## Friday, June 30, 2017

### Potential price structure based on protein in a meal

Question:  How much should a restaurant charge for protein content of a meal?
Answer: As much as they can, but in no case should they ever lose money on the meal.

While true, the statement above is not very helpful.  Let's see if we can pick it apart and come up with a more useful algorithm.

Suppose we are talking with the owner of the restaurant and we mention that we think he should only charge for the cost of the food.  So, for 24 ounces of steamed rice (28 grams of protein) we only want to pay 1.5 X \$0.135 twenty-one cents.

He will respond, "Hey, not so fast.  I have expenses.  I have to pay for the clam-shell pods.  I have wages to pay, rent, electric bills and so on."

And so we might ask him, "What is the bare minimum you could charge for 24 ounces of steamed rice in a take-out clam-shell."  I expect that he would say something like, "I would have to charge \$3 to cover all of the incidental costs of producing that meal, and at that point I might almost be breaking even."

That suggests that there is a fixed cost component of producing a meal of \$3.

Going through the same exercise for 24 ounces of beef (245 grams of protein) brings another cost driver into play.  The material cost of the beef is \$7.50 under our simulation.  Adding \$3 to that brings the cost to \$10.50 which is pretty close to what the restaurant charges now.

At that point the restaurant owner will point out that producing 24 ounces of cooked beef incurs more costs than producing 24 ounces of rice.  Beef is more demanding of controlled storage, both before and after cooking.  Preparing beef is more labor intensive than producing steamed rice.

There is also the psychological aspect of pricing luxuries.  It is easier to hide a larger markup in a product that is intrinsically more expensive to start with.  One way to satisfy the higher costs and the need to turn a profit all while not making customers angry is to have a pricing component that is a function that increases as the price of the components goes up.   That is, to have an additional mark-up that is a percentage of the base cost.

 The Mark-up is applied to the Cost of Material + Fixed cost.  Fixed costs are real costs and cause real aggravation.
This goes back to algebra where the formula for a line is Y=mX+b.  In this case "Y" is the price that the black box will calculate.  "m" is the slope shown in the table above.  "b" is the "y" intercept, that is, the value of "y" when "x" equals zero.

Another function of mark-up is to smooth out the exceptions.  There might be some ingredients that are expensive relative to their protein content.   Green beans would be an example.  As long as the customers don't start putting huge amounts of green beans in their pods, the mark-up should smooth that over.

#### 1 comment:

1. Every restaurant I ever worked at had a 45% cost of markup.

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