The Restaurant Industry: Consequences of a $15 Minimum Wage
By late 2024, the $15 minimum wage will be fait accompli in major metropolitan areas in the United States, with CPI inflators expanding wage increases into the future. Habit Restaurant’s Russ Bendel told an audience at a January conference in Orlando that “it’s only a matter of time before what’s happening in New York and California will spread to the rest of the country.”
Once blessed with an abundant pool of teenage and young adult workers willing to accept lower wages in return for experience and flexibility, restaurants are now feeling the pain of state and local wage mandates and a tight labor pool. The gloomy combo is squeezing margins and changing the very nature of hospitality.
There are consequences of wages rising beyond the level of what businesses are capable of paying, however, the restaurant industry is fairly resilient and capable of making adjustments, albeit slowly.
Here are 10 things investors and operators should think about as the $15 minimum wage is implemented nationwide across the country in the next few years:
1. Fewer Restaurants. The industry is due for a reset. There are too many marginally profitable restaurants kept alive by low interest rates and financial engineering. The rationalization of locations has already begun and the dominoes will fall in the next recession. Casual-dining’s expenses are rising faster than recent sales gains and fast casual isn’t the slam-dunk as predicted years ago. The unit economics of new construction is underwhelming and public restaurant companies are no longer rewarded for unit growth. Money is harder to come by for emerging brands. All of this means the restaurant count in the United States will decline over the next few years. Take that to the bank. Needless to say, restaurant companies with strong balance sheets, real estate ownership and manageable debt will benefit.
2. The Chick-fil-A model. Who says you have to be open seven days per week when Chick-fil-A generates huge volumes in six and the franchisee store operators spend Sunday with their families? Casual dining generates the majority of their sales on Friday and Saturday nights, and many QSR businesses gain at breakfast and lunch only. Smart operators will narrow their open window to maximize productivity.
3. Delivery-Only Locations. Who cares if a pizza is delivered by the store on 10th Street, or the one on 20th Street, as long as it’s hot and tastes good? And would you care if it were delivered from a production plant located in a light industrial corridor in the middle of the city that took the place of 10 locations? Okay, maybe not a Domino’s or Pizza Hut with many franchisees in a single market, but some enterprising pizza, chicken or burger operator might consolidate their stores into a few highly efficient warehouses, or perhaps a ghost kitchen, such as the ones Kitchen United is building. Outback and Chick-fil-A are already testing takeout and delivery-only locations. Locations become less important if mobile ordering and delivery triggers a more convenient meal occurrence.
4. Delivery Costs. Restaurant owners complain about paying large delivery fees to third-party providers and rightly so. Operators can’t make money at that level. True, but competition is starting to drive those costs down.
5. Smart Equipment. The machines won’t take all of the restaurant jobs but they’ll eliminate a number of them. Blame it on the customers. Foodservice consultant Larry Reinstein says that when a restaurant provides easy, efficient kiosks and mobile ordering it becomes a value add to consumers. Shake Shack CFO Tara Comonte told a recent ICR Conference audience in Orlando that guests are now driving their move to kiosks. Kiosks were hated in grocery stores when they were first introduced, but customers now flock to self-checkout. Taco Bell has kiosks in over 1,000 stores, McDonald’s even more. Pay two people $15 an hour to take orders at the counter or pay one person $18 an hour to watch two order kiosks, expedite and keep the customers happy. No brainer. Results Thru Strategy’s Fred LeFranc sees cobots, or collaborative robots, working side by side with restaurant workers to improve productivity. As long as wages continue to rise and employees are hard to find, restaurant operators will load up on technology to become more efficient.
6. Tip Credit. Tip credit is a wage equalizer that sit-down operators rely on in 43 states. If Congressional Democrats and Bernie Sanders get their way in eliminating tip credit, sit down restaurants will be decimated.
7. Consolidation. When you add the mandated costs of higher wages, don’t be surprised when more restaurant businesses consolidate to attack costs. You are going to see a consolidation of the restaurant industry in the next five years like you’ve never seen before. Look for more mega- franchisees like Flynn Restaurant Group and PE-backed firms such as Inspire Brands to emerge.
8. Franchisee Unrest. The smart money moved to a 100% franchised model and no surprise: Franchisors are insulated from labor costs and benefit when franchisees raise prices to cover them. This is not a favorable quid pro quo for franchisees. There will be more franchisee unrest, the likes we’re seeing at Jack in the Box and McDonald’s. If a franchisee’s bottom line remains under pressure and they’re receiving fewer and fewer services from a brand intent on cutting G&A for big shareholders, there can be no positive relationship. A franchise system can’t survive long term if the franchisor takes a greater share of the store bottom line than the franchisee.
9. Turnover. The $15 minimum wage isn’t lowering turnover. In fact, it’s a sign of how tight the labor market actually is right now that hourly employees can still pick up their tent and move down the street at the blink of an eye. Restaurants have to get a handle on turnover in a $15 minimum wage environment. ShiftOne’s Ashish Gambhir says turnover costs a single restaurant anywhere from $2,100 to $5,800 when a single team member quits. There has to be another model for restaurants, perhaps more full-time employees, which might be more cost effective in the long run.
10. Discounting. Watching QSR and casual dining television commercials, you’d think the restaurant business is dog eat dog with deals, deals and more deals to get customers in the door. It is. However, there are many successful restaurant companies that focus on hospitality and eschew discounting. One thing is clear: In a rising wage environment, you have to be able to pass these costs on to your customers and you can’t do that very well by discounting. Executing at the restaurant level with highly trained employees is the best strategy to win customers and deal with increasing labor costs.