In one of previous articles, we have talked about two main menu pricing strategies and shared tips for designing your menu. Today we want to introduce five menu pricing methods that restaurants can apply when pricing their menus..
We will emphasize the pros and cons of all restaurant menu pricing methods and show what’s the most optimal method right for your restaurant.
Five menu pricing methods
Five menu pricing methods are:
- Competitive pricing
- Dynamic pricing
- Cost-plus pricing
- Penetration pricing
- Price skimming
#1 Competitive pricing
Competitive pricing involves tracking your competitor prices and pricing your menu items based on what your competitors do. Depending on your type of restaurant you choose to price your menu the same as your competitors, lower or higher.
If you’d like to attract more price sensitive groups of consumers, you’d want to set lower prices. In case you are direct competitors and target the same segment of consumers, you’d prefer to set the same prices.
This method is popular among restaurants who are new to the market, don’t have a customer base and can’t analyze what prices are right for their customers. By tracking competitors and setting prices accordingly, restaurants assume their competitors have already analyzed consumers and have chosen the most appropriate prices.
Following this approach is easy but price shouldn’t be the only competitive advantage. And in the long run it will hurt your revenue.
Competitive pricing might be good for small restaurants that compete with dozens or hundreds of similar restaurants and offer similar menu items. In similar cases, price might be a deciding factor and have a huge impact on your sales volumes and revenue.
Restaurants offering unique recipes, unique atmosphere or ideal location should avoid the competitive pricing method because it devalues the efforts that you put into and uniqueness that you offer.
Recommendation: If you are new to the market and have lots of competitors, you can start with this pricing method to see how your consumers react. Time will show who your ideal audience is and how they are different from your competitors’s audience. Ultimately, you shouldn’t let competition control all your strategic decisions.
#2 Penetration pricing
Penetration pricing is implemented by setting low prices, sometimes lower than the original cost.
To gain a competitive advantage and a bigger market share, restaurants set prices at a below-market level. The goal is to entice a large audience, including the customers of your competitors, and increase the prices after restaurants are able to build a customer base with low pricing.
As the demand for natural, healthy food is growing, the goal is to help large consumer groups get acquainted with these products.
For example, Costco and Kroger, grocery store chains, set initially low prices for organic products that under normal conditions cost higher.
In the beginning the revenue might be extremely small or even won’t exist. But after some period of time, when people see the benefits of organic, locally sourced food, the prices will go up and the businesses will start making a profit. As you can see, you implement this method for a limited time and it’s not a permanent strategy.
This approach is dangerous because you are targeting a segment that is looking for cheap options and is usually not ready to pay a higher price.
Besides, this approach implies that you should sell your products at a loss in the beginning, in the hope of making profit after increasing the price.
Last but not least, your competitors might also lower their prices and enter a race with you. If your original costs are higher than the costs of your competitors, you might totally fail at this strategy.
Recommendation: Though small, new restaurants usually plan to follow penetration pricing, this method is more risk-free and suitable for established businesses who launch a new product or simply want to expand their customer base. Don’t forget that large restaurants sell at high volumes and even a tiny profit from every order might turn into a huge profit eventually.
If you are a restaurant that has established competitors, this method might do more harm than good as your competitors might follow your suit and decrease their prices. However, if your competitors aren’t very big you might want to test this method as a new and small business.
#3 Price skimming
Price skimming is setting high prices initially and lowering them over time. First, you target high-income customers who want to be trendsetters and then you lower your prices to attract consumers who are price sensitive.
This pricing method allows businesses to target different groups of customers depending on their income level. Besides, the method helps to cover the cost of novelty quickly and make a profit quickly as well, However, the price decrease may disturb early adopters who bought the product at a high price.
Price skimming strategy is perfect for technology companies who innovate and create products that can’t be easily copied. And as they are the first and only company offering that technology, the high price is justified. Later, when the same or other companies develop better versions, the price of the initial product drops significantly.
Apple is a perfect example of a company who follows this strategy. For example, the original cost of iPhone 11 was $699 and then it went down to $599.
As a restaurant, you can apply this method if you offer an exclusive recipe or use a special cooking method. Initially, you can set a high price to attract affluent buyers who love trying new and expensive stuff. However, duplicating a recipe isn’t as difficult as duplicating a technological product and you might not be able to sell at a high price for a long time.
Recommendation: If your chef can offer a recipe with his/her own secrets that will be hard to copy, then you can follow this approach. Especially if you actively promote the new menu item’s launch and describe it in an attractive way, you will be able to generate a large profit. Once your competitors start offering a similar version, you might start lowering the price.
You can implement this method for specific recipes only and don’t make it your principal strategy for all menu options. Ultimately, this method can be applied with dynamic pricing that we will discuss a bit later.
#4 Cost-plus pricing
Cost-plus pricing or markup pricing means that you calculate the initial cost of the product and then add a percentage. Definitely not a good fit for service-based companies because no physical product is involved and owners set a price based on value. But for product-based businesses, including restaurants this method might seem logical and appropriate.
This approach helps restaurants understand the initial costs involved and make sure they don’t sell them at a loss or simply break even.
You should first calculate the original cost (ingredient cost), then understand utility, labor, renting and other costs, and add your profit margin (3-5% on average).
If your restaurant also offers delivery, you should also calculate packaging costs – boxes, disposable tableware, etc. Profit margins in a restaurant industry are slim – around 3-5% on average.
Markup pricing comes with multiple disadvantages. It doesn’t analyze the market and whether consumers are ready to pay the determined price. Besides, production costs may vary from time to time as ingredient costs change and so your revenue won’t be predictable.
Recommendation: In a market where production costs rise and fall irregularly and recipe ingredients might change, markup pricing isn’t a viable method. Markup pricing has a better alternative – value based pricing that sells the product based on demand and the benefits and value it provides.
#5 Dynamic pricing
Dynamic pricing implies pricing your menu items based on how high the demand is. This pricing method is widely used in the hospitality industry, from hotels to restaurants and travel agencies.
For example, if you book a hotel room in May, you pay a lower price than if you booked the same room in summer when thousands of people are traveling.
The same principle implies when it comes to restaurants and cafes. For example, fruits and vegetables are cheaper in summer compared to late autumn or winter. So restaurants will naturally set high prices in these seasons. A holiday menu, a holiday catering menu, and a seasonal menu also tend to be more expensive than an ordinary day menu.
Or price fluctuations of ingredients. Ingredients costs vary not only from season to season but from supplier to supplier as well. That’s why you should keep your finger on the pulse and change your prices accordingly.
Another example. Dish popularity. If you have a popular product that your guests enjoy, you should try to turn it into a profitability machine (read more about menu profitability analysis here). Meaning that you should increase the product price step by step because it’s valuable for consumers.
As you can see, price optimization is everywhere in the food and beverage industry. And as an owner, you should follow this method and price your menu items based on their value and popularity, not solely based on what your competitors do or how much the original cost is.
Recommendation: If you want to grow your restaurant business and charge based on value, follow this pricing method. Increase your prices in the festival/holiday period, on weekends, and on certain hours of the day. Do you think it’s illegal? It’s not!
Final thoughts
These five menu pricing methods are proven to work but it’s your responsibility to make the right choice depending on different factors, e.g. your business stage, market saturation, whether you are an affordable or expensive restaurant, etc.
EagleOwl team is available not only for helping you track and optimize your operations with a restaurant management system but also for discussing your restaurant challenges, food trends, etc.
Book a demo and let’s see how this call will transform the way your restaurant is growing and serving its customers.