Who Stole 17.46% of My Cheese?

How to differentiate between food cost and margin in retail, foodservice formats.

By  Jack Cushman, Executive vice president of foodservice

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Without question, the retail foodservice format of c-stores is a competitive advantage that is growing in importance and sophistication in the foodservice trade channel. A critical question at this juncture is: Why does foodservice in a limited-menu restaurant or other traditional foodservice environment generate in excess of 17% more food-margin dollars than foodservice in a convenience store or other retail environment? The disparity in food costs between these two business models deserves investigation to chart a path of greater financial success in the broader retail environment.

The purpose of this article is to explore best practices in the traditional limited-menu (what we’ll call LMR) sector of the restaurant industry with respect to food cost. Additionally, we will explore how to adapt these best practices into a retail foodservice format without harming the strategic advantage that the retail environment has over the traditional LMR format.

According to the 2007/2008 National Restaurant Association Restaurant Industry Operations Report, food-andbeverage margin specific to the LMR format (not including alcohol beverages) is 69.6%. Meanwhile, NACS reports a food-and-beverage margin of 52.14% in its 2008 State of the Industry Report.

The difference is a staggering 17.46%. Both LMR and retail foodservice formats cater to consumers who are on the go, desire to multitask and fulfill the basic human needs we call hunger and thirst. Because retail foodservice straddles the line between restaurants and traditional retail, it’s crucial to explore this 17.46% disparity to get on the right side of the line.

COST VS. MARGIN

Before beginning, take a moment to infuse clarity to the basic terminology in the LMR and retail foodservice sectors with respect to cost and margin. Each industry uses different terms to describe synonymous lines on the income statement. The term gross margin in the retail industry is synonymous with the term gross profit used in the restaurant industry. Food cost in the restaurant industry is synonymous with cost of goods in the retail industry. The critical difference is that food cost comprises a series of ingredients, while cost of goods is a single cost of a finished good. It may help to think of foodservice preparation as a manufacturing process, because multiple raw materials are used to produce a finished good. (Retailers should consider adopting income statements used in the restaurant industry for this segment of the business.) For example, a frozen pizza in a retail environment is one cost from one vendor. A margin is determined, and a retail cost is set to achieve a targeted margin. The pizza is typically bought by the case and sold individually, and the price of the product does not generally fluctuate from week to week. The key component in profiting from this product is to keep it fully stocked and rotated and to control theft.

In the restaurant industry, a pizza is made up of dough (flour, water, salt, oil, sugar and yeast), sauce, cheese and toppings such as pepperoni. To keep this explanation simple, assume that a raw dough product is purchased and that the sauce is fully prepared.

The cost of each ingredient (dough, sauce, cheese and toppings) must be calculated and a standardized recipe must be determined. The food-cost target is calculated and a retail price is established so that a gross profit can be derived after managing each ingredient effectively. Further, the costs of raw ingredients will fluctuate based on a number of commodity indices such as the block and barrel for cheese.

LMR BEST PRACTICES

Managing each ingredient effectively and determining a proper retail price is the key reason the LMR sector derives a 17.46% better gross margin than the retail-foodservice sector. So how do they do it? The simple answer is that restaurants live and breathe food cost; it is the largest and most critical variable cost. It is more critical than labor cost, and it can fluctuate dramatically if not managed properly. Here are key ways to achieve more gross margin in your retail-foodservice business model:

Retail Price. One of the biggest mistakes made by retailers is being afraid to charge what a menu item is worth. While price is important, the competitive advantage is never primarily price. You do not want your foodservice customers differentiating between you and your competition based on price. When a consumer visits a discount retailer, he or she always remembers the great price paid; but when a consumer visits a LMR, he or she remembers if the food was a good value. Value is a ratio between quality and price, not price alone.

Further, a lower retail, even slightly, will have a drastically negative effect on your food cost and, consequently, your margin. For example, a slight discount of 10 cents on a menu item that retails for $1 will erode your margin by a full 10%. Unless you are absolutely certain you are making up the difference on volume, a slight discount actually subtracts from your net income.

Portion Control. Nothing will erode your margin faster than bad portion control. Calculating ideal food cost is of little value if the recipe derived from your calculation is not executed consistently. For example, if you determine each pizza to have 10 ounces of cheese but your employees do not realize that cheese spreads when it melts, they may overportion. If they place 12 ounces instead of 10 ounces, you waste 2 ounces of cheese. You can easily fit 2 ounces of cheese in the palm of your hand, but if you sell 1,000 pizzas a week, that equals 2,000 ounces in a week, and consequently 104,000 ounces per year. If your cheese costs 23 cents per ounce, you will be missing $23,920 of margin at year’s end. If your average pizza retails for $10, then your missing margin will be approximately 5%—based solely on one ingredient. Creating standardized recipes, training aids and preportioned prep tools is key.

Distributor. Selecting the right distributor is critical to deriving the best margin or food cost, and there are multiple types of foodservice distributors. Some distributors specialize in institutional foodservice, others independent restaurants, and some in regional and national chain accounts. Some large distributors have dietitians on staff who can help you create your menu, but you will pay a premium for this value-added service, which will affect your food cost. Smaller distributors may encourage brokers and manufacturers’ representatives to fill the role of guiding menu development and will offer less value-added services but lower prices. So determine which value-added services truly add value to your bottom line.

The critical questions you must ask yourself are threefold:

  • What value-added services do I need?
  • Do they carry the products that I need so they can purchase in the largest bracket and pass the savings on to me?
  • Am I selecting the right distributor who specializes in the menu I want to have?

Having a foodservice director inhouse may be less expensive than using value-added services, but these services are also the least expensive way to manage the menu for single-unit operators.

Your overall objective is to find a partner that fits your business model and doesn’t duplicate the skill set of your staff.

Direct Labor. It is important to understand the difference between labor costs and direct labor costs. Direct labor is the cost associated with paying personnel to make a particular food item; it is a component of your overall labor costs.

Thinking of direct labor as a cost component of food cost may help, because the more direct labor you use, the lower the food cost should be and the higher the margin. For example, you can buy dough for your pizza, or you can purchase a mixer and buy flour, water, sugar, yeast and salt. Your food cost for pizza dough will be substantially lower if you opt to make it from scratch, but your labor cost will increase. So you must ask yourself if you have the skill set to do the job, and if making it from scratch will give you a competitive advantage.

Waste.When designing your menu, understand that made-to-order cold items carry virtually zero waste, while hot items prepared in advance can create a decrease in margin or an increase in food cost. If your waste is above 10% of food cost, then you’re throwing out too much and you should ask yourself whether your customers really want their food prepared in advance—or if the process is managed correctly in the first place. Regardless, you must have a menu that meets the needs of your customer base.

Factor into your retail cost an acceptable waste percentage, and measure that percentage accurately. Your customers must pay a premium for this service or your operation will not be profitable. That is the part of the value equation discussed under “Retail Price.”

The honor system of reporting waste is not a good method. Holding management accountable for the predetermined food cost with little room for error is critical. Proper forecasting, conducting physical count inventory on a weekly or daily basis and calculating actual food cost on each ingredient is the proper method to control food cost.

Use equipment that lengthens the shelf life of hot foods. The best way to do this is to use humidity, but fried foods and chemically leavened breads with low protein do not maintain quality in a humidified environment; these products need a drier holding environment.

Ultimately, the quality of the product when the customer consumes it is what matters, not the quality of the product when it is made in a test environment.

CALL TO ACTION

Each of the above components requires an in-depth study based on your operation. If you apply these concepts religiously you could increase your margins. The potential profit dollars the c-store industry could garner is mind-boggling, and the strategic advantage the retail format has over the restaurant industry is powerful. Profitability will increase in the retail-foodservice format, and this article is a call to action as well as a road map to enable the success that will come as the retail foodservice format adopts triedand- true best practices for success.    


Toolbox

  • Don’t let your customers differentiate between you and your competition based solely on price. Foodservice pricing is also about value.
  • When looking for a distributor, find a partner that fits your business model and doesn’t duplicate the skill set of your staff.
  • The more direct labor you use, the lower the food cost should be and the higher the margin.
  • If your waste is above 10% of food cost, ask yourself whether your customers really want their food prepared in advance, or if the process is managed correctly in the first place.

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