Implications of Increasing State Minimum Wages for Restaurants

California, New York and New Jersey retail and restaurant operators will have problems dealing with the minimum wage increase approved this fall. There could be more states coming. California leads the way with a $2 increase by 2016. As a consequence for restaurant operators, there will be far less room for errors and practices of the past. Less one size fits all, monolithic practices and solutions will work, more customized solutions will be necessary.

Wage expense is the typically second largest expense after cost of goods sold, although it is number one at some brands.  Only a scattered number of restaurant operators including Ruth Chris and In N Out, currently are believed to pay substantially above it. But all operators and those and future locales will be impacted. On the positive side, it will also stimulate cash spending, and the economy but not on a direct relationship dollar for dollar.

Restaurant conditions in the US are sluggish at best, now, with essentially flat traffic experienced since 2007. The US has way too many restaurants, with restaurant growth outpacing population growth over the past 50 years.  Interestingly, California currently is leading the way in terms of current same store sales increases per both Miller Pulse and Block Box, two restaurant data collection firms.  Whether that continues is problematic.

A 25% wage average wage rate increase could negatively affect restaurant margins by 4-5%, depending on the wage cost mix. Unless offsetting actions are taken, restaurant store percentage margins could be 20-50% lower. Some restaurant margins will go into the red.

Here are top predicted implications and imperatives for restaurants beyond the expected price increases that we know will take place:

• There is no more room for error. With the higher cost structure, operating margins will be thinner, at least for a time.  Prior poor practices such as opening too many units or too expensive or too distant or unplanned restaurants will now have a real negative bite. The increased wage will drive the new unit start up operating loss even higher during the ramp up stage. And if the site is wrong, forget it.  
• $1 menus, the bane of certain fast food QSR players since the 1990s, will have to go.  Perhaps in California, $1.99 becomes the new $1. Marketing agencies will have to become creative and not rely on pure price, big GRP media efforts to drive traffic.
• The franchising model in general must be fixed. Royalties and rent margins have to be sized to the actual store economics model in place now, not what it was hoped to be in the 1960s and 1970s.

Imperatives for change for the Industry:

• Restaurant planning needs to get smarter. The competition for consumers, capital, sites and good employees, and now higher wage rates means there is no room for error. The previously used ‘‘make it up on volume” mentality will be problematic going forward. Restaurants are notoriously “cultural insular” but that leads to a lag in decision making. Brands can’t afford bad locations or botched menu or marketing,
• Toxic company cultures will be fatal. With so much competition and flat demand, companies must compete on the quality and creativity of their people and cultures.
• As the US continues to diversity in all ways, one size fit all menus, store facades, marketing and media strategies have diminishing returns. We’ve seen that already; with several massive expansive menu redo at some brands, but with smaller and shorter  comps gains “pops”.  This industry is not centered in 1960s homogenous suburban America anymore.  These circumstances call for just the right blend of decentralization and centralization to management approach. For example, clearly, California prices need to be higher. A national media campaign in Los Angeles needs to be constructed differently than Topeka, KS.
• “Asset light” franchising models may be a hit on Wall Street but not on Main Street. Driving through the United States today, one sees mile after mile of run down, recapitalized restaurants, some the result of excessive franchising. The overloaded restaurant sprawl contributes to brand perception weakness with consumers.  There are a shocking number of single digit franchise store level EBITDA margins brands in the US. Franchising economics needs to be massively improved.