How Restaurant Operators Can Effectively Manage Prime Costs

Posted by Brady Thomason, NetSuite Solution Manager, Restaurant & Hospitality

The restaurant industry was rocked by a series of large bankruptcies in 2019. Family dining chains Perkins and Marie Callender’s succumbed to not just one, but two bankruptcies, recouping less than half of the company’s $115 million debt with the sale of Perkins to Huddle House. Houlihan’s and Restaurants Unlimited declared bankruptcy and were then purchased by Landry’s for $40 million and $37 million, respectively.

Concurrently, restaurant operators are in an unending war to retain employees without breaking the bank. Fast food chains suffer the worst with 130-150% turnover. The average restaurant loses $150,000 annually just in employee turnover, and turnover costs an average of $5,864 per front-line employee, per year. Meanwhile, U.S. unemployment is at a record lows, minimum wage increases are sweeping the country and baby boomers are retiring in droves.

Though these seem like disparate events, they all tie back to one critical element in the operation of a restaurant: managing prime costs. If restaurant operators don’t keep tabs on prime costs and work to reduce them wherever possible, the likelihood of running a long-term, profitable operation is slim to none.

Quick Primer on Prime Costs for Restaurants

Prime costs encompass the total of a restaurant’s cost of goods sold (COGS) and labor costs. COGS includes all the direct costs associated with creating customer orders, like food, beverage and sometimes take-out packaging inventory. COGS can be calculated using the following equation:

(Starting Inventory + Purchased Inventory) – Final Inventory = Cost of Goods Sold (COGS)

Labor costs include everything that a restaurant pays to employees directly in wages or somewhat indirectly to retain employees (taxes, benefits, and the like). The easiest way to calculate labor costs is to look at the same time period as your COGs calculation and pull salary payments, hourly wages and all taxes and benefits for that period.

In order to understand prime costs, restaurant operators need to calculate COGS and labor costs for the same time period and then add them together. The prime cost goal for restaurants hovers around 60% of total costs. Too much higher, and prime costs eat into margins and profitability; too much lower, and food quality, guest satisfaction and employee retention suffer.

Calculate Prime Costs Regularly

In order to understand the overall health of the business and improve outcomes, restaurant operators need to calculate prime costs frequently. This will give them a pulse on what’s going on in the restaurant. Aim for a weekly cadence in order to make timely changes.

And beyond just the static number of prime costs, operators need to know how prime costs compare to total costs. For example, if a restaurant incurs $8,000 in prime costs in a week and $13,000 in total sales, divide the prime costs by total sales to get the prime cost percentage – in this case, 61.5%.

Once restaurant operators know their prime costs and prime cost percentage of total sales, what actions can they take?

Let’s face it: there’s a lot happening in the restaurant industry that operators have zero control over. They can’t control the seasonal fluctuation of food prices, the ever-increasing minimum wage, and the changes in the workforce based on Baby Boomers’ retiring. What they can control is how they respond to each of these market conditions.

Cost of Goods Sold (COGS)

Operators can’t control the price of food, beverages or disposables required by their restaurant. However, when rates go up, they can control which suppliers they buy from. Calculating prime costs on a weekly basis will help operators see when there are sharp increases in COGS. They can then reach out to different suppliers to see if they can secure a lower rate for their next inventory purchase.

In the case of food suppliers, paying attention to what’s going on in the restaurant industry can also mean big savings. During Chipotle’s food safety scare, the company lost 30% of its customer base overnight. That meant the massive amounts of chicken Chipotle had previously bought under contract had nowhere to go. Restaurant operators were able to buy into Chipotle’s chicken contracts at half the price.

Similarly, operators only have so much control over the yield of a chicken breast – or any other ingredient in their kitchen. What they have total control over is portioning, in terms of how much of that chicken breast is included in their signature salad, and how much is wasted in the production of the chicken salad. When COGS as a percentage of prime costs is higher than operators would like, it’s time to scrutinize specific ingredients and how they are being used (or not used) to prepare customer orders. Today’s restaurant operator needs to be great at the basics. For more industry-leading ideas on how to control your food cost, read ‘Leveraging Your Restaurant’s PMIX to Reduce Food Cost.’

Labor Costs

Instead of trying to control the ever-increasing minimum wage, restaurants can seek to hire fewer staff at higher hourly rates. Taking advantage of automation to do repetitive manual labor can look like more order kiosks, improved mobile ordering and even some ingredient preparation by machines. Operators who reserve the humans for critical customer touchpoints can help save on labor costs—and focus those precious dollars where it counts. Check out this video for some great hacks to reduce labor costs in your restaurant.

With unemployment low and baby boomers phasing out of the workforce, that means more Millennials, Generation Y, and Gen Z in the mix. All these groups have higher expectations from their employers that restaurants can capitalize on. A growing trend around the world (with restaurants and other industries) is the 4-day workweek. Shake Shack has piloted the move with managers in key locations.

In addition to flexible working arrangements, restaurant operators have a wealth of benefits to select from to retain employees. Health insurance, retirement savings plans, free or discounted meals, tuition reimbursements, and group discounts are all great examples. Chipotle has taken it a step further by offering mental healthcare and financial wellness support. And In-N-Out Burger takes it back to basics by creating some of the highest-paid positions in the fast food industry: its restaurant managers receive an average annual salary of $160,000.

Beyond flexible work arrangements, benefits, higher salaries and the like, operators can strive to create a positive culture in their restaurant. Creating a safe work environment, being transparent with employees about restaurant financials and even just making work more fun than the next place can help drive retention.

Measurement and Response is Critical

Razor-thin margins have always been a key component of the restaurant industry, and that’s not about to change any time soon. In order to stay afloat, operators need regular visibility into prime costs and how they relate to total sales. With that information, they can drill down to learn where they can respond to changing food prices, waste and portioning issues, increasing wages and higher expectations from employees.

Download the white paper on how restaurants can manage their business on NetSuite’s unified software.

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