What is the Average Restaurant Profit Margin?
Do restaurants really have thin margins?
As a restaurant owner or manager, you may have heard the common misconception that restaurants have thin margins. However, this is not necessarily true, in fact, many restaurants have healthy profit margins, especially when they are able to effectively control their food costs, labor, and markups on menu items.
So where is this misconception of thin margins coming from? Let's review the restaurant as a business and go through the numbers.
First, let's discuss the margins. Think of another business where a fountain drink is purchased for $0.25 cents and sold for $3. That is a 1,200% markup.
A bottle of crown or titos for $30 dollars and sells for $300, which is a 900% ROI.
A bottle of wine for $10 dollars and sell a 5oz glass of it for $14 dollars.
The least profitable dish sells for $15 bucks, costs you $4.50, still a 230% markup on your lowest profitable item on the menu.
The cherry on top, your servers' wages are also paid by your customers through tips. So again, where is the low-margin outcry coming from?
The short answer is that restaurants make a ton of money, but they also burn a ton of money, which reduces their profit margins.
So let's discuss the misconception and how to fix it.
A typical restaurant has no idea who its customers are, and they do nothing to cater to individual customers. They open a restaurant, advertise through some channels, gain some customers, and never follow up with those customers to maximize the return on advertising dollars spent. In all other industries, this is completely absurd. Specifically, within software companies, there is a vast amount of resources invested in learning everything from customer acquisition cost, to lifetime value, to churn rates, customer satisfaction, and other similar metrics to gauge the health of the business. Now in a restaurant, you will be lucky if the manager stops by the table and asks; “How was your food?” This is a rhetorical question. as if anyone will confront the manager in a face-to-face confrontation and tell the truth.
Now a typical restaurant realizes that they've saturated their existing resources and moves to paid advertising to try and spend their way out of the situation, mind you, the same situation that they put themselves in. As you may expect, the results are more catastrophic because now they are spending money without tracking or measuring any return on investment. They may have some initial success, but without a proper follow-up on the customer side, they unintentionally minimize their return on investment. The restaurant owner/operator is its own worst enemy.
Now comes the desperation phase, they start discounting and giving away free food in order to attract customers and just barely stay afloat to pay the bills. As we all know, the best way to attract your best customers is to discount and devalue your brand; no, that is the worst way. To state the obvious; coupons will almost always bring in the least profitable customers, those looking for bargains.
Let me give you an example; for the past six years, I have strived to reduce my pure sugar intake, which means avoiding anything with unnecessary sugar, including Bundt cakes. So the only way that you can entice me to buy one, is to give me a deep discount which conveniently Nothing Bundt cake does every month or so through a direct flyer with an aggressive buy one get one free offer. Spend six dollars and get another six dollars for free. So now they cut their profit margin by half simply by bringing in a customer who would otherwise never spend any more money with their brand as they have to. This a classic example of why coupons only attract the least profitable customers. On top of that it is costing them at least one dollar to create, print & mail the flyer, and get it in my hands. So do coupons work? Yes, they do! but there is a place to utilize coupons, however, with the right metrics in place.
By now the restaurant owner is in complete panic mode, they are losing money hand over fist, couponing is making matters worse so they trying email marketing, i.e. electronics couponing. Although more efficient, they only manage to shave off $.50 cents versus a dollar to reach out to the customer compared to direct mail.
After some ups and downs, a great salesperson sells them the grand idea of implementing a loyalty app in order to learn customer behavior and turn things around. Wallah, a magical solution to their exact problem. Exactly as if God sent The salesman to solve their specific problem, a messiah, a miracle sent straight from God himself! Milagro! (by the way, Milagro means Miracle)
So now they continue investing in promoting a loyalty app in order to learn customer behavior and use that information to turn things around. After a good 12 months of time wasted, they have a maximum of 15% of their customers for which they are tracking some of the customer behavior. Now the problem is they don't have a way to monetize the data, they have some generic data, but what do I do with it? Those who have the means to monetize the data, seem to continue down the same path as digital coupons. Send out Kids eat free every Tuesday of the month to 1.2m customers, 75% of whom do not even have kids! Brilliant!
Almost every restaurant owner has at least once a week complained that my restaurant has thin margins. But is that really the case or are they trying to run away from reality and hide behind this mask, this misconception that restaurants have thin margins…
By the way, to be clear, we aren't underestimating the challenge of running a restaurant! It is in fact a very difficult business to operate, the sheer fact that you have to make the food the exact same way every single time is a massive challenge by itself.
Let's continue on. With any business, profit margin will always be a problem up to about $700 to 800,000 /year in sales. The reason that this figure is important, is that it will help pay for all of the fixed costs, think rent, utilities, software subscription cost, that loyalty app, etc.
After fixed costs, you have v>
Training the employees to upsell better
More efficient use of marketing funds
But most importantly, Implementing aCustomer Data Platformsand how they help increase sales and profits in restaurants. We hope you enjoyed this conversation, stay tuned and subscribe to be notified when we release future episodes.