Restaurant Finance 101: Let's Unpack Why That Dish Costs So Much

This is an entry in The ARTery's new food and culture column from Irene Li, chef and co-owner of Mei Mei in Boston, that explores food and the role it plays in our lives.

We’ve all noticed it: Restaurants are always getting more and more expensive. A high-end dinner for two can easily add up to over $100, even without second drinks or dessert. Bottles of wine that retail for $15 are going by the glass for that price or more. Understandably, guests are increasingly frustrated. In response to a recent Boston Globe article, a theme emerges in the battle royale of the comments section: “Why not serve good food and wine at a reasonable price?”

It may seem like a rhetorical question, but it’s not. At most restaurants, menu pricing relies on a specific set of principles and industry standards that have nothing to do with the owners’ greed or disregard for his or her customers’ budgets. Yet, when faced with this question, owners and operators tend to cite vagaries like competition from corporate chains, rising commercial rents or unfavorable changes in wage laws. Those answers aren’t wrong, but it’s understandable that they can’t quite soothe the sting of food that truly seems overpriced.

Restaurants need to get better at explaining this stuff, but lots of operators feel like this is just shouting into the void. It’s true that some customers aren’t interested in the challenges we face. But menu prices continue to rise, and our diners are younger and more curious than ever before about the "true cost" of the products they consume. As a restaurant owner, I want to shed some light on what those costs really are. Diners deserve to know the complexities of the industry, and fortunately, there are models for precisely this kind of education.

Last year at Mei Mei, we started implementing open book management. At its core, open book is about making sure every "player" on the team understands how to win the "game." So at open book restaurants, like the ones that work with local consulting firm Rethink Restaurants, everyone on the staff learns the basic economics of the restaurant business. From industry benchmarks for expenses to the nuances of the profit-and-loss statement, employees get to see the financial inner-workings of their employer, and to understand how we achieve our version of success: the generation of "good profit" that creates value for all stakeholders.

Some of our own employees, when analyzing our best-selling sandwich, the Double Awesome, started out shrugging their shoulders at the price point ($8.50). “It’s just an egg sandwich,” they remarked, not incorrectly, like so many Yelpers before them.

As they saw deeper in to our financials, the price tag began to make a certain amount of sense and staff turned the conversation from reducing the dish’s price to properly communicating its value to guests. With open book, the team gains insight into our business decisions and performance, and to see how they personally fit into the bigger picture. Everyone on the team is educated and empowered to play to win.

To further belabor the sports metaphor, it’s valuable to make sure that the consumers of the "game" — our diners — also understand how it’s played. So let’s start with a scenario that you’ve probably experienced: You go into a restaurant and order a simple, delicious-sounding $10 menu item, like a fancy avocado toast — hi, fellow millennials! When it comes to the table, it tastes pretty good, and it looks nice, but it just feels overpriced. “I could have gone to the grocery store and made this myself for three bucks,” you think.

And you’d be right. The ingredients on your plate, by restaurant industry standards, should not cost more than $3 for the restaurant to buy. If that feels like a scam, then know that this is the social contract that restaurants and diners have been engaged in for a long, long time. Still, many of us believe implicitly that a menu price should reflect the tangible, physical value of the food on the plate.

Most of us know that we’re paying for more than just the ingredients, but we’re not that good at identifying exactly what those things are or what they cost. In our open book classes, we ask our team to estimate — after we spend two or three dollars on ingredients — how many dollars go toward the labor required to produce the dish? How many dollars go toward other expenses, and what are those expenses? How many dollars does the restaurant keep?

Our staff usually underestimate expenses and overestimate profit — maybe you do, too. Typical benchmarks for a financially healthy restaurant go something like this:

[*Increasingly, as minimum wage and cost of living increases, the split between food and labor is trending towards the latter. At Mei Mei, we drive for 20 percent food cost and 40 percent labor cost. In most businesses, the combination of the two is known as prime cost, and should not exceed 60 percent.]

While food cost is relatively straightforward for our team to understand, labor and overheads expenses require a bit more exploration.

Labor cost, or more specifically direct labor cost, can be summarized as "all the money it takes to pay people to make our product." It includes not only hourly wages, but overtime, training expense, payroll tax, workers’ compensation insurance, and any other benefits that are offered, like family meal or health insurance.

In our scenario, it covers the cost of employing the dishwashers who clean your dirty dishes properly for the next guest, and the cooks who are carefully trained to prepare your avocado toast safely and quickly. There are real skills involved in working in the back of house, even for the simplest of dishes. When you consider that your health is literally in their hands, perhaps $3 or $4 out of $10 seems a fair price to pay.

Overheads cost can be summarized as "everything else." However, this shorthand leaves much to the imagination and allows us to minimize the important of these expenses to restaurant operators. In the early stages of training, our staff might be able to identify 20 or 30 types of overheads — so it’s usually a surprise when they see our full-form profit and loss statement for the first time, with over 100 lines in the overheads section. The big ones are fairly obvious — utilities, rent, and so on — but the little ones are everywhere, and they add up fast. Some are guest-facing, like cloth napkins, free internet access and air conditioning, but most are tougher to identify, or completely invisible, like credit card processing, dishwashing chemicals and administrative expenses such as accounting fees and office supplies.

As you munch on your toast, you’re experiencing the sum of these parts. The restaurant pays for them, but doesn’t charge you to use them, at least not directly. Three dollars from your $10 allows the restaurant to provide things like hip plateware, soothing playlists, and my favorite example, a completely unglamorous but universal necessity: toilet paper. Restaurants don’t charge extra for it, but will provide as much as you need with no questions asked. It goes back to the social contract of dining out: Guests pay not just for the food on a plate, but for the full experience that the restaurant creates, and the restaurant provides accordingly.

Ten percent profit might seem like a reasonable margin, but in truth, the average operating profit for small independent restaurants in the United States is estimated at 4 to 6 percent. In other words, your favorite neighborhood restaurant is probably keeping only about five cents from every dollar you spend.

Owners rely on this small percentage to pay taxes replace necessary equipment, and make any needed improvements to the business. Most restaurants open with significant debt (unless they have $400,000 for a liquor license lying around), so repayments can represent the lion’s share of profit use. If there’s anything left over — and that’s a big "if" — it can then be distributed to the owners, reinvested in the business, or shared with the staff.

Hopefully these numbers shed some light on restaurant closure statistics you’ve already heard. It’s a brutal business, driven by chefs’ passion and some degree of willful ignorance, and we’re not looking for nor do we deserve pity. It would be nice, though, if there were a greater shared understanding of our industry’s financial realities — if we could allow guests to see the context and forces that shape our choices, and by extension, their dining experience. Dining out can feel unjust -- $10 for a piece of toast! -- even for me. But knowing where my dollars go, my feelings of contentment and satisfaction go deeper than the deliciousness the food I eat. And experiencing fulfillment is what dining is all about.