Should I charge a deposit / cancellation fee? The maths!
In the vexed question of how to deal with restaurant "no shows" there are two arguments.
One of them goes like this: theatres, cinemas, airlines, holiday companies…. none of them give consumers a refund if the customer can’t make it. Why should restaurants be different? Why should they not charge at least something up front and keep it if the customer does not turn up?
Some restaurateurs have started doing this and swear by it. For example, Joff Day of Ben's Cornish Kitchen, Marazion, says: “Having the ability to take deposits for online bookings via the simpleERB booking system has eliminated no-shows - the bane of most restaurants.”
Others think differently, like the restaurateur Keith McNally, who says: “Although we take credit card numbers for parties of five or more at my restaurants, we never actually charge the customer for not showing up. Of course, we tell them in advance they’ll be charged for not showing up, but it’s difficult to have the heart to do it. Even, as in my case, when you don’t have a heart to begin with.”
This is an emotional argument. There is a more hard headed rationale, exemplified by Sabato Sagaria of Union Square Hospitality Group, who says, “If you’re penalizing people with a cancellation fee, it’s also probably an effective way of cancelling the relationship in the long term. If the first interaction is making the reservation and the second interaction is the cancellation fee, chances are there won’t be a third interaction.”
So who is right? Which course is right for you and your restaurant?
Fortunately there is some math that can help us here. Business consultants have the concept of "LTV" or to give it its full title, “Customer Life Time Value". This is quite simple, it is the “total amount of money that you will earn from a customer”. To be contrasted with “the amount of money you will make from a single visit”.
The opponents of charging deposits or cancellation fees argue that annoying a loyal customer who doesn't turn up by actually charging them a cancellation fee or keeping a deposit costs you money in the long run as there is a good chance they won't come back.
This is where you need to start to categorise your customers. And for this you either need a really good memory or you need a "Restaurant CRM" (Customer Relationship Management System) like simpleERB. Of course it makes sense NOT to charge a customer who has been a dozen times in the past 12 months and is likely to keep coming. But what about someone who has never been before?
Here you need to look at the data. How many "first time visitors" become regulars?
Let's take an example: say your typical spend is £/$/€20 per person, your average party size is 3 and your gross profit before staff and fixed costs is 70% - then a no show costs you £/$/€42 and your profit (or rather contribution to costs) would be £/$/€42 if they turned up.
If you have taken a deposit of 50% or have a cancellation fee of 50% , then you will get 50% x 3 x £/$/€20 = £/$/€30 from that party if they "no show”.
You then run the risk that they are so annoyed with you that they never return.
What you have lost is the "LTV".
Let's plug in some assumptions and say that there is a 1/20 chance that they come a second time and a 1/60 chance that they come a third time and a 1/100 chance they come a 4th time. The expected LTV for that customer (in gross profit terms) is :
£/$/€ (42/20) + (42/60) + (42/100)
Which adds up to £/$/€ 2.92
Not a lot!
Certainly not enough to make you give up the deposit / cancellation fee of £/$/€30.
In fact for it to be worth while for a restaurant to forego the deposit / cancellation fee the expected LTV has to be more than £/$/€ 30.
That needs the likelihood of repeat visits to be very high. In fact the chances need to be something like:
1/3 chance of returning again, 1/6 chance of a 3rd visit, 1/9 chance of a 4th visit, 1/12 chance of a 5th visit, 1/18 chance of 6th visit etc. etc.
This gives an LTV of something like £/$/€ 40.
Is this the kind of repeat visit pattern you see in your first time visitors?
You don't need to do all the calculations , just asking your self the question, "Do one in three of my first time visitors come back a second time?" is enough.
If the answer is an unequivocal "Yes" then you should pay attention to the argument that "Enforcing a deposit / cancellation fee policy will hurt my business".
If the answer is “No”. Then you are almost certainly better off enforcing a deposit / cancellation fee.