The VAT reduction and its impact

The VAT reduction and its impact

With Covid-19 causing chaos for the hospitality sector, the government took the decision to reduce VAT earlier this year, but what has been the impact so far? In this article, we discuss how businesses can benefit from the reduction.

Overview of VAT cuts for hospitality and tourism 

In case you missed the details, the UK government announced a cut in VAT for hospitality and tourism businesses in an attempt to help these struggling sectors during the pandemic. The reduction from the standard 20% to 5% came into effect on 15th July and will remain in place until 12th January 2021. According to the MoneySavingExpert*, this reduction in tax is expected to cost the government an estimated £4.1 billion.

Pass it on or keep the difference?

We believe that the approach taken by the government can impact the hospitality sector in two positive ways, depending on the approach you take.

Firstly, businesses can continue to charge the same price but benefit from the reduced VAT to increase their profitability. A meal option, for example, that would cost a customer £10 previously would mean a restaurant charging around £1.67 in VAT and keeping £8.33 to cover its costs and make a profit. With the reduction in VAT, the same £10 meal option provides the restaurant business with £9.52 after the 5% VAT has been taken off. That’s an increase of just over 14% in gross profit contribution.

The second option is to pass all or some of the VAT reduction back to customers. Nando’s for example, has passed on the entire reduction and reduced its prices accordingly, which has provided the benefit of receiving a huge amount of positive publicity (the fact we are mentioning it is an example of how they have benefitted!). McDonald’s and other chains meanwhile have not reduced prices on everything, or by the full amount - McDonald’s has reduced prices fully on selected items such as Happy Meals whilst only making a small reduction to the price of its Big Mac.

At first glance, it might appear that keeping prices at the higher (existing) price makes more sense. After all, the idea of the VAT reduction is to help hospitality businesses that are finding the current business climate challenging. Why reduce VAT for small businesses, only for them to pass on the benefit to customers and not make any extra money? While this might make sense for some businesses, we believe that it has its flaws. Let us explain…

The footfall dilemma

At the moment, many people are reluctant to dine out for fear of the Covid-19 virus spreading. Added to this, many people are either furloughed, taking a pay cut or have been made redundant meaning that money is tight.

Re-opening, following the closures of several months, can make it a challenge to attract customers back and, with fears over the virus and money, the challenge is getting harder. Making extra money per transaction is of very little or no benefit when footfall is low. An extra 14% profit contribution from zero sales is still zero, right?

 

If your business isn’t attracting enough people to dine with you, then passing on the VAT reduction could be a great way to encourage them back into your restaurant.

 

We know from proven marketing theory that consumers love a special offer or an enticing marketing campaign and, promoting the fact that you are open and passing on the VAT reduction, could be a great way to attract more diners. It will also appeal to customers who are increasingly on a tight budget but are keen to eat out.

After a long lockdown, consumers also need to be encouraged to go out and socialise sensibly and safely, which the VAT reduction is designed to support.

What’s your strategy?

If your business is already close to capacity, then you might not want to pass on the VAT reduction. Financially, it makes more sense to increase the profit contribution per transaction or customer. If, however, like many businesses, you are struggling to attract enough custom then passing on the VAT reduction and promoting your decision with a well-worded marketing message, will help.

In the latter scenario, you can always return prices back to their previous rates once business picks up or you can decide to be selective on which options you continue to discount.

How are you reacting to the VAT reduction? We would love to hear from you. Why not get in touch with our Food Service Consultants here at Ramsay Todd and share your experience?