Ryan Williams
Jeremy Julian

From Speculation to Fact: The Real Effect of a $15 Minimum Wage on Restaurants

June 14, 2016

Today, we are continuing from last week’s article, Is the $15 per Hour Wage Hike a Death Blow to Your Restaurant?

For the past few weeks, we have been discussing our opinions, possible benefits, shortcomings and problems of the new $15 minimum wage law but they, in fact, are just speculation. We cannot tell the future – and frankly, no one knows what will happen. Economists, both conservative and liberal, have speculated that this could either greatly benefit or destroy California’s economy and growth factors for smaller, private and family-owned restaurants.

Instead of making more speculations, we want to give you facts and real consequences of a $15 minimum wage.

Below are excerpts from an article written by Grant Chen, a restaurant owner in Seattle, Washington, which passed a $15 minimum wage law in 2014, but went into effect on April 1, 2015 (click on the link to read the full article). Chen talks about the extreme difficulties maintaining a sustainable restaurant business with already thin margins. He also brings to light the inconvenient truths and hard numbers that supporters of the wage law do not think or talk about when it comes to trying to run a successful, profitable business.

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Most people think that restaurants are some type of hugely profitable enterprise. The reality is that restaurants are “profitable” but are usually paying back loans or trying to recoup initial costs of building out the restaurant. The breakdown of expenses is usually along these lines:

  • 25-40% food cost
  • 30-35% employee wages
  • 15-25% rent plus utilities

If you add up the low side, it equals 70% expenses, leaving 30% profit. If you add the high side all up, it actually equals 100%, leaving little profit. If you’ve ever wondered why the steak or lobster costs so much at the fancy restaurant in downtown, it’s because the margins are thin and expenses are high. Famed Seattle restaurateur Tom Douglas stated that his profit margins were 5% and he has some of the most popular restaurants in Seattle.

For this reason, buying or building a restaurant is a form of gambling. You put a huge amount of money up front and hope to make your initial investment back in about three to five years (if you’re lucky). That means for those years, even if everything goes according to plan, you cannot make money if something happens at the end of the third year. As it stands, most restaurants fail during the first or second year, because they can’t get enough traction or repeat customers during this incubation period or they simply run out of cash. It’s a risky business, because you have to generate immediate cash flow, otherwise your business is burning through cash keeping your rent paid, the ovens on and servers to stand around doing nothing.”

Grant then discusses the restaurant math of a 61% increase in labor costs:

As of January 2016, Seattle’s minimum wage is $13 an hour, which represents a 40% increase in our labor cost from the prior hourly wage of $9.32. This puts our expenses over 100% [of sales revenues], but we’re trying to offset it with price increases of 10% across the board and cutting hours by about 10% as well.

The difficulty in increasing prices is that 5 minutes away, the Seattle city boundary ends, which means that we are competing with restaurants that don’t need to charge extra. If our customers don’t run away, we anticipate a slight loss or ideally, a break-even year. Most other restaurant owners we’re talking to are all in the same boat of trying to raise prices without upsetting customers and digging into profits to make it work. Those with sit down service can at least go from a tip system to service charge system, at the risk of alienating their best servers. So far, customer complaints have been fairly muted, with the occasional mention, but we usually just tell them that it’s the side effect of minimum wage.

To put things into perspective, the average American household in 2013 spent almost $3,000 or 6% of their budget on gasoline at $3.50 per gallon. If you take an overall 20% increase in restaurant expenses and apply an equivalent increase to a gas budget of 6%, it would be the equivalent of $11.70 per gallon gasoline prices. This is the type of shock that restaurant owners are facing.

Come next year, when minimum wage of $15 an hour goes into effect, it will be a 61% increase in our labor cost, which will bring our total expenses to well over 120% [of sales revenue]. This is when the real economics experiment begins, when we can no longer cut hours and have to raise prices by another 20% just to break even. Will customers balk at this price or will the general lift in wages throughout the city enable people to afford to pay more while eating out?

I really don’t know, but we’re all going to find out soon enough.”

Grant ends by discussing how higher government-mandated labor costs have forced him to operate now as a “private charity” as he anticipates the inevitable closing of his restaurant:

“This will be a complete loss of savings and retirement money that we put into the restaurant. Rather than being “rich old white guys,” we’re young, minority entrepreneurs. Two of us just became proud fathers last year and another is about to have his first this year. The final kick is that since the mass exodus from the retail space, commercial leases almost always require a personal guarantee. In the event that we the tenant cannot pay the bills, the guarantor and their personal assets (read: our homes) are on the hook. This means that even with a failing business, we would be better served continuing to bleed money instead of letting the landlord come after us, short of negotiating a buy-out or other arrangement.

When we eventually close the restaurant, we’re going to be laying off a team of extraordinary employees. They are hard workers and I respect all of them and they deserve the increase in pay. I simply wish I could continue paying them while making a living myself. As it stands, we’re more or less operating a private charity now.”

Bottom Line: It’s unlikely that Grant Chen’s situation operating a restaurant in Seattle today is in any way unique. It’s probably a pretty typical example of the new “restaurant math” that all restaurants in Seattle are now facing and that California restaurants will face in the near future. If the typical restaurant makes a profit margin of 5%, there’s just no way that most restaurants can possibly survive a 61% (Seattle) or a 50% (California) increase in labor costs.

In the end, it’s about math, not politics. And the restaurant math of a $15 an hour minimum wage is an arithmetic for restaurant failures, not restaurant survival.

Need to pass the time before our next article? Our friends over at Custom Business Solutions just released a whitepaper that analyzes restaurant technology solutions that can help your business save money and offset the costs of the higher minimum wage.

If you want to help your restaurant be more efficient, reduce cost and weather the storm of the upcoming economic changes, learn more about the NorthStar Order Entry System and request a free demo by clicking on the link provided.

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