Activity-based pricing: can it be

applied in restaurants?
Carola Raab and Karl Mayer
William F. Harrah College of Hotel Administration,
University of Nevada Las Vegas, Las Vegas, Nevada, USA
Stowe Shoemaker
Conrad N. Hilton College, University of Houston, Houston, Texas, USA, and
Steve Ng
Institute of Professional Education and Knowledge, Hong Kong
Abstract
Purpose This paper aims to demonstrate how activity-based pricing can be applied in a restaurant
setting by combining the use of price sensitivity measurement with activity-based costing.
Design/methodology/approach Data are collected at a Hong Kong buffet restaurant, based on
guests price perceptions and the establishments detailed cost structure. These data are analyzed by
using price sensitivity measurement techniques and activity-based costing methods, separately, and
then combined to create an activity-based pricing analysis of the restaurants menu.
Findings The use of activity-based pricing techniques reveals that, although the guests are
relatively price-insensitive, drastic measures were needed to reduce costs for the restaurant to become
protable. Without the benet of this study, the restaurants management would not have been able to
see clearly the nature of the challenges that they faced, since a single pricing study, or cost study,
would have missed the combined cost and pricing effects that were captured by activity-based pricing.
Research limitations/implications Activity-based pricing is shown to be a powerful technique
that can be applied effectively in a restaurant. Utilizing this method allows a restaurant truly to
understand both its operating cost structure and the price perceptions of it guests. Since this study
involved only a single buffet restaurant, further research should be conducted to conrm that
activity-based pricing can also be applied in other restaurant and hospitality industry settings.
Practical implications The ndings from this study suggest that activity-based pricing may be a
viable way for restaurant managers to gain a better understanding of both their guests price
perceptions and the true cost structure of their restaurants. Use of activity-based pricing allows
restaurant managers to set price levels that cover all operating costs and prots, while still meeting
guests expectations of value.
Originality/value This study is the rst of its kind in the hospitality literature, since no prior
research has applied activity-based pricing in a hospitality research setting. This study represents an
important new addition to the existing body of hospitality cost and pricing literature.
Keywords Activity based costs, Pricing policy, Restaurants
Paper type Research paper
Introduction
Establishing effective pricing strategies is critical to managers. The pervasive
inuence of price is due, in part, to the fact that the price cue is present in all purchase
situations, especially in services. At a minimum, price represents to consumers the
expense that must be incurred in the given purchase transaction. Zeithaml et al. (2006)
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0959-6119.htm
Activity-based
pricing
393
Received 7 January 2008
Revised 10 March 2008,
23 May 2008
Accepted 17 September
2008
International Journal of
Contemporary Hospitality
Management
Vol. 21 No. 4, 2009
pp. 393-410
qEmerald Group Publishing Limited
0959-6119
DOI 10.1108/09596110910955668
propose that, because price serves as a proxy for quality for customers, it must be
determined very carefully. Many authors have identied the importance of pricing for
every companys protability, mainly because it is the only element of the marketing
mix that generates revenues for a rm, while all other elements of the mix are
associated with costs (OConnor, 2003; Shoemaker et al., 2006; Kotler et al., 2005).
Avlonitis and Indounas (2006) suggest that pricing decisions can be implemented
easily, and at relatively low incremental costs. In addition, Shoemaker et al. (2006)
suggest that pricing is a powerful force in attracting attention and increasing sales, and
that it can also have a major inuence on customer loyalty. Despite the signicance of
pricing, several authors indicate that pricing is the most neglected element of the
marketing mix (Drucker, 1993; Avlonitis and Indounas, 2006; Hoffman et al., 2003).
When setting prices in services, basic economic pricing theory needs to be adhered
to in which prices are a balance of supply and demand factors. In addition, a detailed
understanding of total cost (variable, undistributed and xed costs) per unit sold has
become increasingly important for restaurant pricing decisions, since management
must be certain that prices are adequate to cover all costs while allowing reasonable
prots to be earned (Raab and Mayer, 2003). For example, in the restaurant sector,
undistributed operating expenses, such as labor and other indirect costs, have
increasingly captured a larger percentage of the total cost structure (National
Restaurant Association, 2001; Schmidgall, 1997). However, prices also need to be
established with the concept of customer loyalty in mind and not just short-term prot
maximization (Shoemaker et al., 2006).
The goal of this article is to replicate and extend prior work in the areas of both price
sensitivity measurement and activity-based costing by combining both of these
methods to demonstrate the use of activity-based pricing. Activity-based pricing (ABP)
is a pricing method that combines market research data with cost accounting
information to establish prices for products and services that result in designed prot
levels (Daly, 2002). In this study, activity-based costing is used to establish a total cost
picture for a restaurant (excluding taxes), and price sensitivity measurement is used to
identify customer price perceptions. Thus, this study applies ABP to the restaurant
industry for the rst time.
Understanding costs in restaurants
Typically, whether in the USA or Hong Kong (HK), very little attention is paid to total
operating expenses when restaurant menu prices are established (Chan and Au, 1998;
Raab and Mayer, 2003; personal communication, 2006). Most often, menu prices are
calculated strictly as a function of the cost of goods sold along with a certain mark-up
percentage (Schmidgall, 1997). In this regard, Chan and Au (1998) addressed the lack of
incorporating overhead (especially labor and energy costs) into menu-item protability
analyses. They investigated the signicance of these overhead costs in HK Chinese
restaurants and identied the factors that affected quantication of such costs. They
interviewed food and beverage professionals to learn about the degree of signicance
of labor and energy costs in HK restaurants and the likelihood that managers
incorporated these overhead costs into their menu item protability calculations. Chan
and Au (1998) also found that HK restaurant operators stated that labor costs were a
major expense which should be included in gross prot calculations (i.e. labor was up
to 36 percent of total revenues in HK hotel restaurants). Furthermore, their study
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revealed that energy and water costs were less signicant than labor costs but should
also be considered in calculating overheads on a per menu item basis. They concluded
that most HK restaurant operators were prevented from quantifying labor and energy
costs on a per menu item basis by the high implementation costs of doing so. A major
nding of their study involved the need for a system that allows for the tracing of labor
and energy costs to menu items. This nding is also important for the current study, in
that activity-based costing (ABC) is a system that can accomplish this goal for
restaurants.
ABC is a theoretical approach that has provided manufacturing rms with a
better grasp of their costs, and has led to important practical implications for
operating managers in both the manufacturing and service industries. Kaplan and
Cooper (1988) demonstrated that the domain of traditional contribution margin
analysis could be greatly enhanced by the use of ABC. ABC has major advantages
over other costing methods by showing the ability to trace overhead costs to
individual products, which allows for more accurate unit costing (Cooper and
Kaplan, 1992; Garrison and Noreen, 1997). The key to proper use of ABC methods is
to trace overhead costs to products and not merely to allocate them (although some
cost allocation may be necessary during the ABC process). Furthermore, ABC infers
that activities are the antecedents of cost and that cost objects create the demand
for activities. The general conditions that make companies good candidates for the
application of ABC systems have been pointed out, such as a diversity of resource
consumption, or the fact that product and resource consumption are not correlated
with traditional cost allocation methods. Rotch (1990) stated that these conditions
also apply well to services companies.
Raab (2003) adapted Coopers (1989) ABC model to restaurants, and found it to be a
feasible way to gain detailed insights about the operating prot margins of individual
menu items. The ABC restaurant model was subsequently applied in a pilot study to
test the applicability of the ABC concept to a buffet style restaurant in HK (Raab et al.,
2005). That study revealed that the ABC model established for a ne dining restaurant
in the USA by Raab (2003) could also be applied to other restaurant segments. Thus,
ABC appears to be a method that restaurant operators can use to help better
understand their menu item protability.
However, standard operating practices in restaurants still reect the fact that
individual menu item prices often do not directly incorporate any major operating
costs, such as labor, utilities, direct operating expenses, or xed costs (Schmidgall,
1997). This situation presents a major challenge for restaurants, since in highly
competitive market conditions, proper pricing measures become extremely important
as prot margins are subjected to downward pressure. Therefore, in highly
competitive markets, restaurant operators may no longer be able to afford to price their
menus based on simply marking up their variable product costs but may need to use
more sophisticated approaches to ensure the survival of their businesses. The next
section of this paper will discuss how prices are commonly set in the hospitality
industry.
Types of pricing applied in the hospitality industry
Hospitality rms use various methods to set prices for their products. Hospitality
managers often select different pricing approaches based on a combination of several
Activity-based
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395
factors, which include a rms cost structure, competitors prices and customer value
perceptions of hospitality services (Kotler et al., 2005). Cost-based pricing usually
involves mark-up techniques using actual variable costs (product costs) at a desired
product cost percentage. This pricing method is commonly used to set menu prices in
restaurants. Alternatively, pricing methods based on customers value perceptions of
hospitality products exclude the consideration of costs and attempt to provide value by
offering high quality at reasonable prices (Lewis and Shoemaker, 1997; Shoemaker
et al., 2006). Furthermore, several price adjustment strategies, such as volume-based,
time-of-purchase discounting, or discriminatory pricing, are also commonly used in the
hospitality industry (Kotler et al., 2005). Many hospitality rms set their prices by
considering guest demand and costs only as secondary factors; they set prices
according to the going rates of their perceived competitors. In addition, hospitality
rms can also apply price sensitivity measurement (PSM) methods. PSM is a technique
that reveals how relationships between price and quality affect customers perceptions
of value (Lewis and Shoemaker, 1997). PSM data can then be combined with ABC
methods. When ABC and PSM methods are combined, the resulting approach is known
as activity-based pricing (ABP; Daly, 2002).
This study will apply ABP methods to a buffet restaurant in Hong Kong. It
established optimal price points for a buffet restaurant by adapting the PSM
methodologies used by Lewis and Shoemaker (1997) in their study of the association
meeting market. The study contributes to academia and to the restaurant industry in
several ways. First, it introduces ABP as a management tool that emphasizes
protability over revenue generation. Second, the study adds depth to the existing
restaurant pricing literature. Finally, the study shows restaurant managers how to set
optimal prices based on customer derived-pricing ranges and more complete
(ABC-based) cost information. Next, PSM methods are discussed to examine how
relationships between price and quality affect guests perceptions of value.
Price sensitivity measurement
In services, price often plays an important role in a consumers expectation of quality.
Thus, if price is used as a primary marketing tactic, operators must take into account
at least two roles of price (Kotler et al., 2005). First, when price acts as a dominant
indicator of quality, the pricing aspect of the marketing mix can be used to position the
product. Alternatively, when price acts as a relative indicator of quality, it can be used
to alter guests perceptions of value. A guests price-value relationship usually extends
beyond the simple monetary price of a service and includes other aspects of value, such
as search, credence, or experience costs (Zeithaml et al., 2006).
The PSM approach was applied to the association meeting market by Lewis and
Shoemaker (1997). PSM can be used to investigate how consumer perceptions of value
are affected by the interaction of price and quality. The Taco Bell fast food restaurant
chains value-pricing menu is an example of the application of PSM. Usually, value
pricing is misconstrued as offering deep discounts, which can lead to a detrimental
industry-wide focus on price cutting. However, when value pricing is based on PSM,
value pricing becomes a technique that actually establishes a balance of price with
product or service value (Lewis and Shoemaker, 1997). PSM was rst explored by
Gabor and Granger (1966), who asked retail customers about upper and lower price
limits in their minds when considering a product purchase. They determined that,
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within certain limits, price acts as a quality indicator, but not as a purchase barrier;
however, outside of these limits, price can actually become a barrier to purchase.
The concept of price limits was further developed by Travers (1983), who
determined the level of consumer price resistance over a range of prices in relation to
customers perceptions of value. The fundamental premise of PSM incorporates two
basic goals:
(1) to determine the threshold range in price; and
(2) to determine the stress price level (Lewis and Shoemaker, 1997).
The threshold range of acceptable prices incorporates both the lowest price (i.e. the one
below which the consumer will question the quality of the product) and the highest
price (above which the consumer feels that the product or service is too expensive). On
the other hand, the price stress range refers to the difference between the prices points
at which an equal number of customers feel that a product is cheap as think it is
expensive (Lewis and Shoemaker, 1997). Lewis and Shoemaker (1997) also pointed out
that PSM is a far more realistic approach than reference pricing. A reference price
consists of the price last paid, the price most frequently paid, or the average of all
prices paid for similar offerings (Zeithaml et al., 2006). They indicate that reference
pricing for services can be confusing in the mind of the consumer, and can produce a
lack of any specic reference point or price limits for a service. Next, the methodology
for applying PSM in a restaurant setting is discussed.
Methodology
In this study, ABP was applied to a 200-seat buffet restaurant in Kowloon, HK. The
PSM approach was combined with ABC methods at this restaurant, which had been
steadily losing money and customers (over a period of one year). As a result,
management wanted to investigate whether the operation could afford to cut prices in
order to attract new customers. The restaurant was situated within a hotel and served
breakfast, lunch and dinner. The restaurant was leased from the hotel, and the lease
cost included charges for storage and air conditioning expenses, but excluded the costs
of utilities, such as gas and electricity. Lunch and dinner were both served buffet-style
at this property. Since management felt that the food operations loss was attributed
mainly to the dinner meal period, the study was conducted for the dinner buffet only.
The regular price for a dinner buffet was HK$128, and the price was occasionally
discounted to HK$99. When management chose to offer the discounted price, the
restaurant was busy, but it apparently did not realize any prots from the added
number of guests. The buffet price was increased only during the Chinese New Year
holidays, but not on regular weekends. This is consistent with the approach reported
by Chan and Chan (2008) in their study of revenue management strategies in Chinese
restaurant operations. Given this situation, nine research questions were posed in this
study to implement ABP at the buffet:
(1) Is there a point at which the dinner buffet price is considered to be cheap?
(2) Is there a point at which the dinner buffet price is considered to be expensive?
(3) Is there a point at which the dinner buffet price is considered to be too cheap and
quality is questioned?
Activity-based
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397
(4) Is there a point at which, no matter what the quality, the dinner buffet price is
too expensive and purchase is beyond consideration?
(5) Is there a point at which it will be feasible to sell the dinner buffet at a discount
in order to attract additional business?
(6) Can the ABC model established for ne dining restaurants be applied to trace
restaurant overhead costs to a dinner buffet?
(7) Does the application of ABC reveal the true costs and prot margins of a
dinner buffet?
(8) Can restaurant management afford to lower the price for the dinner buffet for
promotional purposes?
(9) What should the price of the buffet be so that it can guarantee prots and be
between the points of marginal cheapness and marginal expensiveness?
The rst four of these nine research questions were addressed in a questionnaire
(Figure 1), along with several demographic questions; the other ve questions were
explored through the ABC analysis. The survey was handed out to dinner buffet
customers during a one-month period. The study applied a simple random design by
Figure 1.
Price sensitivity
measurement
questionnaire
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asking every second customer to answer the questionnaire. Customers who answered
received a choice of a free alcoholic beverage as an incentive. Since it was crucial that
the sample of respondents was representative of the target market of the restaurant
and familiar with the buffet dining product, qualifying questions were asked to
determine whether customers had ever purchased a dinner buffet before, and whether
they had frequented the restaurant at least once in the past. The study was conducted
only on days when no discounts were applied. Respondents were able to choose
between a Chinese or English version of the survey. The researchers, management, and
a graduate student from a local university assisted respondents in lling out the
questionnaires properly.
A total of 350 surveys were collected, of which 247 were usable. The Statistical
Package for the Social Sciences (SPSS) Version 14 .0 was used to determine whether
data were normally distributed and to identify any nonsensical responses. It was found
that the data were normally distributed. Furthermore, outliers that were identied by
using boxplot analyses were removed from the data set. SPSS also provided the
cumulative distributions necessary to graph the responses, which are presented later.
All data shown in this study are expressed in HK dollars. In addition, ABC costs were
calculated, following the approach that was developed in prior ABC studies in
restaurants (Raab et al., 2005, 2007). Thus, a detailed discussion about the application
of the ABC process has been omitted from this paper. The next section of this paper
will examine the results of the PSM analysis and then discuss how the ABC costs were
derived. Finally, the ABP analysis for the restaurant involved in this study is
developed, which combines both the PSM and ABC approaches.
Results and discussion
Four graphs were plotted from the data, as recommended by Lewis and Shoemaker
(1997). All prices displayed in the four graphs are expressed in HK dollars, and were
rounded up or down to the nearest whole dollar value. Figure 2 plots the cumulative
distributions of responses for cheap (question 4) and expensive (question 5) from
the guest survey. The intersection of the two graphs (at approximately HK$130)
represents the indifference price (IDP), which is the pricing point at which an equal
amount of customers feel that the price is cheap as it is expensive (Lewis and
Shoemaker, 1997).
Furthermore, an indifference price percentage (IPP) was established in Figure 2,
which is the subsequent cumulative distribution percentage (on the vertical axis) at the
indifference price. A low IPP indicates a high level of price consciousness, while a high
IPP indicates a lot of variability in the data with regard to price (Lewis and Shoemaker,
1997). The IPP in this study is approximately 15 percent, which indicates a fairly
high level of price consciousness by dinner buffet guests.
Figure 3 depicts the optimal pricing point (OPP), or the point at which the purchase
resistance is at its lowest. It is plotted by combining the cumulative distributions of
too cheap (question 3), and too expensive (question 6), responses from guests. The
OPP for this sample was HK$139. The OPP is positioned to the right of the indifference
point, which may indicate that there is less price consciousness in this market than rst
assumed, since the OPP is HK$9 higher than the IDP.
Figure 4 combines the cumulative distribution of guest responses to questions 3-6 in
the survey in order to determine whether the respondents are experiencing stress
Activity-based
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399
over the price they paid for the buffet. In general, it can be assumed that the closer the
OPP and the IDP are, the lower the price consciousness of the respondents is (Lewis
and Shoemaker, 1997). The results illustrate that the indifference point (HK$130) is
lower than the optimal pricing point (HK$139), which suggests that guests stress
levels over price are low, since the price that guests are likely to pay for a dinner buffet
Figure 2.
The cumulative
distributions of responses
for cheap and
expensive with the
intersection of the two
graphs representing the
indifference price (IDP)
Figure 3.
The cumulative
distributions of responses
for too cheap and too
expensive with the
intersection of the two
graphs representing the
optimal pricing point
(OPP)
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400
is somewhat higher than the indifference point. Therefore, price sensitivity for dinner
buffet guests is relatively low at this establishment.
According to Lewis and Shoemaker (1997), the basic idea of the PSM technique is
the reinterpretation of the data in a way that reverses the distribution of cheap and
expensive to be portrayed as not expensive and not cheap. Therefore, the fourth
plot (Figure 5) depicts this idea, and establishes a range of acceptable prices (RAP) by
combining the rst two plots (Figures 2 and 3). Figure 5 combines the reversed
cumulative distribution of cheap and expensive from Figure 2 with the
distributions of too cheap and too expensive from Figure 3. The RAP is the
distance between the points of marginal cheapness and marginal expensiveness; the
larger the range, the less price-sensitive customers are. Figure 5 shows that the range
of acceptable prices is fairly wide at $48; thus, the point of marginal cheapness was
found to be HK$100 and the point of marginal expensiveness was HK$148. This
analysis suggests that the buffet dinner guests are not very price-sensitive, since the
acceptable price range is fairly wide (relative to the base price).
Based on the PSM analysis, the restaurant could charge a maximum of HK$148 for
the dinner buffet, which was higher than the price actually charged (HK$128). Thus,
this study was able to establish an indifference point, an optimum pricing point, a
stress level, and a range of acceptable prices, all of which serve as indicators for levels
of price sensitivity in a restaurant market. The price at which customers are least
resistant to purchase the dinner buffet is HK$139, which is HK$11 higher than the
regular buffet price of HK$128. Second, the point of marginal cheapness was
determined to be HK$100. Therefore, it can be assumed that dinner buffet guests
perceive the price range between $100 and $138.99 as cheap, but without major doubts
about food quality. On the other hand, the point of marginal expensiveness was
Figure 4.
Combined cumulative
distributions of responses
for cheap and
expensive and for too
cheap and too
expensive; the
intersections between the
four graphs establish a
stress price range the
difference between the IDP
and the OPP
Activity-based
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401
established at HK$148, indicating that the price range from HK$139 to HK$148 is
considered expensive by customers but they still perceive that it is worth it for the
quality they receive. In addition, a buffet price above HK$148 is considered to be too
expensive and beyond their purchase consideration. Furthermore, dinner buffet guests
indicated that a dinner buffet price below HK$100 would introduce possible doubts
about its quality. All of these ndings are signicant insights about pricing the dinner
buffet that would have been unavailable to management without PSM.
However, even with the above pricing insights, it was still unknown whether the
restaurants protability problem could be solved by simply raising the price for the
buffet. The next step in the ABP process used in this study involved the calculation of
ABC costs for the buffet in order to be able to set a price that would cover all costs and
still allow for an adequate level of prot.
Calculation of activity-based costs
The methodology for deriving the activity-based costs for the dinner buffet has been
extensively documented in prior studies (Raab et al., 2005; Raab and Mayer, 2007), so it
is only discussed in an abbreviated manner in this study. Basically, under an ABC
approach, all costs can be traced to individual menu items using the ABC model that
has been developed and applied previously for restaurants (Raab, 2003; Raab and
Mayer, 2003; Raab et al., 2007).
In calculating ABC expenses for the restaurant, major activities for the
front-of-the-house (FOH) and the back-of-the-house (BOH) were rst identied, and
then overhead cost pools emanating from the restaurants general ledger were
established. Three cost pools were developed in accordance with established ABC
procedures based on prior studies involving ABC in restaurants: a labor cost pool,
Figure 5.
Combined cumulative
distributions of responses
for cheap and
expensive and for too
cheap and too
expensive
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which included all costs related to the employees; a direct operating supplies cost
pool; and a facility sustaining cost pool, which included all other overhead costs (e.g.
rent, maintenance, utilities, or general and administrative expenses). The rent cost item
in this study also included storage costs for inventory and air conditioning costs.
Next, the cost pools were assigned to the activity centers (FOH and BOH) and cost
pool rates were calculated. The restaurants payroll records for the month involved in
this study showed that the FOH activity center incurred a total of 581 labor hours,
including both full and part-time worker hours and management time. The factor of
labor hours worked is considered a rst-stage cost driver in ABC (Cooper, 1989). The
labor cost pool for the FOH was $18,650. Thus, the cost pool rate for the FOH
personnel cost pool was calculated to be $32.10 per hour ($18,650/581 hours). Since
the tracing of overhead costs to one dinner buffet unit (i.e. that which is consumed by a
single guest) required cost pool rates per minute, the hourly cost pool rate of $32.10 was
divided by 60 minutes, establishing a cost pool rate of $0.54 per minute for the FOH.
The BOH labor cost pool was $16,539. A total of 514 hours worked in the BOH could
be attributed to dinner buffet production. Thus, the BOH cost pool rate was determined
to be $32.18 per hour ($16,539/514 hours), or $0.54 per minute.
The direct operating supplies cost pool was determined to be $6,296. The cost
pools for the FOH and BOH were $1,259 and $5,037, respectively. However, since it was
impossible to trace precisely all direct operating supplies to a single dinner buffet item,
the research team, working in concert with restaurant management, deemed it
reasonable to assign one unit of the direct operating supplies cost pool rate per buffet
item.
For the facility sustaining cost pool, no cost driver could be determined, which is
consistent with ABC practice in the literature (Cooper, 1989; Garrison and Noreen,
1997). These types of undistributed and xed costs cannot be traced to a product by
means of activity centers; rather, they must be allocated by some arbitrary base, such
as the number of meals served (Cooper, 1989; Garrison and Noreen, 1997). Using this
approach, the total amount for the facility sustaining cost pool was assigned equally
to both activity centers. Thus, the amount of facility sustaining costs allocated per
one dinner buffet unit was $43.21 ($56,952/1,318, since 1,318 dinner buffets were sold
during the month involved in this study).
Next, the FOH and BOH activity centers were each divided into activity cost driver
pools and levels of activities were established (Cooper, 1989; Garrison and Noreen,
1997). Qualitative research methods (such as in-depth interviews and observation of
employees behaviors in the facility) were then employed to identify second-stage cost
drivers and activity hierarchies, and to divide the activity centers into unit-level,
batch-level, product sustaining, and facility sustaining cost pools. An example of a
second-stage cost driver for the unit-level activities are those activities that were
conducted each time a guest consumed a dinner buffet. General cost drivers for
batch-level activities were formulated based on the number of batches that were
required in food production, such as the number of set-ups per day, or the number of
times purchasing and receiving was needed during the month. Major
product-sustaining cost drivers were identied as the number of new buffet items
created each month and the number of new employees hired per month.
In the next phase of ABC calculations, the restaurants overhead expense was
applied to a single dinner buffet by multiplying the cost pool rates with the number of
Activity-based
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403
units of overhead used by each item in the dinner buffet. After observing all major
activities in the FOH that were involved in the provision of one dinner buffet unit for a
guest, it was determined that daily standards of service were fairly homogeneous for
the service of all individual dinner buffets. Therefore, the same cost estimates were
applied to all items included in the dinner buffet. The FOH main activities used the
time and cost estimates on a per customer basis (consuming one dinner buffet), as
shown in Table I. In addition, the BOH activity administrating (which occurred as
both a batch-level and a product-sustaining activity in the BOH) was also identied as
a homogeneous action for all items in the buffet; therefore, these administrating
activities were included in the bill of activity per buffet customer (see Table I).
Next, one unit of a direct operating supplies cost pool rate was established by
combining and averaging the FOH and BOH cost pool rates, i.e. ($1:36 $5:42=2.
This resulted in a value of $3.39 per dinner buffet guest, which is shown at the bottom
of Table I, along with the allocation value of the facility sustaining cost ($43.21) that
Activities
Resources
used
Cost pool rates
($ per minute)
Total cost
($)
Unit-level activities
FOH
Communicating 1.00 minute 0.54 0.54
Setting up 1.00 minute 0.54 0.54
Serving customers 1.00 minute 0.54 0.54
Processing checks 1.00 minute 0.54 0.54
Total unit-level activities 4.00 minutes 2.16
Batch-level activities
FOH
Setting up 2.05 minutes 0.54 1.11
Cleaning 1.41 minutes 0.54 0.76
Administrating 2.82 minutes 0.54 1.52
BOH
Administrating 2.82 minutes 0.54 1.52
Total batch-level activities 9.10 minutes 4.92
Product-sustaining activities
FOH
Administrating 2.82 minutes 0.54 1.52
BOH
Administrating 2.82 minutes 0.54 1.52
Total product-sustaining activities (FOH and
BOH) 5.64 minutes 3.04
Facility sustaining activities 1 unit 43.21
Direct operating supplies 1 unit 3.39
Total cost per customer 56.71
Notes: Estimated times are based on observation in the facility; all costs shown are in HK$; all BOH
activities were grouped into four major activities: cleaning, preparing, cooking, and administrating;
FOH activity center major activities were: communicating, cleaning, setting up, processing checks,
serving customers, and administrating
Source: Raab et al. (2005)
Table I.
Bill of activity per buffet
customer
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was derived above. Thus, Table I represents a completed bill of activities for a dinner
buffet customer. It summarizes all ABC costs for unit-level, batch level and
product-sustaining activities for the FOH along with product-sustaining activity costs
for the BOH. In addition, each dinner buffet item also received a bill of activity that
accounted for the other BOH batch-level activities and a menu items food cost.
In a dinner buffet context, restaurant management has difculty determining a
menu items exact food cost, because it varies depending upon customer consumption
rates. Thus, in order to account for the differential consumption rate of individual
buffet items by guests, the restaurant manager estimated each items percentage rate of
usage (as above or below an average rate of usage). For example, if a buffet contains 20
items, the average consumption rate would be 5 percent per item (100 percent/20). The
managers estimates were then used to estimate the food cost for each individual item,
as shown in Table II. Table II is an example of the completed bill of activities for an
individual buffet item (salmon sashimi). Table II also contains cost estimates for the
other BOH batch-level activities.
Similar bills of activities were then established for all of the other entrees in the
dinner buffet. The buffets appetizers and deserts were not investigated in this study.
Management stated that the restaurants customers mainly consumed the entree items
when they frequented the buffet; therefore, management was far more concerned with
the protability of the entrees. Finally, the total of all bills of activities was added to the
bill of activity per buffet customer in order to establish an estimate of total ABC cost
for one dinner buffet unit. The results are presented in Table III.
Table III displays the total ABC cost per menu item and the total ABC cost (before
taxes) for one dinner buffet. As a result of this analysis, the operating prots and
margins for the dinner buffet were established. For example, a dinner buffet was sold
forHK$128 and the total ABC cost for all menu items was HK$161.73. Therefore, every
time the restaurant sold one dinner buffet, it lost HK$33.73 ($161.73 2 $128), which
represents an operating loss of approximately 26 percent (($33.73)/$128). This key
nding shows that an ABC approach is indispensable in order to conduct a full menu
protability analysis, since using the PSM technique alone did not involve any cost
information. Without undertaking an ABC process like the one that was used in this
Activities Resources used Cost pool rates ($ per minute) Total cost ($)
Batch-level activities
BOH
Cleaning 1.00 minute 0.54 0.54
Preparation 1.50 minutes 0.54 0.81
Cooking 0.00 minute 0.00 0.00
Total batch-level activities 2.50 minutes 1.35
Food costs 1.6 units 13.60
Total cost 14.95
Notes: All costs shown are in HK$; individual bills of activities were developed for each entree on the
restaurants dinner buffet; all BOH activities were grouped into four major activities: cleaning,
preparing, cooking, and administrating; FOH activity center major activities were: communicating,
cleaning, setting up, processing checks, serving customers, and administrating.
Source: Raab et al. (2005)
Table II.
Bill of activity salmon
sashimi
Activity-based
pricing
405
study, restaurant management would never be able fully to ascertain a menu items
true protability. Thus, for a complete understanding of menu protability, it is
necessary to combine both the effects of customer preferences from PSM and ABC
expenses. The implications that can be drawn from using ABP are discussed next.
Managerial implications
The combined approach of PSM and ABC applied in this study resulted in a true ABP
analysis of a restaurant facility, which has been previously unobserved in the
hospitality literature. In addition, this study demonstrated that either an ABC study by
itself, or a PSM study by itself, would have not been able to integrate both the
necessary cost data and the customers price perceptions to understand the restaurants
total protability picture. Thus, the ABP concept allows a restaurants management to
draw some useful implications for pricing its menu, based in its real (not assumed) cost
structure. For instance, several indicators were identied that determine price
sensitivity in this restaurant. The degree of price sensitivity depends on the interplay
of stress level and the range of acceptable prices. This study found a low stress level
(i.e. an optimal pricing point close to the indifference point) along with a large
acceptable price range (HK$48), which suggests that the market overall is not very
price-sensitive. To minimize resistance to purchase due to price, the recommended
price for the dinner buffet would have to fall within the identied threshold limits. It
was established that the price where the resistance to purchase was the lowest was
Buffet item ABC cost per item ($)
Salmon sashimi 14.94
Fresh oysters 5.34
Shark n soup 6.51
Steamed sh 3.74
Stir fried crab with ginger 4.74
Boiled shrimp 4.54
Stir fried clam with black bean sauce 2.67
Stir fried shredded chicken 2.51
Steamed fresh scallop with garlic sauce 8.67
Stir fried beef 2.51
Curry beef stew 2.67
BBQ ribs 3.54
Stuffed crab shells with cream sauce 5.67
Oyster Rockefeller 7.87
Grilled eel with Japanese sauce 11.41
Deep fried llet of sole 4.11
Chicken kebob 3.37
Lamb stew 3.87
Braised oxtail with red wine sauce 4.27
Yang Zhou fried rice 2.07
Total costs for individual items 105.02
Cost per customer 56.71
Total ABC cost 161.73
Note: All costs shown are in HK$
Source: Raab et al. (2005)
Table III.
Total ABC cost for one
unit of dinner buffet
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HK$139, which is higher than the price actually charged (HK$128); thus, management
appears to be able to raise menu prices without encouraging substantial customer
defections.
On the other hand, because of the low sensitivity to price, the restaurant has some
measure of pricing exibility within this market. An excessive emphasis on price as the
major component of the marketing mix would be a wasted effort and might damage
future marketing strategies. The PSM information developed in this study provides a
context within which management can frame an advertising campaign. For example, the
restaurants existing promotional efforts to advertise the dinner buffet of HK$99 were
detrimental, as the threshold of marginal cheapness exceeds this price point, which
implies that potential customers may feel that the quality of the buffet may be so
questionable that they avoid purchasing it at that price. However, customers attracted by
the promotion may only purchase the buffet for the promotional price, and they may not
return when they have to pay the regular price. Ironically, regular customers will gladly
purchase the buffet and only spend HK$99 when they were perfectly willing to spend the
regular (higher) price. The restaurants regular customers apparently do not perceive the
price of HK$128 for the dinner buffet as being too high. In addition, it could be the case
that loyal customers do not patronize the restaurant on very busy days when promotions
are run, because they may want to avoid the crowds. Therefore, the management should
concentrate on identifying and offering cues that inuence the guests perception of the
buffets quality, given the customers expectations about the range of acceptable prices.
However, in order to identify a price level that will guarantee adequate prots,
management had to add the knowledge of the ABC expenses of the buffet to the price
sensitivity information. The restaurants manager used a traditional variable cost
mark-up approach to set the buffet price, which led him to believe that he could charge
HK$128 as a feasible price for the dinner buffet. In addition, he believed that a price of
HK$99 as a promotional price would still be able to cover his operating costs. However,
the ABC cost analysis determined that the price charged for the dinner buffet (HK$128)
did not truly cover its costs. During the time period tested (one month), the restaurant
lost HK$33.73 every time a dinner buffet was sold. In addition, the calculated cost of a
dinner buffet unit showed that management was not in a position to lower the price of
the dinner buffet for promotional purposes unless total costs could be dramatically
reduced. If management had implemented such a step without doing an ABC cost
analysis, the restaurants prot levels would undoubtedly have declined even further.
In addition, since the point of marginal expensiveness in this study was HK$148,
this study showed that the buffet price could not be raised to a protability point
(which has to be above HK$161.73 or the ABC cost that was developed in Table I)
without taking further actions. This apparent conict (i.e. in which prices were lower
than costs) existed because the restaurant was unprotable, and had been losing
money for an extended period. In fact, this condition is the reason management agreed
to undertake an ABP analysis of the restaurant. If the restaurant had not been
unprotable, the point of marginal expensiveness would have been well above costs.
Thus, instead of raising prices to the point of marginal expensiveness, restaurant
management in this case has to consider other steps such as cutting costs, increasing
customers value perceptions, or changing its dinner service concepts. In other words,
this study made it clear that big changes were needed, or the establishment would not
be able to survive in the competitive HK restaurant market.
Activity-based
pricing
407
Summary and Limitations
This study was able to accomplish a number of goals. First, it supports and extends the
prior work of Lewis and Shoemaker (1997) in several ways. Their study applied the
PSM technique to the association meeting market, whereas this study showed that
PSM also can be applied to a buffet restaurant. Furthermore, this study suggests that
the PSM method may be applicable to other restaurant types; however, this
supposition would have to be conrmed through future research studies. In addition,
although it demonstrates that PSM can be used in other hospitality contexts, its
application in this study produced results that differed somewhat from those of Lewis
and Shoemaker (1997). For example, this study found that the OPP was positioned to
the right of the indifference point rather than the left, which indicates that less price
consciousness existed in the dinner buffet market than in their association meetings
context. There was also a difference between the studies, in that the range of acceptable
prices in this study was narrower than in the Lewis and Shoemaker (1997) study. In
spite of these differences, the current study conrms that PSM can be a very useful
technique in a hospitality context.
Second, the study underscores the importance of using previously-developed ABC
methods to more fully understand a restaurants cost structure. Third, it applies ABP
for the rst time in a hospitality setting, and demonstrates that ABP can be a very
useful tool by which to understand restaurant protability. For example, in this
particular study, management learned that the buffets price could not be lowered for
promotional purposes, since that action, by itself, would only have worsened the
restaurants nancial condition.
However, even though ABP appears to be a potentially powerful tool, there are
some key limitations of the study that must be noted. First, the study results cannot
be widely generalized because it was conducted during only one month at a single
Hong Kong-based restaurant, where guests perceptions of price and value are
culture-based and inherently localized in nature. Further, although the study
applied a simple random design for data collection, it nevertheless used a
convenience sampling procedure, which cannot be generalized to the restaurant
industry as a whole. In addition, the study failed to test price sensitivity levels at
different customer loyalty levels. This limitation suggests that more research is
needed which tests price sensitivity for different customer loyalty levels. Also, price
sensitivity should be investigated to see whether it differs according to key
demographic variables. Furthermore, it would be useful to conduct a study for all
meal periods of a restaurant and to perform studies in similar restaurants to
compare price sensitivity levels between similar target markets. It should also be
noted that the study did not specify the exact time resources or other costs, such as
direct labor, consumed by the researchers in order to conduct the ABP study;
therefore, the study excluded these implementation costs, which were not very
high in the case of this establishment (which can be a perceived barrier to the
implementation of ABC or ABP). Finally, the ABP technique should be tested in
other hospitality settings, such as spas, casinos, or hotels, to see if its application in
these settings also appears to provide useful pricing insights for managers in these
areas. Nevertheless, the study showed that ABP may hold considerable promise as a
protability tool for restaurateurs.
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408
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Corresponding author
Carola Raab is the corresponding author and can be contacted at: carola.raab@unlv.edu
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