Why you should switch to the contribution margin calculation

In this series, gastronomy consultant Uwe Ladwig writes about what restaurateurs might look out for when reopening. The second section episode is about contribution margins calculation.

Your pricing is always at the top of the list of profit influencing factors. For many people, this is no magic trick: It is enough to raise the prices a bit, isn’t it? Other restaurateurs believe they can get by better if they only reduce personnel costs. Both are naive assumptions not leading to success.

 

Stop calculating mark-ups

At least 80 percent of restaurateurs still work with an outdated calculation method that originated after the second world war: with the mark-up calculation. Because personnel costs were much lower than the cost of goods, restaurateurs simply multiplied the cost of goods by a factor of 3 to 4 and calculated the price of the dish based on that. This simple enough for math refusers. It satisfied even tax and financial consultants. Everything was conclusive and comprehensible.

But this calculation method has not worked for a long time. In the meantime, the personnel costs have drifted away. If you still calculate prices with the mark-up calculation, in the long run, it will be difficult to cover the personnel costs, rent and energy costs. I want to motivate you to stop this. If you switch your calculation method now, you will have less stress during audits, and you will have more money in your pocket than ever before.

 

Do you already calculate, or do you still roll the dice?

Whether you use the antiquated mark-up calculation or still decide your prices based on gut feeling: With every day you use the contribution margin calculation, you will earn more money and have a calmer sleep. Because many of your best running dishes contribute to the loss. Excuse me? Curry sausage, burgers, tarte flambée, schnitzel and roast pork in southern Germany: These are all favourites on the menus. But they have another thing in common: they all have a low cost of sales and according to the mark-up calculation, they achieve a low contribution margin (net sales minus cost of sales). Since these dishes, of all things, are “top sellers”, there is a risk the contribution margin is too low to cover all operating and personnel costs.

The dishes on the other side of the price scale, for example beef fillet, are high cost goods and are offered at a correspondingly high price. The result: Hardly anyone orders the dish. This is an unfair pricing for the customer. Because whoever eats an expensive dish ultimately sponsors the guest with the cheap curry sausage.

 

The mixed calculation as a simple alternative?

Participants in my seminars ask again and again whether a mixed calculation would be sufficient. I then like to ask what they understand by mixed calculation. The answers are unsurprisingly mixed. A mixed calculation is when you go to an electronics store and buy a Blue-Ray player at a special price and then purchase additional DVDs at a regular price. With this combination of player and discs, the seller balances the special price and creates more sales.

However, such a mixed calculation does not work in our industry. If your guest has eaten a curry sausage, then he will not order a T-Bone steak afterwards. In the past you might compensate for this by selling drinks. But guests don’t drink as much anymore, and the proportion of drinks is not high enough to compensate for the low contribution margin. Forget the mixed calculation and finally turn away from the mark-up calculation. It is harmful to your business.

 

From “racers” to “winners”

“Racers” are dishes that are doing very well but have a too low contribution margin. For many restaurateurs, 35 to 40 percent of the dishes produce a contribution margin that is too low. This means: The more racers you sell, the more losses hit you. How about you need not care which dish your guest chooses because you earn money with every main course? You can only do that if you switch to the contribution margin calculation.

The following example shows how important the switch is: A company has a cost of goods of 25 percent. That is exceptionally good. The restaurant offers 30 dishes; the drinks account for 12 percent.  It would satisfy any tax consultant. Nevertheless, the business achieves a minus of 4 percent. The reason: The old calculation method cannot cope with personnel costs of over 40 percent.

A typical example is the pricing of the curry sausage, a big hit for many in Germany. How high is your contribution margin for the curry sausage? In a first price diagnosis for a customer six years ago, we calculated a contribution margin of 4.17 Euros for the curry sausage, which accounted for 22 percent. That was too little; the average contribution margin for curry sausage is 5.56 Euros. They sold the dish far below price. Over the next few years, the rather cautious restaurateur increased the price to 7.39 Euros. With about 27,000 dishes, he thus achieved a contribution margin was about 51,000 Euros higher. As a result, he could also increase the other contribution margins and thus sales and profits. By changing his way of thinking and the calculation method, the gastronome achieved about 100,000 Euros more sales in one year through gross profit.

 

How to switch to the contribution margin calculation 

In this example, the racer became a winner. And that’s exactly the goal: If your best-selling dish is a winner, then you will have a great menu. If the best-selling dish is a winner, you will lose money every day.

If the mark-up calculation is outdated, how do you make the switch to the contribution margin calculation and how long does it take? Here it depends on your starting position. If you don’t have a calculation yet, you can start right away. And if you still use the mark-up calculation, get away from it quickly. Some restaurateurs need two to three years to switch, other restaurateurs convert within a few months.

Why not use the time now and make your business more crisis-proof? Many guests no longer know the prices of your dishes. Why don’t you change over completely? What keeps you from switching? Start calculating in the “new normal” with contribution margin calculation.

 

Uwe Ladwig is the owner of F & B Support in Willich. He supports restaurateurs with business management challenges, offers consulting, coaching, webinars, online courses, seminars, and calculation packages. A free online course is available for switching over to contribution margin calculation. Further information is available at www.f-bsupport.de.