Lane Cardwell

To Price or Not To Price?

Costs are going up every time you turn around. Labor, cost of sales, utilities, take-out containers, you name it. 

Common sense would dictate that when your costs go up you have to raise your prices to stay in business. That is the common reaction in the restaurant industry. Tally up the cost pressures and figure out how much you will have to raise prices to maintain your profit margin. Is a price increase always the prudent thing to do? Depends.

I have been reading many of the quarterly earnings conference call transcripts on Seeking Alpha. For those of you who don't have an hour to listen to each company's CEO and CFO talk about their iconic brands and their special relationship with their guests, I highly recommend reading the transcript. Not only do you get the prepared comments of the company, you get to read their answers to the research analysts and institutional investors who own and follow the stock. After reading a dozen or two of these you will realize one thing: everybody has a different reaction to the same set of circumstances. Or do they?

At the risk of being ridiculed by people who know a lot more about economics than I do, I am going to attempt to frame this situation in the classic case of supply and demand. To defend myself, I am going to quote from Investopedia and the work of economist Adam Smith. "The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more." This explains why price increases in our industry are usually accompanied by customer traffic decreases, often of a similar magnitude. The net result is that sales often remain essentially the same after a price increase, but the percentage margins on the income statement look better.

"The law of supply demonstrates the quantities that will be sold at a certain price. The higher the price, the higher the quantity supplied.  Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue." In our industry this usually translates into unit expansion to capitalize on improved economics. When we can't get the prices we want we slow down our expansion.

"When supply and demand are equal, the economy is said to be at equilibrium. At this point, everyone is satisfied with the current economic condition."  Our industry has had many periods like this, however, this is not one of them.  Our customers are having to choose between filling up their gas tanks and getting a cheeseburger at a restaurant. There is no relationship between our cost pressures, and the desire of a customer to understand and pay increased menu prices. When the increases come two or even three times a year, many customers have to make changes in their buying behavior.

Back to the original question: to price or not to price? There is no clear answer among the various chains that I follow. If you are a public company you might be more willing to forego customer traffic in exchange for margin protection. If you are a private company you might be more focused on the dollars on your P&L instead of the percentages. Just be clear about one thing. Our need to cover our costs does not translate into a free pass for a price increase from the customer. They have their own cost pressures to cover.

One thing is for sure. If you are not executing at very high levels you will find your customers walking down the block, whether you raise your prices or not. To price or not to price? That is a very tricky question.
 

Posted by Lane Cardwell on May 22, 2008 | Comments (6)