New York State took a bold step in labor activism last week, passing a $15/hour minimum wage for fast-food restaurant employees, a 70% increase from today's rate of $8.75/hour.
While plenty of ink has been spilled on the political and economic effects of such a law, with the expected outrage from conservatives and cheers from labor advocates, little attention has been paid to the business effects of the law -- for the restaurants themselves, and for stakeholders such as franchisees, employees, and customers.
The fine print
The actual effects of the law won't be as sudden as the headlines might indicate. Wages for the affected restaurant workers would move up incrementally over the next few years, hitting $15/hour by the end of 2018 in New York City. Pay rates in the rest of the state, which includes economically depressed areas such as Central New York, would reach $15 by July 1, 2021.
The law was recommended by a special board appointed by Governor Andrew Cuomo, who latched on to protesters' demands and made them a reality, arguing that his state should not have to subsidize multinational companies whose employees live below the poverty line. Acting Labor Commissioner Mario Musolino must act on the recommendation, and is widely expected to approve it. The new law will affect any fast-food chain with at least 30 locations nationwide where customers order at the counter and pay before receiving their food.
Though the law won't have an overnight effect, the consequences could be far-reaching, especially for the poorer regions of upstate New York, where the median wage for all jobs is barely above $15/hour currently.
How it might play out
Fast food restaurants are more dependent on low-wage labor than most businesses. Most fast-food chains spend in the range of 20-25% of revenue on labor, meaning a 70% increase in labor costs would translate into as much as a 14%-17% uptick in overall expenses.
Chipotle Mexican Grill (NYSE:CMG), the largest national fast-food chain that does not franchise its restaurants, offers a good example, as its financial results are easily decipherable. In 2014, labor costs accounted for $904 million in expenses, or 22% of revenue, down from 23% in 2013. Chipotle tends to pay its employees above minimum wage, but even if its average wages in New York are $10/hour, the mandated increase would still push wages up 50%, leading to an 11% increase in expenses at its New York restaurants.
Businesses confronted with this mandated increase have two options to offset the effects: raise prices, or reduce expenses elsewhere. Simply absorbing the cost increase is not an option since most restaurant chains operate at single-digit profit margins. In a survey by the conservative Employment Policies Institute, over 80% of restaurants said they were somewhat or very likely to raise prices and cut hours in response to such a law.
Restaurants are generally loath to raise prices due to intense competition. Since fast-food restaurant chains are a singular target of the New York law, those operators are at a particular disadvantage against others in the food industry, such as independent fast-food restaurants, full-service restaurants, and convenience stores.
Therefore, restaurants may be more likely to trim costs than pass along the wage increases to customers. Operators have little control over their biggest cost input, food, which fluctuates with commodity prices, so they are likely to focus on eliminating labor costs instead.
Automation and new technology have replaced human labor throughout the history of industry, dating back to the Luddites, and higher wages are likely to accelerate this transition. Some restaurants have already begun automating the order-taking and payment processes through kiosks, tablets, or mobile payments, and new technologies are quickly making cashiers and order-takers obsolete.
Expect restaurants in New York to experiment further with these processes. In the future, a customer may visit a fast-food joint and order through their phone or at an in-store kiosk, pay with a credit card or mobile wallet app, and then present their receipt -- on their phone or on paper -- at the counter to retrieve their order.
In the kitchen, equipment upgrades could also help reduce labor costs. For instance, an innovative company known as Momentum Machines has created a robot that can produce 360 hamburgers an hour, performing tasks such as slicing tomatoes and even custom burger grinds. It also takes up only 24 square feet of space, helping to conserve valuable real estate in crowded kitchens, and Momentum Machines estimates that it would save the average fast-food restaurant $135,000 a year. With the wage hike, the savings could be $200,000 or more.
Of course, not all restaurant duties can be automated, but even tasks like cleaning could potentially be subcontracted, increasing savings.
For fast food employees, this means that fewer jobs will be available. And with higher pay, they will become more competitive as the quality of the labor pool increases. Many of the current fast-food employees who fought for the raise could lose out in the shuffle.
Customers could see higher prices as restaurants pass on the expenses that they can't eliminate through staff reductions. They could also experience lower levels of service as fast food restaurants reduce their headcount. And some underperforming restaurants in poorer areas could close as a result of the higher minimum wage.
For the major restaurant chains like McDonald's, Burger King, and Chipotle, the bottom-line effects are unlikely to be material, as New York makes up just about 6% of the country's population.
For New York-based franchisees of the major chains, however, the effects will be palpable. Not surprisingly, many of them decried the law, saying it's unfair to other low-wage workers, and will force higher prices while creating an unfriendly business environment.
If the law catches on in other states, as Governor Cuomo hopes, it could have a deep impact on the industry. It could force other restaurants to pay more due to competition for labor, lifting prices at all dining establishments, and on a national level, its effects on big-name chains would be much more widespread.
Companies like McDonald's, which franchises most of its locations, may be relatively protected as royalty payments tend to be based on sales, not profit. But chains like Chipotle or Shake Shack could see rising labor costs, as both chains are expanding domestically through company-operated stores and brand themselves as offering a higher level of service.
With the federal minimum wage stuck at $7.25/hour since 2007, states and municipalities have acted independently to raise low-level wages, and restaurants are already responding. On Chipotle's recent earnings call, CFO Jack Hartung said that the burrito chain had raised prices in the San Francisco area to help absorb a wage hike to $12/hour in that city, and expected to implement similar targeted price hikes as needed.
Rising wages are coming -- gradually -- and with them will come higher prices. For chains like Chipotle that have demonstrated pricing power, this shouldn't be a problem. But weaker companies, and especially franchisees, could see profits evaporate.
Jeremy Bowman owns shares of Chipotle Mexican Grill. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.