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.


Mr. Gloom and Doom

Mr. Gloom and Doom. Easy to get press when you’re the first with Gloom and Doom predictions. You don’t mention that after each of the past 7 California wages increases restaurants profits and same store sales year over tear also went up. Mr. Gloom and Doom is that not only good for franchisees and franchisors?

Minimum wages increase provide cover for menu increases all the while helping live life a little better. CEO’s like David Novak have no problem spending 8 million a year advertising the Kentucky Derby and taking million dollar pays.

Why Mr. Gloom and Doom do you want to deprive an hourly worker a raise?

Mr. Bizblur Visitor

<p>Mr. Head-in-the-clouds visitor asks, &quot;Why Mr. Gloom and Doom do you want to deprive an hourly worker a raise?&quot;</p>

<p>Because those entry-level hourly workers with mandated raised salaries will soon be out of work. That is to say, increase the price of jobs and the demand goes down. It is common economic sense that store owners with their slim profit margins see for themselves. Besides the basic supply and demand economic model that you learned in Economics 101, this is also backed by real world macroeconomic studies (see for the most recent example.)</p>

Mr. Gloom and doom

This Mr. Gloom and Doom have you ever RUN a Restaurant? It's real easy to sit back and point fingers. Starbuck's pays higher than minimum wage plus pays health insurance for employees and makes more money and is growing faster than any other large chain. Buy the way they sell 35% food not just beverages.

Mr. Gloom and Doom do you have health insurance? Do you want people preparing your food Not to have health insurance?

Mr. Bizblur Visitor

Starbucks was also one of the first major chains to go to a $4 cup of coffee. McD charges $1. Different market sectors. If all QSRs moved up scale to the high end of fast casual, then fast casual would become the new QSRs of low profit margins. If you have a QSR, do this experiment. Pay all of your entry-level staff double what they earn now. Provide them with health insurance because that is the standup thing to do. Return and report in a year.

The price of raising minimum wages

<p>Go to a department store or supermarket in the Philippines and you&#39;ll see four workers manning a cash register. Go to Luxembourg or the United States and you&#39;ll see only one. In fact, you&#39;ll likely see an automatic self-check out kiosk with no person there at all. There&#39;s an economic reason for that.</p>

NYS Minimum Wage

The author of this article does not have all his facts right. The NYS minimum wage increase excluded tipped workers in restaurants. There is currently a campaign underway to advocate for tipped workers to receive 100% of the minimum increase that their peers received.

NYS minimum wage for tipped workers

Campaign underway? I guess posting a comment can be construed as a "campaign underway." What's the bill number? What's its status? Does it have a chance to pass?

"asset light" franchising model

A senior level executive at a publicly traded "asset light" franchisor is actually pretty thrilled about the upcoming increases in minimum wages.

You see, all of their franchisees in their core markets are complaining about the minimum wage increases and the possibility of the value proposition eroding against their #1 competitor due to the significant menu price increases the franchisees are planning in January 2014.

This franchisor recently lowered their earnings guidance on Wall Street. They are thrilled because not only did they get an opportunity to lower their performance bar but they all know the franchisor is going blow the estimates away once the franchisee's menu increases go into effect. The executive management team believes next year will be a record setting year for their stock price and shareholders.