Can Fast-Food Chains Survive a Wage Hike?

Fast-food workers across the nation are demanding higher wages, saying they are unable to survive on minimum wage. Walkouts over the last year -- and especially over the last two months -- have disrupted normal operations at many fast-food chains, most notably at McDonald's (NYSE: MCD  ) .

Everyone wants more money, but fast-food workers are especially desperate for higher wages. An employee who works 60 hours per week at the federal minimum wage ($7.25 per hour) would bring in just $19,368 after taxes if he or she never took a week off. Most workers are unable to find 60 hours of employment each week, which means they bring in even less money -- hardly enough to live on and support a family.

As a result, fast-food workers and union organizers are demanding a raise in the minimum wage to $15 per hour -- an enormous wage hike. Fast-food workers cite the billions of dollars in profits that McDonald's makes each year as evidence of its ability to hike wages, while McDonald's sympathizers say a doubling of wages would be catastrophic for the company. As usual, both sides have distorted their respective positions, so investors should ignore the noise and get the facts.

Can fast food chains afford a wage hike?
First of all, doubling the federal minimum wage would not double the amount fast-food chains like McDonald's, Burger King Worldwide (NYSE: BKW  ) , and Jack in the Box (NASDAQ: JACK  ) pay their employees. According to Businessweek, the typical wage worker at fast-food restaurants earns about $9 an hour. The workers making minimum wage are predominately seasonal workers, such as high-school and college students. So a wage increase to $15 per hour would be a two-thirds increase, not a doubling.

However, even a two-thirds wage increase would be devastating to fast-food chains' profits. Although information on franchisee profit margins is hard to come by, public fast-food chains release enough data about their company-owned restaurants for investors to get insight into their ability to increase wages.

McDonald's, Burger King, and Jack in the Box pay wages that equate to 25% to 30% of restaurant sales. An aggressive (i.e., inflated) calculation of these restaurants' profit margins yields a 10% to 20% margin -- this excludes corporate-level sales, general, and administrative expenses (SG&A) that are necessary to advertise and run the company.

Even using this inflated measure of profitability, it is clear that each percentage point increase in payroll expenses would have an enormous impact on overall profitability. For instance, an increase of just one percentage point of Burger King's payroll as a percentage of sales would cause its bottom line to shrink by close to 9% (11.27% profit margin falls to 10.27%, an 8.8% decrease).

Moreover, even McDonald's would have difficulty sustaining a large increase in wages; a 20% wage increase would decrease McDonald's net profit by 17%. This assumes that wages account for just half of total payroll and benefits -- likely a conservative estimate -- and that franchisee income would decline by the same amount as company-owned store income.

  2012 20% Wage Increase
Company-owned store revenue $18.6 billion $18.6 billion
Payroll & benefits ($4.7 billion) ($5.17 billion)
Other company-owned store expenses ($10.5 billion) ($10.5 billion)
Company-owned store profit $3.4 billion $2.93 billion
+ Franchise Fees $7.4 billion $6.38 billion
- SG&A and other corporate expenses $2.21 billion $2.21 billion
McDonald's Net Income $8.6 billion $7.1 billion

In essence, since wages are such a high percentage of fast food companies' cost structures, each percentage hike in wages accounts for nearly the same drop in net income. This strong, inverse relationship between wages and profits makes it difficult for fast food companies to raise wages, much less double them.

Of course, McDonald's et al could simply raise their prices. But I'm pretty sure the chains are already milking their customers for as much money as they can get. If Burger King could sell just as many Whoppers for $1 more than it sells for today, it would. But competition makes low prices a necessity, so price increases would cause sales volumes to fall, adding even more pressure to profits. 

Even worse, the people who work at fast-food chains tend to be in the demographic that frequents them the most. A 20% price increase to offset higher wages means 17% higher food prices for the poorest consumers in the American economy. This is hardly the path to digging oneself out of poverty and joining the middle class.

Aside from higher food prices, higher wages would likely mean lower employment. If McDonald's cannot sustain a 20% wage hike without a significant hit to its profitability, it will have to increase its efficiency in order to maintain a respectable profit margin. This means hiring fewer workers and requiring the ones it has to do more.

Bottom line
Despite apparently enormous profits, most fast-food chains operate on a tightrope; even a slight increase in costs has a huge impact on profits. If the federal minimum wage is raised by more than, say, 10%, investors should abandon Burger King and Jack in the Box and remain cautious with McDonald's. These companies simply cannot tolerate large increases in costs and maintain anything close to their current levels of profitability.

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Read/Post Comments (14) | Recommend This Article (1)

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  • Report this Comment On September 12, 2013, at 2:47 PM, skipgainer61 wrote:

    Fast food chains did not put these people in the economic straits they are in. They can thank themselves and our politicians for this mess they are in, our school systems are a joke compared to what they use to be. These fast food chains do offer a way out of the economic chaos they find themselves in. Unfortunately it takes some self initiating on their part to actually want to better themselves

  • Report this Comment On September 12, 2013, at 3:32 PM, JohnSmith4026 wrote:

    With people being paid ABOVE Poverty Wage, there will be MORE customers for McDonalds and other Fast Food restaurants.

    This will allow them to keep prices down.

    They'll make as much, if not more, profit on more sales.

    Right now, that is being held back because more and more Americans are getting below Poverty wages (Americans who used to make $30,000 - $60,000/Year).

    The argument that it will hurt sales and reduce employment is very flawed.

  • Report this Comment On September 12, 2013, at 3:43 PM, dogjudge wrote:

    Simply put, the restaurant industry in general is not known for paying people living wages. It isn't just the fast food folks.

    Some time ask the server at your favorite diner, drive-in or dive if they make the minimum wage. And they get tips!

    The average person who works here is a female working a couple of jobs.

    This is sort of like WalMart.

    The Republicans LOVE to complain about the welfare situation in this country. What they don't talk about is how MANY on welfare ARE working at companies such as WalMart.

    So why is it that Republican voters feel that they can complain about minimum wages AND welfare programs and still call themselves christians?

  • Report this Comment On September 12, 2013, at 3:47 PM, 4pepper wrote:

    The likely answer if this happens will be increased automation and your order will be input by you and you will pay for it and then stand in line for the black box to open and push out your order. Naturally, you will get fewer choices. Only mechanics will be needed to maintain the black box and burger flippers will be history.

    There is always a downside to increasing the minimum wage.

  • Report this Comment On September 12, 2013, at 3:49 PM, cerealmaker11 wrote:

    The Fast food industry might afford the salary increase but could never take the union impact on work rules. SEIU doesn't really care about the wages but wants the union in a these facilities to boost their money and political clout

  • Report this Comment On September 12, 2013, at 4:16 PM, JohnSmith4026 wrote:

    This WON'T increase automation!

    If automation is so great for the fast food industry, they would have done it long time ago.

    I have also seen an automated ordering machine at a Jack-In-The-Box.

    It was there for a while, but is no longer there.

    It wasn't worth it.

  • Report this Comment On September 12, 2013, at 4:36 PM, 696969Fools wrote:

    This article and Mr. Cooper's logic is so flawed as to make this article worthless. Why don't you have an intelligent person make a cogent argument for the workers? My guess is because Mr. Cooper is somehow connected to the fast food industry.

    I'll only pick the most obvious problem with his argument. I don't have time and I'm sure MF doesn't allow me space to address all the issues he mentions.

    $8.6 billion in net profit vs. $7.1 billion in net profit (note how Mr. Cooper says "net income" not "net profit)?

    So we should feel bad for the corporate execs and the investors when they only make a paltry $7.1 billion in profit?

    By sacrificing and and taking ONLY $7.1 billion in profit we raise the economic level of parents, families and children to the point where they may not be dependent on government assistance for income, food or heath care. That reduces the size of government along with the budget. And while those numbers come down, the people who we pay more will be contributing more in tax money. And that's a good thing because I'm guessing the corporate executives at these chains and their employers are paying next to nothing in taxes as they can afford the lawyers and accountants to find every loophole.

    Keep in mind, that tax money will be used for schools, job (re-)training and U.S. infrastructure.

    So investors will go somewhere else? Well so what? First of all, those investors aren't going anywhere. McDonald's is McDonald's. It may pay a bit less to the investors but it's a blue-chip company that will do BETTER when the economy is worse. What would happen if investors move $$ elsewhere. It can't be another fast food chain as they all will be paying the liviging wage.

    And as someone else already pointed out, when those people are making more $$ then they'll buy more burgers. Multiply that by millions of people.

    Greed is killing this country and Mr. Cooper's disingenuous article is designed to get the average uniformed person to believe in arguing (and voting) against their best interests.

    I have no problem with companies making money. I have a problem with companies paying slave wages, eliminating health care and driving down the quality of living for everyone except themselves. Like almost every other corporation, they want to privatize the profits and socialize the costs.

    Mr. Cooper is arguing that it's better to let corporations and corporate execs make billions more in profit than to have millions of families and children get out of poverty. I disagree. The entire country prospers when everybody prospers, not just a lucky few.

    Thanks for listening.

  • Report this Comment On September 12, 2013, at 4:43 PM, freedomwriter wrote:

    OF COURSE they can survive. The same way they have with every other minimum wage hike. DON"T believe the propaganda!

  • Report this Comment On September 12, 2013, at 4:53 PM, JohnSmith4026 wrote:

    COMPLETELY CORRECT, 696969Fools!!

    (BTW - I think you mean "when the economy is BETTER" when you said "....it's a blue-chip company that will do BETTER when the economy is worse")

  • Report this Comment On September 12, 2013, at 5:22 PM, shortdawg1 wrote:

    It doesn't matter what "demographic" you are in, no one should consider McDonalds or other fast food chain a regular addition to their diet. It should be an occasional treat, not a way of life. When I was growing up going out to eat was a big deal. Getting a bottle of soda was a treat, not a beverage to be consumed at every meal.

    I still look at these things this way and also am at the low end of my ideal weight. There are way too many overweight children. I just watched a documentary showing how the prices of fruits and veggies went up in price and along side showing the prices of junk food stayed the same or even dropped in price. Along side that was the rate of obesity which went up. It's pretty sad when only one in six of our youth is qualified to enter our military because of weight issues.

  • Report this Comment On September 12, 2013, at 6:17 PM, mayday05 wrote:

    LIBS

    show me the math. your taking worldwide profit and only giving it to the american workers. just 2 dollars across the board wordwide at an average of 30 hours would bankrupt mcd's. they made 5.5 billion and a 2 dollar hour raise would be 5.6 billion.

    In america we need to add in all the taxes that come with wage increase. ssi,federal,state,local,workers comp insurance, UN employment insurance, workers training funds, obamacare (who knows about that one) all are based on wages. it used to add about 25% to the original wage. the franchisee only makes 100-250k but is on the hook for millions. so there's no money there. show me your work how it's done without raises prices or firing people. p.s. don't give only americans the worldwide profit either

  • Report this Comment On September 12, 2013, at 8:11 PM, Bits2Roast wrote:

    Gotta say that living in Switzerland for a while now I have seen that absolutely every one is better off with higher wages and more parity... even the low end jobs earn you pretty decent money and average hourly salary is sky high compared to the US (so is the cost of living...pretty much like living in Manhattan), but everyone can make a decent living from their work, ppl in general are very happy and hey even though your average shopping center sales person makes 50k+ a year, companies here are still profitable and the unemployment rate is less than 3%!

    So yes, this is a great example of "The entire country prospers when everybody prospers, not just a lucky few" like said in one of the previous comments!

    Too bad a government full of elitist & 'corrupt' politicians will never be able to create a level playing field....most certainly no longer the 'greatest country on earth'... sorry to say, but the truth sometimes hurts! ;)

  • Report this Comment On September 12, 2013, at 8:56 PM, JohnSmith4026 wrote:

    shortdawg1,

    I eat at McDonalds and I LOST weight.

    I've never been obese, but I still lost a fair amount of weight eating at McDonalds.

    It's simple.

    If you eat a salad at McDonalds, don't get the high calorie dressing. Get the Low-fat Italian.

    If you get McNuggets, eat them without any sauce.

    Always get "Grilled" chicken.

    It will save you 100-150 calories you can use on something more filling.

    If you are burning the standard 2000 calories a day, you WILL get FAT if you eat 3000 calories of spinach, etc. (so-called "health foods").

    And, ignore the documentaries, they are biased propaganda without all of the facts.

  • Report this Comment On September 13, 2013, at 3:02 AM, DQ10 wrote:

    In my lifetime according to the fast food industry there has never been an increase in the minimum wage the industry could survive. I'm 62. The industry is bigger than ever. I didn't believe it 40 years ago. I don't believe it now. By the way in another article they all were planning ways to raise prices. That is the one thing you are guaranteed to get.

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