How to Increase Restaurant Profit Margin
December 10, 2019 • 10 minutes
It should come as no surprise that one of the questions restaurant owners frequently ask Ryan Gromfin, the founder of The Restaurant Boss, and one of the most followed restaurant coaches in the world, is about increasing profit margins for their restaurant. Quite often their real profit proves to be lower than the estimate they did when they were planning on how to start a restaurant. Nine times out of ten, they are looking for the magic pill answer: a formula, a checklist, an easy way out. Let’s see what Ryan advices in such cases.
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Dispelling the «magic pill» myth when it comes to increasing restaurant profit margin.
There are literally hundreds of different solutions, tactics, etc. to increase the profit margin in restaurants. Before you can figure which solution or tactic will work best, you need to measure some very important metrics in your restaurant and be sure you are taking a healthy, well thought out approach to this slippery slope.
This happened to one of my clients when they quickly discovered there is a delicate balance to increasing margins. They were operating a restaurant that was very busy, but not making any money. Over time, they lowered staff levels, decreased quality, got tighter with portions, and in an effort to save money they alienated their long-time customers. I have labeled this the ‘restaurant death spiral’.
Many of the struggling restaurants in your community probably are going through this right now. Once you start spiraling, it’s nearly impossible to recover. Save money, lose customers, save more money, lose more customers, and repeat until the ultimate self-destruction happens.
Most importantly there is no one-size-fits-all approach to increasing a fast food restaurant net profit margin or those of a fine dining restaurant. There is no «magic pill» that everybody should be using. There are some best practices, which are often boring, but they work.
The issue I find most often is that people don’t want to do the boring work - they just want to grow, grow, grow.
Growth costs a lot of money and it’s just as dangerous to blindly cut expenses to pay for this growth. There has to be a balanced approach. In order to determine where that balance is for your location, we first need to establish some baseline metrics upon which to develop a plan based on where you fall in those areas.
What is the industry average restaurant profit margin?
Ah, the average restaurant profit margin number. If a restaurant consultant throws out a hard and fast number, they are either lying or don’t know better. That may sound harsh, but it is the truth. The profit margin for a restaurant is hard to determine and the numbers vary!
It’s important to understand that the restaurant profit margin is hard to calculate with 100% accuracy because most independent restaurants aren’t following proper accounting procedures.
They don’t know how to determine what the restaurant is paying for, but shouldn’t be, like cell phones or car payments. Additionally, some restaurants pay the owner’s salary; some owners take a salary in the form of profits; some do a combination of the two.
Let’s break down restaurant profit margin further!
In very simple terms, restaurant profit margin is calculated by subtracting expenses from income. So the formula looks like this: restaurantincome - expenses = profit. Of course, this number will never be a perfect number as there are always variables, such as the owner’s salary. Some owners take a large salary, allowing for small profits; while others do the opposite.
The typical restaurant income ranges that I share with you below are for extremely well-run restaurants. If your restaurant is not run extremely tightly, with measurements in place for multiple different financial metrics, you will see much smaller percentages.
Income Ranges (not including sales tax):
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Less than $500K per year = a very small owners salary and that’s about it
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$500k - $750k per year = 5-8% (owner is working and either taking a salary for their job or taking these percentages in profits)
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$750k - $1M per year = 8-12% (there can be an operator salary, but the owner is still working)
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$1M - $2M year = 12-15% (there can be an operator salary, but the owner is still working)
Note: It’s very hard to get over 15% unless your restaurant makes $2M+ per year.
What do we need to know to increase restaurant profit margins?
I say this on repeat, but it is that important: we can only control what we can control! In the restaurant world, you can’t control expenses such as rent, gas, electricity, trash, insurance, etc. because they are fixed expenses. You are going to have these expenses no matter how busy you are on any particular day, week or month, and they should not vary largely month-to-month. However, you can control your cost of goods sold (CoGS), labor costs, and direct restaurant operating expenses. Here’s a little refresher on what these terms mean:
CoGS = Cost of a good you sell, basically the raw ingredients (food, beer, wine, liquor).
Labor Costs = Cost of labor + employer expenses (taxes, benefits, insurance, etc.)
Prime Cost = Total CoGS + Total Labor / Total Restaurant Sales. In my opinion, this is one of the golden numbers you should be looking at weekly. Your prime cost number should always be under 60%. These days, most restaurants target 55% since rent and insurance expenses have been on the rise.
Direct Operating Expenses = Expenses related to the sale of your goods. This does not include your CoGS number. Examples of direct operating expenses include to-go containers, plastic wrap, foil, gloves, napkins, janitorial expenses. It should be 6-8%. In general, sit-down restaurants see less than 6% and quick service, fast-food or heavy to-go locations see closer to 8% because of to-go containers and more disposables.
Restaurant Controllable Costs (RCC) = Your Prime Cost + Direct Operating Expenses. Under no circumstances should this number ever go above 66%! If you can control this number, you shouldn’t have a problem making your restaurant profit margin.
There is one other number to pay attention to: rent + marketing should never exceed 10% of your budget. To keep this number down, it’s crucial to negotiate a good lease and ensure you have selected a location that is right for your concept. I combine rent and marketing because the better your location, the more you will pay in rent; however, you should not need to spend as much on marketing and care about its ROI that much, as your location will drive traffic. All too often I see startups choose lower rent, and then they are forced to spend large amounts on marketing. Warning: no amount of marketing can make up for a really bad location.
How to make your restaurant more profitable?
Enough of the number talk - it’s time for the fun stuff! The only way to improve restaurant profit margin is to grow your top line (the income generated by a restaurant) while maintaining or shrinking your expenses. Chasing the latest craze or being distracted by bright, shiny object syndrome isn’t going to render your results. If anything, your profit margin will go down due to the added expenses from this rabbit hole chase. Remember: You have to control the controllables!
There are three ways to accomplish this:
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Increase revenue while maintaining your expenses (hard).
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Maintain revenue while decreasing your expenses (easy).
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Combination of both, which is ideal! (medium).
There are only three ways to increase your top-line revenue:
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Attracting more new customers into your restaurant.
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Getting repeat customers to come in more often.
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Increasing the average ticket price per visit.
Please do NOT start down the journey of chasing the next new marketing tactic or purchasing advertising until you have a very clear idea of where you need to focus and what your entire marketing plan is.
If you are going to run an ad with a coupon to bring in new customers, then what is your plan to ensure they come back again? Otherwise, you are just wasting advertising dollars on customers who will come in once with a coupon. You make little to no money on them, and they won’t come back because they don’t have another coupon. I see this happen quite often, and there is a good chance you have done this.
Remember, there is no magic pill for increasing restaurant profit margin. Sure, there are millions of different strategies for marketing or for controlling food costs, etc. But at the end of the day, it’s going to come down to these key factors:
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Did you properly negotiate your lease?
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Is your food priced right?
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Are you offering what your target market wants?
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Are you purchasing your CoGS properly?
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Are you controlling usage, waste, and portions in your restaurant POS system?
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Are you getting the most out of your labor?
If you are not sure what your food, beverage, labor and DOE costs are, then look into tools like clickBACON that can help you determine these numbers in real-time so you can better control your expenses and increase your profit margins.
It’s all about controlling the controllables!
