Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.

Understanding menu costs

The theory behind menu costs harks back to the late 1970s with research performed by Israeli economists Eytan Sheshinski and Yoram Weiss. In more recent times, menu costs have been influenced by aspects of New Keynesian economics which promoted the idea that a business would only make price adjustments if the benefits of doing so outweighed the costs.

Menu costs are one explanation for sticky prices, or a tendency for the price of goods and services to remain static despite fluctuations in supply and demand. Menu costs also vary according to the industry or context. The restaurant, for example, will discover that it is more expensive to alter its printed menu prices than it is to alter online menu prices. Less literal examples of menu costs include the hiring of a consultant to identify profitable values and the installation of updated point-of-sale systems.

Implications of menu costs for businesses

Menu costs play a crucial role in determining how prices can be adjusted to an optimum level where profits are maximized, expenses are minimized, and consumer expectations are met. Every business should quantify its menu costs – not only to measure profitability but also to evaluate the capacity to adjust its prices in the first place.

In a 1997 study entitled The Magnitude of Menu Costs: Direct Evidence From Large U.S. Supermarket Chains, the researchers noted that menu costs in five multi-store supermarket chains required dozens of steps and a significant investment. In fact, menu costs comprised 35.2% of net margins and cost 52 cents per change, with the cost per change increasing to $1.33 for supermarkets required by law to place a price on each item in addition to the shelf price.

The implications of this research for supermarkets and indeed other retail businesses are clear. No change in price should be made until the increase in revenue can compensate for the expenses incurred – though it can sometimes be problematic to determine the correct market equilibrium price. For the supermarkets in the above study, this meant the profitability of an item needed to drop by more than 35% to justify the cost associated with raising its price.

On occasion, it can also be difficult for a business to determine all relevant menu costs. One such cost that flies under the radar is the consumer reaction to an increase in price. In other words, will consumers become more hesitant to make a purchase? With shoppers now savvier than ever before and a diverse range of products on the market, there is a very real chance that an individual will simply choose to shop elsewhere.

Key takeaways:

In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.
Menu costs play a crucial role in determining how prices can be adjusted to an optimum level where profits are maximized, expenses are minimized, and consumer expectations are met.
In theory, changing item prices should not occur until the increase in revenue can compensate for the expenses incurred. However, ascertaining the equilibrium point of the market may be more difficult in practice and the business must also consider the impact of the increased price on consumers.