Businesses accrue menu costs when prices of items change. This is often unavoidable for companies due to economic inflation; therefore, as prices rise in other establishments, a business will eventually have to increase their prices as well.
Understanding the factors that impact menu costs will enable appropriate and informed price adjustments.
Menu costs are expenses that come from changes in prices. For example, hiring consultants to identify new profitable values, printing new menu catalogs, and updating point-of-sale systems can all be classified as menu costs. The loss of potential customer sales due to new prices is also a menu cost that businesses should consider.
Generally, price adjustments are less frequent when menu costs are high. Businesses tend to avoid these expenses unless they are losing their profit margins and revenue due to not changing their price strategy. This leads to sticky prices, which is when the financial value of a product is resistant to revisions or does not alter quickly, despite changes in economic conditions.
Companies are more likely to change prices when there is a sufficient difference between their existing rate and the equilibrium price, which is when supply and demand meet.
How the Theory of Menu Costs Derived
The theory of menu costs dates back to the late 1970s with scholars Eytan Sheshinski and Yoram Weiss. It was also influenced by various New Keynesian economists during the late 1980s, as they promoted the idea that businesses are more inclined to perform price adjustments if the benefits of doing so outweigh the costs.
Importance of Menu Costs to Businesses
Menu costs provide insight into how restaurants or retail businesses can strategically adjust prices to an optimal level, to maximize profits, meet customers' expectations, and minimize expenses.
Businesses should measure menu costs to gain insight into their profitability and their capacity to adjust prices. For instance, a study in 1997 reported that a supermarket chain's average menu costs for each of their stores were more than 35 percent of their net profit margins. Executives of the chain could use this information to justify repricing, only if an item's profitability decreased by more than 35 percent.
Additionally, menu costs can lead to price stickiness in neighboring establishments, markets, and suppliers. Therefore, inadequately managing menu costs could affect an entire industry.
There are various approaches that a restaurant or business can take to effectively price menus. Some of these methods include-
1. Compare Markets
To identify the most profitable price for menu items, organizations should compile data about competitors' prices in the same industry and location. With this information, businesses will have clarity into where their prices stand in the competitive market.
2. Understand Your Market
There are 2 forms of markets that a business can be a part of. Executives should identify which market their organization belongs to so that they are properly educated on their customers and priorities.
The 2 markets are-
Businesses that are unique compared to other establishments or have a smaller client base generally fall under this category. Retailers that have original menu items and few competitors are also a part of a demand-driven market.
This form of the market typically includes organizations that sell relatively common menu items. For instance, restaurants that sell burgers or chicken sandwiches will be in a price-driven market. Consumers that are interested in these eateries would be more likely to choose the establishment that offers a reasonable price.
3. Identify Differentiators
Although there may be an average price for a certain product, businesses do not necessarily have to follow suit. If a company's product is different or specialized in some way, it may be reasonable to price the item above average.
To figure out whether or not an item's price should be higher than competitors, companies should look into what makes them stand out. Some of these differentiators include-
Restaurants that incorporate high-quality ingredients or use products from premium sources can increase menu prices to cover these costs.
If businesses plan to do this, it is recommended that they market their brand well. By informing patrons about how the restaurant uses the finest or freshest ingredients and showcasing positive testimonials, consumers will feel justified in spending more.
Various forms of food-serving businesses, such as fine-dining or casual eateries, have an expected price tag. Understanding which type of brand a restaurant falls in will ensure that menu prices are appropriately decided.
For example, quick and casual bars will generally offer lower-priced dishes compared to classier, fine-dining restaurants. If an item is highly-priced for a fast-food eatery, owners may risk experiencing high menu costs in the future.
Throughout the preparation and cooking process, executives may find that they are revising recipes by adding new ingredients for presentation or taste. This leads to an increase in food costs than what was originally budgeted. Restaurant owners need to be aware of these additional expenses and consider increasing menu prices to maintain profits.
- Menu costs refer to the overall expenses that come from price changes
- Understanding menu costs is crucial to maintaining profitability and meeting customer demands
- Businesses need to identify their market and how they differ from their local competitors to effectively price their menus and products