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6 Factors that Shrink Profit Margins in Restaurants and How to Minimize Them

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The average restaurant profit margin is only around 6-9%Even small mistakes can eat away at these thin margins, and put your business at risk. Restaurants are facing a critical challenge to maintain profitability in this highly competitive industry, and unexpected costs and inefficiencies can quickly erode profits. In this article, we’ll identify the top factors that shrink profit margins, while giving you strategies to minimize their impact and boost your bottom line.   

Expressed as a percentage, a restaurant’s profit margin is how much revenue remains after all of the expenses have been costed in. This key indicator shows the financial health of the restaurant and tells you how much of each dollar earned is profit. For example, if a restaurant has a profit margin of 10%, it would mean that $0.10 for every dollar earned is profit. The higher the figure, the more profitable the restaurant is. 

Things like inefficiencies, unexpected expenses, or management mistakes can reduce profit margins. Understanding these can help you reduce their impacts and protect your profits. 

#1: Food Waste

Food waste is a huge problem on a wide scale. For restaurants, it can silently shrink profit margins. Estimates suggest that $218 billion worth of uneaten food (1.3% of GDP) is grown, processed, transported, and disposed of each year among farms, businesses, and consumers. This exorbitant figure, while shocking, has the potential to be reduced significantly. 

When margins are already tight, even the smallest amount of food waste can have a large impact on your profit margin. Every ounce of food thrown away is considered money lost–and it’s money that could have been better used elsewhere, whether as take-home pay or to improve the business. 

The Real Cost of Food Waste

If we put the direct costs aside (the ingredients, for example) and concentrate on the indirect costs like labor, this can be equally damaging. Over time, the costs of labor in food preparation and disposal can really stack up.

Strategies to Reduce Food Waste

Food waste reduction calls for proactiveness and smart strategies:

  • Use Portion Control Measures: One of the easiest ways to reduce how much food is wasted is by serving up the right portion sizes. If you notice that on the whole customers are leaving large amounts of uneaten food, it’s time to reconsider how much food you’re giving them. This will help cut down on food waste and its disposal while also improving the effectiveness of how you’re managing your inventory. 

  • Use Inventory Management Software: Knowing what you have on hand and how quickly it is used can help you reduce food waste significantly. Rather than heading to the wholesalers and buying what you think you need, using inventory management software with real time reporting can help you monitor stock levels as you go so you’ll only need to buy fresh food when you know stocks are low. 

    Although we’re talking about food waste in regard to profit margins, it’s also important to consider the sustainability aspects of it. Consider using ESG reporting software to track and report on sustainability metrics so you can align your food waste goals with wider sustainability efforts.
  • Train Your Staff: Proper training is crucial for reducing food waste. All employees involved in food storage, handling, and preparation should be taught appropriate protocols and techniques to keep food fresher for longer. Using innovative training resources like flipbooks for eLearning can provide information in a fresh way to retrain staff and wipe out bad habits.  

#2: Labor Costs

Typically, your restaurant labor costs are around 30% of revenue but this depends on your restaurant. When we talk about labor costs, we’re not only considering wages. Other expenses can also fall into this bracket. For example:

  • Incentives and bonuses
  • Health insurance
  • Payroll taxes
  • Overtime

This makes this the single largest expense, but when managed well, your staff are arguably your greatest asset. However, mismanaging labor costs means your employees can become a drain on your profits. 

The Financial Impact of Mismanaged Labor

Problems arise from overstaffing, understaffing, and employee turnover, which can all impact a company's bottom line.

  • Overstaffing can lead to excessive labor costs if there are too many employees working in quiet times. 
  • Understaffing can harm customer service and result in lost sales or a damaged reputation.  
  • High employee turnover has its own associated costs: the costs of recruiting, hiring, and training new employees add up quickly.

Strategies to Optimize Labor Costs

To optimize labor costs, consider the following strategies:

  • Use scheduling software: Software can help you work out the right number of people needed at work for the typical customer flow. It can help you analyze historical data so that you don’t overstaff or understaff, which helps to reduce unnecessary labor costs and maximize staffing and scheduling.

  • Cross-train employees: When employees can carry out multiple roles, they’re more flexible and efficient. It means your staff can provide cover as needed, which reduces the risks of being short-staffed. 

  • Create incentives: By rewarding employees for their loyalty and performance through Incentives, you can help to reduce turnover—and the associated costs. When staff are motivated and engaged, they’re more likely to stick around and be productive too. For some restaurants, investing in a business VoIP phone service can improve communication and efficiency too, which contributes to cost savings.

#3: Inefficient Menu Design

While you might think that offering a large menu will bring more customers and, therefore, more profit into your restaurant, it could actually be a major drain on profitability. 

Having too many choices makes it difficult for guests to choose, but it also makes things difficult in terms of inventory management, food preparation, and quality. A streamlined menu helps to reduce food waste while improving guest satisfaction and food quality.    

An inefficient menu design might also mean you end up with poor sales of high-margin items or high sales of low-margin dishes. Your physical menu design should draw attention to the dishes that have a higher margin. If these items stand out, your customers are more likely to choose them, and you’ll reap the rewards with higher profits.

Strategies for Optimizing Your Menu

To optimize your menu for maximum profitability, you should:

  • Perform a menu engineering analysis: Identify which items are high-margin and which are low-margin so you know which ones are most profitable. Use this information wisely and promote high-margin items prominently. Consider removing low-performing items. 
  • Update your menu regularly: Keep the menu fresh and appealing with regular updates. Base any alterations on sales data and customer feedback.
  • Streamline the menu: Concentrate on offering dishes that are both popular and profitable. Reduce the number of items and streamline your operations to enhance the dining experience, reduce food waste, and improve efficiency. 

#4: High Overhead Costs 

Overheads like rent, utilities, and equipment maintenance can quickly mount up and eat into your profits. The great thing about these costs compared to your revenue, however, is that they’re relatively stable. Of course, should your revenue dip, they can be a significant financial burden. 

The Burden of Fixed Costs

Although you know what you’re paying each month, which is great, the fact that your overhead costs don’t fluctuate with your sales means they can pile up in periods of lower trade. 

High rents, expensive utility bills, and costly maintenance can mean financial strain for your business. 

Strategies to Manage and Reduce Overhead Costs

Firstly, using tools such as financial planning and analysis (FP&A) from OneStream can help you to better manage your fixed expenses and forecast them more accurately. With such software, you can project future costs, create budgets, and make more informed decisions so your overhead costs are kept under control. 

Here are some other ways to help manage and reduce overhead costs:

  • Negotiate with your landlord: Your rent is one of the largest outgoings and negotiating with your landlord might help you to secure better lease terms or lower rent. 
  • Invest in energy-efficient equipment: You can reduce your utility bills by investing in more energy-efficient equipment. Modern appliances can reduce how much energy you consume, which contributes to cost savings. 
  • Maintain your equipment regularly: Ensuring regular maintenance is carried out means that you’ll help prevent costly breakdowns. When equipment is well-maintained, it operates more efficiently too. 

Finally, to manage risks associated with overheads, third-party risk management tools can be useful too. 

#5: Poor Inventory Management

We’ve already touched upon food waste but it’s important to understand the larger costs of poor inventory management. If you’re not monitoring your inventory carefully, you can run into problems like over-ordering, stockouts, and inflated food costs. Carrying out regular internal audits can help you find areas where things aren’t working as well as they should. 

But, what is an internal audit for a restaurant? Simply put, this is a formal evaluation of the procedures and practices in place to make sure things are in order. In terms of inventory management, this can help keep things on track in terms of food stocks and waste, which impact your customer satisfaction as well as your profitability.

#6: Not Moving with the Times

Customer expectations have evolved significantly in the last five years. It’s almost as if the COVID-19 pandemic was a reset button for restaurants and how they work with technology. Being online and using technology is no longer considered optional—this is now essential for any restaurant seeking to attract customers, maintain efficiency, and stay relevant. 

Technological Lag

Restaurants that don’t move with the technological times are facing a range of issues. Outdated systems can result in slower service within the restaurant while elsewhere, it makes it difficult to track your customer preferences or market to them effectively. This can erode profit margins and affect your reputation too—a double whammy impact.

Strategies for Keeping Up

Fortunately, there are useful tools available, like sales engagement software, that can help enhance customer interactions and streamline sales processes. However, the most impact on your profit margin will come from:

Embracing online ordering and delivery

Offering these options, whether through your own website or third parties, can expand your customer base and increase sales. More and more people are choosing to eat restaurant-quality food at home and so you need to be a part of this change. 

Using a modern point-of-sale (POS) system

Modern POS systems have advanced features that track customer purchases and provide detailed reporting and insights. These systems can help you know which dishes are most popular and which you could consider leaving off your menu. You can also use these to help with inventory management.

Staying active on social media

Having an active presence on a range of social media platforms will mean you have a better connection with your audience. This also allows you to promote what you offer, highlight any restaurant promotions, and stay in line with current trends.

Conclusion

The restaurant industry is challenging—it’s a competitive landscape with thin profit margins. Tackling things impacting your profit margin can make a significant difference. By managing food waste, optimizing labor, refining your menu, controlling overheads, improving your inventory practices, and embracing technology, you can set your restaurants for long-term success and profitability. 

The key to all this is being vigilant and proactive about changes. In doing so, you turn potential pitfalls into opportunities for improvement. In this article, we’ve explored six critical profit margin killers that impact your restaurant’s bottom line. By understanding and addressing these issues quickly, you can improve your restaurant’s financial health now and in the future. 

Don’t let profit margin killers undermine your success. Start implementing the strategies we’ve discussed today to protect and boost your profit margins. 

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