Why Menu Pricing Now Requires Market Basket Analysis

Menu pricing experts are seeing the old approaches for determining the best price for each item no longer work. The simple explanation for this shift lies in the changes in customer behavior and the financial reality of those customers with the devastation of inflation, and the effects of the pandemic. Learn why menu pricing now requires Market Basket Analysis.

Traditional Menu Pricing Methods

Menu pricing has long been a critical aspect of the restaurant industry, shaping the perception of value, profitability, and overall success. Over the years, various traditional menu pricing methods have been developed by restaurants to determine the prices of their menu items. These methods include:

Cost-Plus Pricing: This method involves calculating the total cost of preparing a menu item and then adding a desired profit margin to determine the selling price. It is a straightforward approach but may not consider factors like customer demand or competitor pricing.
Competition-Based Pricing: Some restaurants set their prices based on what their competitors are charging for similar menu items. The goal is to match or slightly undercut competitors' prices to attract price-sensitive customers.
Demand-Based Pricing: In this approach, menu prices are adjusted based on the perceived demand for specific items. Popular dishes may be priced higher, while less popular ones may have lower prices.
Fixed Markup Pricing: A fixed percentage markup is added to the cost of each menu item. This method provides consistent profit margins but may not consider fluctuations in ingredient costs or customer preferences.
Psychological Pricing: Pricing is set just below a whole number (e.g., $9.99 instead of $10) to create the perception of a lower price and encourage more purchases.
Seasonal Pricing: Prices for certain menu items may be adjusted based on seasonal availability of ingredients or to reflect seasonal demand fluctuations.
Menu Engineering: Analyzing the popularity and profitability of each menu item to strategically adjust prices and menu placement to maximize revenue.
Value Menu Pricing: Offering a selection of lower-priced menu items to attract budget-conscious customers while maintaining higher prices on premium items.
Prestige Pricing: Setting higher prices on certain items to create a perception of exclusivity and quality.
Dynamic Pricing: Using real-time data and market conditions to adjust prices dynamically based on factors like demand, time of day, and customer traffic.

It's important to note that while these traditional approaches have been commonly used, the shift towards data-driven techniques like Market Basket Analysis is becoming increasingly valuable for understanding complex customer behaviors and optimizing menu pricing in the current restaurant landscape.

The Need for New Pricing Methods

In a recent article, pricing expert Michael Lukianoff said “If you’re running the models the way we normally would have, you’re going to get some crazy readings.” The recent changes in behavior require a different approach, and a different set of data than just a few years ago. “That doesn’t mean that you shouldn’t be using the data to understand what’s happening, but a pure price elasticity model is not going to work,” says Lukianoff. Instead, he recommends looking at basket elasticity, rather than individual menu items to see how customers are altering their behavior.

The effects of delivery, the safety protocols of the pandemic, school from home and work from home have all contributed to the change in customer behavior. Generally, the data you need today is far more granular than a simple product mix view of customer behavior. Instead, operators should be examining how the basket of items a customer buys changes over time. For example, you may see that the data related to your signature item could appear to be insensitive to price increases because every time the price is raised, the quantity sold stays steady. What you don’t see if you only examine that one menu item is that the customer has dropped a beverage from the order and used water instead. The lost revenues and margins of the beverage is a negative to both the top line and the margin.

Times have changed, and the most successful companies are studying the market basket to identify more effective price adjustments.

What is Market Basket Analysis

You may be asking what the term Market Basket means and why is it better than the traditional Product Mix report to evaluate price elasticity? The simple answer is that Product Mix measures demand at a menu item level, in other words each menu item is examined individually, apart from other menu items. A Market Basket approach takes into account all of the purchase decisions the customer makes during their transaction, meaning it examines the contents of the entire check and not each menu item individually. With a market basket approach you can see trade off decisions the customer makes to achieve an overall check amount target.

Data Requirement for Market Basket Analysis

To use Market Basket analysis effectively, restaurants need access to comprehensive and granular data. This includes detailed check information, a breakdown of menu items included in each transaction, applied discounts and promotions, time of day, server information, revenue channels used by customers (e.g., drive-thru, eat-in), and payment methods. Leveraging technology is crucial for data collection and organization, allowing operators to group and analyze similar checks over time to identify trends and customer preferences.

Identifying Trade-offs and Trends

Market Basket Analysis empowers restaurants to identify trade-up and trade-down behavior among their customers. By analyzing long-term trends, operators can make data-driven pricing decisions that optimize revenue and enhance margins. This approach also reveals subtle adjustments in customer preferences, enabling restaurants to fine-tune their offerings and adapt to changing market dynamics.

As the restaurant industry continues to evolve, it is essential for menu pricing methods to evolve as well. Understanding customer behavior and preferences through granular data enables restaurants to make informed pricing decisions that drive revenue growth and enhance customer satisfaction. By utilizing Market Basket Analysis, restaurants can navigate the dynamic market landscape and ensure their continued success in an ever-changing world.