Margins thin, menu prices up as food costs put bite on restaurants.

Restaurateurs who have long complained that rising food costs were squeezing already thin margins may finally have solid data behind them when they start raising prices.

And they will start raising prices.

Costs all along the supply line--from feed to workers' compensation--have been escalating, a result of factors ranging from increased global demand, a weak U.S. dollar and higher fuel costs. Commodity and restaurant analysts believe relief may be at least a year away.

Two weeks ago, executives at both the Cheesecake Factory Inc. and California Pizza Kitchen Inc., two publicly traded L.A.-based chains, announced at an analysts conference in New York that they would raise menu prices by about 2 percent to adjust for increased food costs.

Cheesecake Factory Chairman and Chief Executive David Overton told investors that the price hike is higher than the company's average menu increase of 1 percent to 1.5 percent, and he warned that menu prices could again be raised in June, depending on dairy prices.

Signaling that investors--and diners--may be prepared to swallow the increases, shares of both firms have increased since the announcements.

"The entire food chain is seeing tightness that may well continue into 2005," wrote Andrew M. Barish, managing director and senior research analyst for Banc of America Securities LLC's consumer group in a March 26 report. "It appears as if feed costs are well above historical averages and this can have an impact on prices into the next year."

Still, local restaurant owners say they are limited by how much they can raise menu prices. They noted that price increases have ranged between 2 percent to 5 percent--far below the double-digit increases in the cost of food.

"To get our food costs down, we had to bring in a different grade of beef and raise our prices," said Michael Cardenas, a partner in Innovative Dinning Group, which owns the Balboa steakhouse on the Sunset Strip. "But we've tried to keep our price increases small and invisible to the consumer."

Bulk power

In many ways, the dynamic of the restaurant business is like any other. While big players like Cheesecake Factory and California Pizza Kitchen can leverage the buying power that comes with operating chains numbering into the hundreds, smaller restaurant operators are feeling the pinch to a greater degree.

"The little guy gets hurt the most," said Randall Hiatt, president at Costa Mesa-based Fessel International Inc. "If there are higher beef prices and you have the leverage of an Outback Steakhouse, you're not as affected. The small mom and pop operations are the ones really feeling the fallout from this."

Compared with last year, many restaurants now pay 25 percent more for steak, 50 percent more for chicken breasts and 40 percent more for dairy products.

According to the United States Department of Agriculture, wholesale boneless skinless chicken breasts were selling for $2.28 a pound last week, a 32 percent increase from the $1.56 a pound the same time last year.

The cost of a 40-pound block of cheese, the indicator tracked for dairy prices, was $2.09 last week, a 46 percent increase from $1.12 a pound from the same time last year. A prime strip steak, a staple of restaurant menus, fetched $9.87 a pound, a 40 percent increase from $5.93 a pound during the like period last year, according to the USDA.

"Every month it seems to continue rising, but you can't raise your prices every time it goes up," said Selwyn Yosslowitz, part owner of the chain of Marmalade Cafes. "In the past it was always a cycle you could feel comfortable would change, but this feels like a much longer loop than ever before."

Yosslowitz said his company has been able to contain some of the price increases thanks to bulk buying programs for its seven restaurants. He also uses lower priced items for daily specials.

"We talk to suppliers in the morning and call around to all the chefs and let them know what we can get," he said. "You have to be a much more efficient to stay ahead of the game."

Shrinking portions

What may have heartened investors bidding up shares of CPK and Cheesecake Factory are signs that gathering strength in the economy gives operators more flexibility to raise prices, according to Janet Lowder, president of Restaurant Management Services in Rancho Palos Verdes.

"I've been watching the chains, and telling the independents to go ahead and raise their prices, too," Lowder said. "Cheesecake did, so did Outback. I don't see it being a problem."

Still, Lowder said restaurants can't set menu prices to reflect the full increase in commodity costs. Instead, she's recommending restaurants make portions smaller but add other low-cost items to plates to make them appear full.

"They need to add something to the plate to make sure it doesn't look empty," she said. "If they downscale slowly and they're not obvious about it, that's another way to counteract the price increases. With everybody trying to lose weight, smaller portions might not be so bad."

So far, said Adam Lewis, who helps manage Kate Mantilini and two other restaurants operated by his parents, Marilyn and Harry Lewis, they have avoided cutting portion sizes and running specials based on the cost of food.

"Poultry is at a 20 year high, dairy is higher than I have ever seen it," he said. "It's a problem. Prices have gone higher than they've ever been and you can't raise something $5 to make up the difference. You just can't do that."

Still, he said, the business is left with little choice.

"We'll have to respond on some level and I'm sure that means raising prices unless we can find something else," he said. "But how much higher can we go before people stop coming?"