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Updated 28 Sep 2020

What price for success?

What to consider when determining prices.

16 June 2013  Share  0 comments  Print

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When cost of living continues to rise and place pressure on consumers’ disposable income, determining prices of items to be sold can prove a particularly challenging aspect for running and growing a business.

After all, you need a price that is competitive and attractive to your target market, but also one that has a big enough margin to allow you to remain sustainable, turn a profit and ultimately grow.

Price point win-win

Patrizio Nebuloni, development manager at quick service restaurant, Sandwich Baron, elaborates.

“Developing consistent and competitive costing models and structures are central to ensuring a food franchise can achieve short term profitability and sustainable success. Every pricing decision should result in a win-win outcome in which customers obtain value for their money, while businesses still make a reasonable profit.”

Carlo Gonzaga, CEO of Taste Holdings and franchisor of Fish & Chip Co, shares the philosophy.

“Lower LSM markets are incredibly interesting, they’re made up of consumers who are incredible opinionated about what they want and what price point they’re willing to pay. If they’re not happy with the price or the quality of the product, they go elsewhere.”

This poses a challenge for businesses trying to gain their share of the win-win.

“Anyone can sell a R20 pizza, but you can’t make a profit it that’s all you sell. In most cases it would need to be supplemented through a range of additional products. And by and large, fast food concepts tend to get grumpy when they do less than 60% gross profit.”

Making price points work

To make a profit, it’s essential to run a low-cost business and try control supply and distribution as much as possible.

“Someone always makes money on the distribution,” says Gonzaga, which is why they chose to take over their own distribution. “This enables us to charge significantly lower royalties, which in turn helps our franchisees turn a profit, and our price points attract customers.

If you’re not into franchising though, savings can be made by following Taste Holdings’ example. “All head office staff stay in Formule 1 hotels when travelling on business, we also keep an eye on little things, like self-service coffee and tea stations at head office instead of fancy machines.

These small measures all add up. Our franchise sets ups and menus are also simple, meaning inventories franchisees need to carry are basic.”

Your starting point

As a starting point, the most efficient and recommended way to determine a selling price is to source the Cost of Sale amount and multiple this figure by two and a half.

“Generally, food and beverage costs should be around 36% to 40%. This means that if a franchisee spends R1, they should charge a maximum of R2,50 for that same product,” says Nebuloni.

“While this charge may seem excessive, one needs to bear in mind that the pricing model is not limited to the item itself, but should also factor in preparation, service and cleaning. Other variables like electricity, fuel, cooking gas, and wages also impact the pricing model.”

Nebuloni advises the following questions should be asked to assist price setting:

  • What are the direct costs of the product or service? This refers to the direct materials used and associated with a business offering.
  • What are the business's indirect expenses? These are often referred to as overheads and include expenses such as insurance, advertising, rent, office expenses and salaries.
  • What is the company’s breakeven point? This term refers to when costs and income are equal, meaning there's no profit.
  • How is the competition pricing their offerings? Compare the offerings and prices of competitors, to evaluate where the company’s goods fit into the existing market. Efforts should be made to examine internal processes, and determine where value can be added without increasing costs.
  • What is the current state of your industry and the overall economy? One needs to understand the changing nature of the marketplace to ensure that good business decisions are continually made.

When prices need to be raised

At some point in time, the need will also arise to raise prices, in order to enable a significant increase in revenue. There are various methods in which to raise prices:

  • Move prices up to the next psychological barrier. For example, if the price is R9,00, it might be possible to raise it to R9,99 without difficulty.
  • Shift fees formerly included in the price. For example, instead of raising the price of a food platter with dipping sauces from R199 to R200, remove the dipping sauces as a standard offering, and maintain the price at R199. Now charge an extra R10 for the sauces as an add-on if requested.
  • Keep price increases modest for signature items and raise the price on items less well known by the general public.
  • Test the impact of a price increase by conducting market research.

Keeping ahead of price hikes

Owing to the volatility of raw materials in South Africa, pricing should be reviewed on a six monthly basis, but business’s ultimate goal should be to only increase prices once a year.

Customers are prepared to accept a yearly price increase, but will soon start questioning a business offering if two or three increases are implemented in any given year.

When setting these prices, cognisance should be taken of the fact that the realistic or acceptable Return on Investment (ROI) figure in South Africa in the restaurant and fast food industry is around 20% to 25% per year, or a full return over four to five years.

Ultimately, through understanding and applying these costing principles, and accurately assessing market needs, a business can offer competitively priced and profitable products.

In doing so, the business will not only lay a platform to attract more customers, but ensure that their business can be sustained and grow well into the future.

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