The rise in operating costs and shortage of restaurant labor has forced restaurant owners to incentivize key employees with performance bonuses and equity by building the ideal restaurant management incentive plan. The ideal incentive or bonus plan should:
- Incentivize and reward key employees for increasing profitability and improving the hospitality experience;
- Provide an ROI to owners; and
- Be simple, self-sustainable, and scalable.
With an effective compensation incentive plan, owners don’t need to be involved in day-to-day operations, and can focus on growing and scaling their concept. Sharing your profits or ownership can be scary, but if executed correctly, it can generate significant value for owners, employees, and customers.
In this article, we will show you how to design an ideal restaurant management bonus plan in 3 easy steps. We will cover issuing equity in a separate article.
Step 1 – Determine the Financial KPIs for the Incentive Plan
The ideal management bonus plan is driven by industry-standard financial key performance indicators (KPIs) that are easy to measure and understand. The first step in designing your management bonus plan is choosing which financial KPIs you will measure.
The financial KPIs that we suggest measuring are EBITDA or Prime Costs
The financial KPI you choose to measure should be directly tied to your goals. Let’s look at each one to determine the best fit for you.
EBITDA measures management’s overall effectiveness in managing sales and expenses. EBITDA represents the restaurant’s overall profit before deducting depreciation expense, income taxes, and interest paid on loans and credit cards. EBITDA is similar to operating profit or “four wall” profit, but it excludes depreciation and amortization expenses. I like this KPI because it’s easy to measure, calculate, and understand. A bonus plan calculated based on EBITDA rewards managers or key employees with a certain share of EBITDA in addition to their base pay. For example, if EBITDA reaches $X per quarter, then anything more than $X goes into a bonus pool that gets allocated to managers based on a simple formula. $X is determined by the minimum amount of ROI expected by owners and investors. Using this model, if an owner invested $1m to open the restaurant, and they’re expecting a 25% pre-tax ROI, they would allocate all or a portion of the excess of $250k EBITDA to a bonus pool that gets allocated to the manager. The manager can also share this bonus with key employees (like an executive chef) so they can help the manager achieve their goals.
Alternatively, you can allocate a fixed percentage of EBITDA to a bonus pool and pay it out to your manager and other key employees at the end of each quarter. Typically, this percentage would be somewhere between 5-15% depending on how much control your management has, how the restaurant is currently performing, and if other employees will participate in the bonus pool. Assuming a restaurant grosses $3m in revenue and nets $75k per quarter, then $7,500 would be allocated to the pool which would go to management and key employees. Contact us to learn more about these calculations.
Many restaurants calculate bonus plans based on controllable profit instead of EBITDA because it is theoretically a more accurate measure of management performance. Controllable profit is sales minus expenses that can be controlled by management. It does not include expenses like rent, depreciation, insurance, accounting, legal, etc. because management doesn’t typically have control over these expenses. The disadvantage to using controllable profit instead of EBITDA is that it’s trickier to calculate and may not be as readily and quickly available. Obviously, controllable profit will always be higher than EBITDA, so take that into consideration when setting the bonus payout benchmark. If you’re using controllable profit to calculate the bonus amount, then make sure your management clearly understands the calculation and what is included.
I recommend basing your management management incentive plan on EBITDA if you are having profitability issues and want your managers to think like owners.
Prime Costs as Part of the Incentive Plan
Prime costs are cost of goods sold (COGS) plus labor costs. Prime costs typically consume about 55-65% of sales and are highly controllable by management, making them a very useful KPI for calculating bonuses.
If profitability is low, it’s usually caused by high prime costs. Given that prime costs are the primary driver of profitability, you could calculate your bonus based on prime costs. A bonus plan calculated based on prime costs is not meant to cut costs. A bonus plan calculated based on prime costs should incentivize management to meet the ideal prime costs. Ideal prime costs are the (1) least amount of labor that generates the optimal guest satisfaction, plus (2) your theoretical cost of goods sold. The theoretical cost of goods sold is your ideal cost of goods based on your sales as determined by your recipes and menu pricing. Your manager is not typically responsible for pricing out a menu, they are responsible for ensuring the team is managing costs of goods sold to ensure they’re on budget with how each menu item was priced. You can use a variety of tools such as Marginedge, xtraCHEF, Restaurant365, or Craftable to cost out your recipes and track your actual vs theoretical cost of goods sold in real time.
Prime costs for quick service and full-service restaurants range from 50-60% and 55-65% of sales respectively. A bonus plan based on prime costs should reward management for achieving the ideal prime costs within these ranges. For example, you could set a budget for ideal prime cost of 60% (the ceiling), and any savings below that ceiling will go 50% to the manager(s) and/or key employees responsible for the shift. If the quarterly sales are $300k, and prime costs are 58% (a 2% savings of $6k), then $3k would go to the bonus pool.
Basing your restaurant management incentive plan on prime costs is recommended if you’re having profitability issues and your prime costs are consistently greater than 65% of sales. This KPI can also be used for non-General Manager roles like Executive Chefs, and other back-of-house managers. The more specific the role, the more granular KPI you can use, such as Sales per Labor Hour for kitchen managers and chefs. However, that is out of the scope of this article.
Financial KPIs Summary
A mistake that many owners make is basing their bonus plans on sales only. Sales is an extremely important number, but it doesn’t mean much on its own. I’ve seen restaurants generating $1,000 in sales per sq ft annually, but are losing money because their labor costs are too high. By measuring EBITDA and prime costs as a percentage of sales, you are also indirectly measuring sales performance. No matter how well you manage your controllable expenses, if the sales aren’t high enough for the space that you’re in then it will be extremely difficult to have a healthy bottom line because of fixed expenses like rent, insurance, management salaries, chef salaries, etc.
Before rolling out a management bonus plan containing financial KPIs, you need to ensure your financial KPIs are accurate, timely, and consistent with restaurant industry standards – otherwise you will lose your management’s faith and trust in the plan. The financial KPIs need to be prepared by a qualified restaurant accountant and should correctly reflect wages paid or accrued for work performed by owners, ending inventory, and other factors that could impact accuracy. The reason most bonus plans are not successful is because they’re either too complicated to attract buy-in, or managers don’t have access to accurate, timely, and consistent financial data. Please feel free to schedule a discovery call with us if you want to achieve this.
Step 2 – Determine Your Influencing Non-Financial KPIs
You can have the most efficient prime costs and be highly profitable, but if your customer experience starts suffering then your success will be short-lived. That’s why it’s important to incorporate non-financial KPIs in your bonus plan such as:
- Secret shopper scores
- Google/Resy/Opentable/Etc. reviews
- Health inspection scores
- Inspection scores assessed by owners via surprise visits
If you are providing managers with equity, a non-financial KPI may not be necessary in your management bonus plan because they are looking out for the long-term success of the restaurant regardless.
The non-financial KPIs that you choose to measure will depend on your goals and the problems you are trying to solve. For example, if your main problem is that you’re not receiving enough (positive) Google reviews, then you can tie your management incentive plan directly to that. On the other hand, if customer service is suffering, then the non-financial KPIs should be your secret shopper program results.
Step 3 – Determine the Bonus Calculation
A management bonus plan is meant to incentivize a manager with additional compensation, not replace their salary with variable pay. Therefore, managers should always receive a competitive base pay regardless of a bonus plan. The bonus amount should be calculated based on a combination of the financial and non-financial KPIs determined in the step above.
The weight of financial KPIs vs non-financial KPIs used in calculating the bonuses should be driven by the problem you are trying to fix or the goal you are trying to achieve. If you’re trying to fix profitability, then a larger chunk of the bonus should be dependent on financial KPIs. If you’re extremely profitable, but your Resy reviews are poor, then you may want to stress the non-financial KPIs.
Example of an Ideal Management Incentive Plan
Let’s walk through an example of a simple yet effective bonus plan. Joe’s Seafood generates $3m in revenue in a 4,000 sq ft space, but is not profitable. Joe’s prime costs are 70% of sales, most of which is attributable to kitchen labor and high food costs. Joe’s goal is to generate at least $255k in pre-tax cash flow from his restaurant without being involved in the day-to-day management, and to maintain a good reputation in the community. Therefore, his bonus plan allocates 15% of all EBITDA to a bonus pool on a quarterly basis once EBITDA reaches $75k per quarter ($300k/year). If the restaurant generates $75k per quarter in EBITDA then the bonus pool is $11,250 ($75,000 x 15%). This $11,250 gets adjusted down by 50% if a 4-star review status is not maintained on Resy, and another 50% if the health inspection scores drop below 90. After the non-financial KPI adjustment, the bonus pool gets split 50/50 between the Executive Chef and the General Manager. With $75k EBITDA on $750k of sales per quarter, they can each walk away with $5,625 per quarter in addition their base pay. At the manager’s discretion, these amounts can be paid out to other employees, if it helps them achieve their goal.
We encourage involving managers and key employees in the bonus calculation process to ensure you have their buy-in. If they don’t have a say or don’t agree with a particular calculation, they may not be fully invested in this program.
Putting an Incentive Plan in Action
A management incentive plan is an effective and impactful way to create value for a restaurant if it is implemented correctly. The management incentive plan must be simple and easy to understand, and contain both financial and non-financial KPIs to be successful. The KPIs need to be measured accurately, consistently, timely, and according to industry standards, otherwise you will lose the trust of your managers. Therefore, it is extremely important to work with a restaurant industry accountant, like The Fork CPAs, who can deliver on this promise. Feel free to contact us if you want to learn more.
Written by Raffi Yousfian, CPA