Restaurant Economics 101: What You Need to Know about the Economics of Running a Restaurant
Here is your Restaurant Economics 101: what you need to know to develop a strong business plan.
Financial literacy is a crucial part of running a restaurant, whether it’s having an understanding of the unit economics of your restaurant or having a pulse on economic trends affecting your restaurant. Understanding the economics of managing a restaurant will help you develop a strong business plan and better assess the risks of opening and operating a restaurant.
The economics of running a restaurant
Like any other business, restaurants aim to generate more money than they cost to start up and to operate. Understanding your cost and revenue drivers is key to running a profitable restaurant.
Let’s start by taking inventory of your cost and revenue drivers.
Restaurant Start-Up Costs
If you’re starting a new restaurant, make note of the start-up expenses you expect to incur. Here are some examples:
First months of rent, or down payment
Restaurant Operating Costs
For operating costs, consider the ongoing expenses of running your restaurant. Below are some examples:
Food inventory from various vendors
Repairs and maintenance
Services like laundry
Restaurant Revenue Channels
Make a list of all the ways your restaurant generates revenue. Here are some ideas:
Takeout and delivery
Over the phone
Through your website, in partnership with your POS provider’s online ordering service
Through third-party food ordering apps
Bundles like holiday meals or meal prep boxes
Restaurant Unit Economics
Now that you’ve identified your cost and revenue drivers, you can analyze your restaurant’s unit economics.
Unit economics refers to the understanding of how the individual units you sell are influencing the profitability of your business. Calculating the unit economics of your restaurant helps you get actionable insights from your financial data. You’ll be able to set goals for how many orders you need to generate for your business to be profitable, how much you should be cutting costs, or where you might want to try increasing revenue.
Start by deciding which unit to use in your analysis. Which unit can you easily measure and translate to goals for your business? A common choice is using a single order as a unit, though you could also choose to use individual menu items sold if you’re looking to do some menu engineering.
Once you’ve chosen the unit for your analysis, consider if you want even more specific data.
Let’s say that you’ve decided to use orders for your analysis. You might suspect that the unit economics aren’t the same for all orders. For example, you may notice that dinner orders have better unit economics than lunch orders because they bring in more revenue, or that delivery orders have worse unit economics than pickup orders.
With this analysis, you can quantify those differences and understand how much impact there could be to your bottom line by directing your energy to optimize what and how you sell. Make a note of which revenue channels you’d like to better understand.
From there, line up your costs with each revenue channel. For each revenue channel, calculate how much revenue you generate per unit and what your average cost is per unit. For now, only include the production and operation costs for that specific unit (for example, include the food cost and labor cost needed to produce the order, but not the cost of your rent). Subtract the costs from the revenue to get the variable contribution. This reflects the dollars per unit sold that you have left to pay for start-up costs or other one-time business expenses.
With your unit economics analysis in hand, you can consider how to optimize your business. Here are some thought-starters:
Are there certain revenue channels with higher variable contribution per unit? How can you grow these channels? For example, would you consider investing more in marketing these channels?
Are there revenue channels with lower variable contribution per unit? Are there opportunities to increase revenue or lower costs? For example, if your online takeout orders have worse unit economics because of higher costs, perhaps you could raise prices slightly on those channels, or add suggested items to increase revenue per order. If there are few ways to improve unit economics for a given revenue channel, or you’ve tried and it hasn’t worked, should you consider turning it off?
If you’re starting a new restaurant, how long will it take for you to break even on your startup costs? Your unit economics analysis will tell you how many orders you’d need for the variable contribution to pay back startup costs.
The economics of the restaurant industry
As you evaluate how to improve your business with your unit economics analysis, you’ll also want to take a step back and consider the broader economic environment. As we have seen with the COVID pandemic in the past year, staying up to date with the economic environment can help you understand and navigate shifts in your business.
Areas to watch:
Trends with the restaurant industry evolving with the recovery from the pandemic: Are there changing trends in health and safety standards or contactless modifications that you should consider adopting to help ensure that customers keep coming back?
Trends in your local market: Are there new concepts or trends that are becoming popular in your area that you’d want to consider adopting? Has there been any new local legislation that could affect how profitable your revenue channels are? Is the pace of new restaurant openings speeding up or slowing down in your area?
Labor market trends: Are current labor market dynamics affecting what wages you should offer and how quickly you should expect to be able to fill job openings?
Inflation: Is inflation increasing your food costs or driving consumers to eat out less to save money?
Restaurant Economics 101: Done
With a strong understanding of your restaurant’s finances and how your restaurant could be affected by the broader economic environment, you’ll be well-equipped to run your restaurant profitably, even as the economics of the restaurant industry change.