Restaurant labor expense makes up ~24% of total sales
From a business perspective, restaurant owners can’t possibly increase wages to $15 per hour. IBIS World had estimated labor expense to make up ~24% of total sales for fast food restaurants. Although some sources proclaim ~33% in employee salary, that figure likely includes management’s salary, which isn’t directly affected by the increase in minimum wage. In the real world, managers’ salary will likely increase, because managers will think, “Why are entry-level employees getting raises while I’m not, given the difference in the work we do?”
How operating margin for McDonald’s would decline
Although McDonald’s doesn’t report its restaurant employee expense for the United States, it does show what its restaurant labor expense is for international branches. That figure has consistently been around 25.5%—close to the industry average, using McDonald’s “payroll & employee benefits expense” and “company-operated store sales.” This excludes the effect of franchise revenues and expenses. So if minimum wage were to increase from $7.25 an hour to $15 an hour, doubling the payroll and employee expense, fast food owners’ operating margins would decline by ~25%.
Franchisees can’t offer $15 an hour
Fast food business owners, franchisees, aren’t likely able to absorb higher costs without significant changes. IBIS World estimates that the average industry profit, which it refers to as EBIT (earnings before interest and tax—somewhat equivalent to operating income) is just 3.6%. A decrease of ~25% in operating margin would put several fast food business owners in the red and lead to layoffs. If wage expense increased by 15%, which equates an increase of 3.75% in payroll and employee benefits expense as a percentage of sales, the average company wouldn’t make profits.
Because McDonald’s is well recognized, franchisee owners could be earning above the industry average, ranging from 5% to 10%. But that wouldn’t be a reason for owners to increase pay compared to other fast food restaurants. If franchisees increase wages, then there will be more people who would want to work at McDonald’s, which would increase competition. McDonald’s would then be able to demand more from its employees, and other employment seekers wouldn’t be able to find jobs.
McDonald’s won’t be able to absorb a wage increase without doing anything
Turning to McDonalds, how would an increase to $15 per hour affect the company? In 2012, the company generated $4,530 million in revenue from its U.S. stores. The increased wage would have a direct negative impact of $1,132.5 million to its operating profit. With operating income of $883 million from U.S. company-operated stores, the company’s operating income for the United States would become negative.
If McDonald’s didn’t raise its menu price alongside wages, it would shut down most—if not all—of its stores in the United States. Thousands of employees, strikers included, would be unemployed. But that’s not going to happen, because the probability that McDonald’s will raise its minimum wage to $15 an hour is zero.
- Part 1 - Fast food companies pay near minimum wage, yet high wage expense
- Part 2 - Why do most workers at McDonald’s work part-time?
- Part 3 - Must-know: Majority of fast food workers “not” above 25 years old
- Part 4 - Why time favors fast food business owners during strikes
- Part 5 - Why fast food business owners can’t offer $15 per hour
- Part 6 - Why the proposed minimum wage act wouldn’t affect restaurants
© 2013 Market Realist, Inc.