How Inflation Affects Your Restaurant

William Lynott

Chances are that you haven't been giving much, if any, thought to inflation lately. Those white-hot increases in the cost of living throughout the '70s, '80s and early '90s are largely a memory now. With inflation hovering around two percent for the last several years, there are other, more important, economic considerations in your business life. Besides, inflation rates are an abstract concept to many people — just a lot of numbers.

In truth, inflation, whatever the current rate, plays a vital role in everyone's life, business owners as well as individuals.

Consider how consumers are complaining about today's gasoline prices. This past summer, many Americans were groaning at the "highest prices ever" for a gallon of gas. But was the average $1.82 per gallon we were paying at midsummer the highest ever?

No way. Gasoline averaged about $1.35 per gallon 20 years ago. With inflation factored in, a gallon of that same gas would cost $2.47 per gallon today. At today's general price level, that makes gasoline cheaper than it was in 1983.

If you've been around long enough to remember when McDonald's dished up their 15-cent hamburgers in 1955, you may feel nostalgic when you shell out 89 cents for that same treat today. But which burger offers the better deal?

Surprise. That same hamburger would sell today for about $1.05 if it kept pace with inflation.

Inflation is misleading because it makes direct price comparisons
from one year or era to another meaningless.

Inflation's Effects Are Complex
That's the trouble with inflation: It's misleading. It makes direct price comparisons from one year or era to another meaningless. It makes some of today's products seem expensive when they are actually cheaper, and vice-versa.

The only meaningful way to compare prices from one period to another is to compare them with the general price level of each period or to the percent of average wages necessary to pay for the item during each period.

Money itself takes on a flexible value when inflation rears its ugly head. We've all heard that computer guru Bill Gates is the richest person in America today. With a reported net worth of $45 billion, Gates is thought of by some as the richest American ever. But he's a long way from that distinction when you compare his fortune's purchasing power with some of the great industrialists of a century ago.

While the fortunes of John D. Rockefeller and J.P. Morgan were far less than $ 45 billion ( expressed in dollars of their day), their purchasing power greatly exceeded that of Bill Gates today. That's because a product or service that costs $1 today sold for five cents a hundred years ago. Put another way, if you paid $1 for a product in 1903 and bought the exact same product today, it would cost you $20.76.

Obviously, the bargain-price phenomenon evident in such areas as the price of hamburgers and gasoline doesn't extend itself throughout our universe of products and services. During the Great Depression, a first-run movie ticket in a neighborhood theater sold for 15 cents. How does that compare with the tab at one of today's multiplexes? With inflation factored in, a movie ticket should cost $1.90 today. Obviously, with ticket prices now running at $6 or higher, it's costing us a lot more to visit the local movie emporium than it did back in the dark days of the Depression (and don't forget today's $2.50 Coke, which used to cost a nickel).

Any restaurant owner paying for medical services or health insurance is well aware that costs have risen far faster than inflation. College tuition is another of today's costs that is mind-numbingly more expensive than in days of yore.

So what does all this have to do with your restaurant? Plenty. Misleading comparisons of prices can lead not only to a healthy dose of nostalgia, but faulty business decisions as well. Being aware of the true increase in costs after inflation is a necessary part of good financial management.

Inflation Never Lets Up
The rate of inflation can vary wildly from one year to the next. However, regardless of the variations, inflation continues its work relentlessly year after year. And, of course, each year's increase compounds on top of the previous year's.

Even that harmless-seeming two percent inflation rate of recent years takes a significant toll over time. After a decade of two percent inflation, that dollar bill in your pocket today would be worth only 82 cents in today's dollars.

Perhaps more important, it is unlikely that the current low rate of inflation will last much longer. An analysis of the long-term trend over the past 70 years clearly indicates that yet another round of stiff inflationary increases is inevitable.

When Franklin Roosevelt decided that something had to be done to stop the destructive deflation of the Great Depression, he instituted an economic policy with a built-in inflationary bias. His New Deal in 1933 guaranteed that there would never again be deflation serious enough to disrupt our economy. But his bold move came with a hitch: Inflation, sometimes rising well above 10 percent, would become a permanent part of our economic life.

Inflation may seem to be a rather tame beast of late, but don't be fooled. That ravenous predator is poised to come roaring back. When it does return, action on your part now will make it easier for you to deal with it then.

How Inflation Affects Your Restaurant
Here's an example of how inflation has affected your business in recent years: If you paid $100 for some fresh produce in 1983, the cost for those same items in 2003 was $182.35.

In another example, if you paid $500 for a cash register in 1993, it would cost you about $640 to buy a similar model this year.

Of course, these figures assume that the increases in costs for the items mentioned kept exact pace with the rate of inflation. In practice, the inflated price may be higher or lower than the calculated one.

Either way, the overall costs for running your restaurant are rising steadily, more or less in step with the annual inflation rate.

That's why it's so important for you to understand that when you fail to adjust your prices to reflect trends in inflation, you have effectively lowered them.

Are your prices keeping pace with inflation? Are you maintaining your markup over the increased costs you're paying to suppliers? If not, the shortterm effects may not be especially noticeable, but over the longer term, the consequences will be unavoidable: Profits will be eroded, your ability to attract and pay quality employees will suffer and the overall health of your business will enter into a destructive decline.

Yes, raising menu prices can be a risky business in an uncertain economic climate, but failing to keep pace with inflationary pressures poses an even greater threat. Remember, if you fail to adjust your prices to at least mirror inflation, you are effectively losing money.

So, how do you go about determining the proper amount by which to increase your prices? If you do it on an annual basis, the calculations for figuring inflation's effects are simple enough. Just look up the previous year's inflation rate and adjust prices upward by that percentage.

But calculating inflation's effects over a period of two or more years can be dauntingly complex. That's why it's difficult to make simple dollar-to-dollar comparisons from one year to another. If you'd like an easy way to gauge inflation's effects on some specific costs in the operation of your restaurant, log on to http://www.westegg.com/inflation/. This easy-to-use inflation calculator adjusts any given amount of money for inflation, according to the Consumer Price Index, from 1800 to 2002.

Until the website's publisher updates the chart to include 2003, you'll have to add that year's percentage of increase (1.9 percent) to the 2002 result to arrive at the latest result.

One type of economic comparison that remains valid from one era to another is figures expressed as percentages. For example, the 25 percent unemployment rate reached at the height of the depression would be just as devastating today as it was in 1933.

When you don't adjust your prices in line with inflation,
you have effectively lowered them.

Another economic yardstick that has remained valid through the years is the prevailing interest rate. An interest rate of two percent on a passbook savings account would bring the same return today as it brought 60 years ago.

From another perspective, that miserly 1.2 percent interest rate on your one-year CD today is worth far less to you than the 10 percent you were getting 10 or 15 years ago. Further, with inflationat 1.9 percent, your investment is actually losing-money.

The complexities of inflation and its effect on your business can be daunting when viewed from a strictly technical perspective. But you don't have to be a mathematical wunderkind to benefit from an understanding of the inflation phenomenon and how it mandates periodic upward adjustments in the prices you charge your customers.

Raising menu prices, especially in a less-thanvibrant economy, may seem distasteful, even harmful, in view of competitive pressures and skittish customers. Still, an understanding of inflation and how it works leaves little room for alternatives.

William J. Lynott is a former management consultant and corporate executive who writes on business and financial topics for a variety of consumer and trade publications. His latest book, Money: How to Make the Most of What You've Got, is available through bookstores. You can reach him at [email protected].