How inflation expectations are driving inflation higher: The restaurant owner pricing loop unfolds

Jeremy Bess, Senior Director, Consulting Services at RMS

As anyone who runs a restaurant can attest, the restaurant business never has a shortage of concerns. But these days, the concerns are nearly unprecedented. Based on the Labor Department’s latest price index figures, consumer prices in October 2021 marked the fastest yearly increase in 30 years.

So how can restaurant owners navigate increasing market-based pressures, especially inflation and the increased costs it brings?

Consider what’s driving prices up

Restaurants are impacted by labor changes and pressures — in August, 892,000 workers in the food service and accommodations industry left their jobs.

But our industry isn’t alone. Labor shortages are negatively impacting supply chains, also driving up the cost of goods. Fueled by the need to either fill empty positions or keep current staff, operators are trying to incentivize workers with higher pay and signing bonuses, only increasing the financial squeeze they already feel.

A good indicator of inflation on menu price changes can be viewed by looking at consumer price indexes for Food Away from Home. Year-over-year changes in the index for this category are significantly higher than in previous years; it sat around 5.3% in October 2021, with limited-service restaurants rising 7.1% over the past 12 months — the largest 12-month increase in the history of the measurement.

The recent price increases have been reactive, a way to quickly reduce negative changes to the operator’s bottom line. Starting in the early part of 2020, during the early phases of the pandemic, we saw restaurants begin to pass these costs to the customer in the form of menu price increases.

However, these cost increases did not slow, and operators began to review their P&Ls using price increases as an important lever to offset costs on a month-by-month basis. Now those conversations are beginning to change as the industry assesses whether costs will remain permanent or are just a temporary fix. Even the CFO of Chipotle was quoted as saying, “It’s not clear yet what inflation will stick and what will be temporary.” While across-the-board price increases are real, uncertainty is a big factor and will continue to drive prices higher if cost relief doesn’t come soon.

Don’t always believe what you expect

This assumption that uncertainty and expectations can further drive inflation isn’t a stretch — in fact, it’s a relatively common discussion in the field of economics. See the Friedman rule, which argues why inflation expectations can actually impact inflation.

This finding continues to be a useful tool even for the Federal Reserve in understanding and managing inflation. As an example, consider the restaurant worker who believes prices will rise next year. This worker will likely demand a pay increase out of concerns that their buying power will soon be negatively impacted.

Workers’ demands put further pressure on restaurant owners who already face month after month of cost increases fueled by pandemic-related labor and supply shortages. The restaurant owner who anticipates staff demand for pay raises may increase menu prices to maintain margins.

Enter the pricing loop. Whether the increased costs actually occur is not relevant to the restaurant owner’s decision to raise prices. The expectation and feeling that they will increase drives pricing decisions. Employees do not even need to demand higher wages; operators who expect higher labor costs will raise prices in anticipation.

The price is not always right

My RMS colleagues and I are hearing rumblings of double-digit price increases to be taken now to offset potential future costs. In some cases, these price decisions are driven not by individual financial needs but by industry expectations that they believe they should follow.

I have heard clients say that they believe now is the best time to take price because it is currently so common in the industry. Over the summer, many of us closely followed the news when Chipotle made its public announcement that the company would be increasing menu prices due to labor pressures. Our team relies on a more customized approach. What works for Chipotle, for instance, may not work for another operator due to the unique operational and price value equations for every brand and even every location.

Until uncertainty recedes, the trend of increasing prices before costs rise will most likely continue. Randy Esponda, Director of Operations for Sun Pubs, a restaurant investment group operating nearly a dozen eateries across South Florida, said, “The supply chain shortages, due to many variables, have caused unpredictable ups and downs across the board with no end in sight.” His team now has weekly pricing discussions about how to manage the squeeze on profits while balancing how customers perceive their brand’s value.

Take these actions before taking price

Although pricing is a tool in the quest for better profit margins, it is not a silver bullet. Pricing decisions can have long-lasting effects on traffic. Before operators make eating out more expensive for consumers, we recommend considering the following:

  • Review your P&Ls closely. If the data is available, compare your P&L to other restaurants within the same brand — what we call peer benchmarking. Benchmarking allows store operators to pinpoint weak spots and discover areas of opportunity you may have overlooked.
  • Examine your restaurant’s processes. As you do, you might find some additional places to save costs — whether from decreasing labor hours during slow periods, monitoring waste/spillage or even discovering theft.
  • Take a look at the menu. Are there opportunities to streamline your menu to reflect what diners want while balancing what your kitchens can produce? RMS uses a proven Test and Learn approach, which can be applied to assess your quick reactions to the changing times or design a long-term strategy to create systemic change.
  • You’ll also want to examine your menu real estate. Is it optimized to drive customer spend, or are you reserving suggestive sell opportunities for checkout? If printing menus comes at a high cost, explore less-expensive alternatives such as QR codes. Now might be the time to consider upgrading to digital menus.
  • Understand your purchasing power. Although food costs continue to mount, you may be able to get better deals by purchasing more. If you can stomach the inventory space or find ways to drive incremental traffic, you can leverage these economies of scale.
  • If pricing is the last resort, or inflation expectations turn into real inflationary pressures, then consider understanding how your guests have absorbed recent price changes, which products are your brand’s traffic drivers and what items are bought together. Don’t react without taking time between pricing rounds to analyze the effect. RMS recommends waiting at least 3-4 purchasing cycles.
  • Lastly, consider removing promotional deals that haven’t demonstrated increases in traffic or higher average spend. Promotions can be turned on or off easily, while price increases are harder to reel in and may have a long-term effect on traffic.

The trajectory of inflation remains to be seen. One thing is certain — RMS is here to support the industry with solutions including profitability and pricing strategies, menu engineering, actionable financial insights and more.

If you’re interested in accelerating your brand’s growth, we encourage you to reach out to schedule your personalized demo of our new financial solution, metiRi, or any of our other solutions. RMS is committed to equipping you with a path forward — informed by data. Contact us today.

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