Saturday, January 3, 2009

How A Restaurant Can Increase Its Profit?

This posting is dedicated to my friend, Mr. Tong a restaurant manager. Well, I’m no great consultant. Neither am I, someone experienced in food business, but I can always give sound argument & opinion on how to increase business efficiency

The restaurant is operating in a monopolistic environment, since it fulfills all the condition:

(a) There are many customers & restaurants in the same area

(b) It produces goods (in this case chicken rice & hor fun) which are identical to many other restaurants BUT is differentiated with branding (the restaurant is well known for recipes from Ipoh)

(c) It has some price making ability

(d) It operates in an environment of low entry barriers & exit barriers. New restaurants can therefore come in easily & leave as they wish due to low set up costs. RM 150,000 to RM 400, 000 is considered low enough compared to setting up a multinational firm. He even told me that several restaurants have went bankrupt

(e) In long run it (may) achieves normal-profit (AC = AR), since any short run supernormal profit (AR > AC) will be competed away by new restaurants operating in the same area. Probably true, since the growth rate of restaurants greater than growth rate of customers in that area. In other word, profits being ‘shared’ out

Since all firms exist to make profit, thereby the restaurant operates where MC = MR. This intersection is called profit-maximisation. In other word, profit of the restaurant is maximised when MR (marginal revenue) is equal to MC (marginal cost). Producing there means profit is at its peak & can no longer go any higher

Equally, one can also look at the TR (total revenue) & TC (total cost) diagram above. We can see that profit is maximised when the gap between TR & TC is the BIGGEST

One should never think that profit is the same as total revenue. This is because

Profit = TR – TC
Profit = (price x quantity) – TC
Profit = (PxQ) – TC

From our conversation, he mentioned that since the restaurant (2nd branch) is relatively new in the area of about 5 months & the margin is thin due to stiff competition & high operating costs, he needs to think how to reduce costs & increase volume of food sold

Here’s what I think:

To increase the profit, there are generally 3 broad ways, either increase TR or minimise TC or if both can be done simultaneously, that would be great

(1) To increase total revenue (TR = P x Q):

(a) Manipulate P. Flirting with P could be a little difficult. Increasing the price may lead to fall in quantity of food sold in near term. In other word, losing the customers. The more sensible, but indirect way of price increase would be to reduce the amount of chicken, rice, hor fun, putting more ice in the drinks etc while maintaining the same price. However, he outlawed that option since the restaurant’s policy is ‘generosity’.

(b) Manipulating Q. He repeatedly used the word VOLUME & this is tied with quantity of food & drinks sold. From economic point of view, this refers a necessarily increase in demand. To increase demand the following can be done:

(b)(i) Advertising. Earlier, Kar Heong has launched an advertisement in the form of booklet. According to him, it was effective in pulling a larger crowd to the restaurant. It costs them about RM4, 000. Since that’s the case, I would recommend the restaurant owner to advertise more often, e.g. every few months. Never belittle the power of advertisement. The short term advertising expenditure should not be seen as a great barrier towards greater sales in future

(b)(ii) Credit card facilities. At the meantime the restaurant is accepting cash payment. Later it will have credit facilities as well. This is important since modern urban consumers are increasingly not carrying cash with them when they go out

(b)(iii) Good customer relationship. Always ‘attack’ parents that bring kids along with them e.g. giving them candies or sweets. I saw you did it that day, congratulations! I remembered a businessman told me that if you can make the kids like you, for some reason you have already won the heart of their parents. This will ensure them to come more often. Also I recommend, greeting the names of those regular customers. People like when their names being called. It is actually a kind of respect. I got this from Dale Carnegie in his book “How To Win Friends & Influence People”. To me, I always look at customers as the ambassador of the product we sold

(b)(iv) Loyalty cards. Although there is, I feel that the 10% discount given for the tenth visit is not strong enough to create an incentive for customers to ‘hit that target’. Perhaps a 30%-40% would do. Anyway, I do understand that at the meantime the profit margin is thin. Perhaps, putting 2-3 marks for every visit is good a beginning. At least people will think, to reach the hilltop, I just have to climb 4 stairs rather than 10 stairs. This may create those incentives

(b)(v) Promotion at the entrance. There are many passer-bys & of course many will take notice of this. If it’s appealing enough, people may want to step in. The previous ice-cream promotion wasn’t a bad one, just that it’s not sufficient, although I understand that it’s not cost-effective due to last minute of getting a provider for that. I would recommend the restaurant owner, to reconsider the ice-cream option. Perhaps over the time, something else could be dished out as dessert, e.g. pudding. Higher initial expenditure is common in any business, but this is necessarily to create those demand

(b)(vi) Introducing new menus. I would recommend the types of drinks to be diversified e.g. cappuccino, mocha, cokes with ice-cream top, ice-blended drinks etc. First, it is not that difficult to learn how to produce these drinks. Secondly, they give very high MR (marginal revenue). People don’t mind paying. I have seen simple drink like those being sold at RM 5.50-RM 6.00 & how much is the cost? Or perhaps could introduce dessert to be added in the menu

(b)(vii) Customers’ suggestion form. As mentioned earlier, businesses must strive to understand consumers’ need. Those who are successful at doing so will win their heart & loyalty. Customers don’t pay for the sake of paying it. They are willing to pay because they like it. Having a suggestion form on the table, shows how much the business owner is concern towards customers’ need. This is also part of the effort to achieve greater allocative efficiency (P = MC). I understand that it is difficult to fulfill everyone’s need, but having that form on the table at least will also create an impression that you care for their need

(2) Reducing cost

(a) Energy efficiency. A small space shouldn’t be occupied with so many air conditioners. It’s time to shift one & move it to the right, so that the cool air circulation is more balanced. Closed, perhaps one air conditioner after peak period such as lunch. I don’t see the need of fans too

(b) Reduce water shortage. Make more frequent trips to the back to ensure that the kitchen helper do not waste water by turning on the tap all the time

(c) Reduce wages cost in future. Since the commitment has been made, it is sort of difficult to turn & reverse the decision. However, for future maybe the owner can consider reducing the payroll. In fact I feel that the current pay is extremely high for a Myanmar worker. Furthermore, they have been provided with food & accommodation or even transportation. Busy during the peak period is not a good excuse to ‘overhire’ workers. Many restaurants operate the same way too

(d) Not necessarily for specialisation. Normally, division of labour each specialising in a specific task applies more to big large organisations. This is because the volume of production is very high & also it enables them to actually achieve economies of scale (EOS) from doing so. For small scale business, such action is not feasible as it only increase the production costs. Say, 3 workers preparing the meals are paid RM 1200 each (RM 3600). I would rather reduce them to 2 & the task of the third worker is shared between those 2. Now I will just have to pay them say, RM 1400 each (RM 800 cost saving). The restaurant at the meantime is said as being productive inefficiency (MC ≠ AC, not producing at the minimum of LRAC)

I didn't mention about reducing the cost of raw materials due to difficulty to get a supplier for good meatballs, vegetables, chicken etc at reasonable price

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