. Owners are greatly concerned about how much close to capacity the restaurant is operating. It is directly related to the investment they have made in the number of seats available. In a manner of speaking,, in the example given, only half of their investment in the restaurant asset is being utilized through covers served volume. This is a situation that causes great alarm in owners and needs to be remedied quickly.
Market Share
In your current restaurant competitive set, where you are positioned in the Revenue Share Index is critical and determined a great deal by the combination of Covers Served and Average Check. It is not just the Average Check or price level that determines market Share. So, if your pricing is profit oriented, meaning it is a balance of covers served and average check, you will find yourself in a better position from the perspective of market share. After all, at the end of the day, sustained covers at a particular price point is a more focused owner objective than merely registering the highest price at a point of time which eventually sees volume getting diluted. The chances that you are utilizing seat capacity better is also when you achieve a balance between covers served and average check and not merely be price focused.
What is your opinion? Do you think a holistic approach to pricing needs to be adopted to achieve better revenues as well capacity utilization? Comment on this article below.