Minimum wage in Limited-Service Restaurants 1 The Minimum wage, A Competitive Wage and the Price of a Burger: Can Competitive Wages be Offered in Limited-Service Restaurants? RICHARD GHISELLI School of Hospitality and Tourism Management at Purdue University, West Lafayette, IN, USA JING MA School of Hospitality and Tourism Management at Purdue University, West Lafayette, IN, USA Abstract The purpose of this paper was to examine the effect that higher wages and health care benefits have on costs and prices in limited-service restaurants. In order to compensate for higher wages, prices would have to increase between 4% and 25% and/or product size would have to be scaled back between 12% and 70%. With tax credits that are available in the nest few years, the Affordable Care Act will have minimal effect on limited-service restaurants with fewer than 25FTEs. The extent to which higher wages and more benefits will help ameliorate turnover must be balanced with the cost of turnover and the potential effect on sales. Keywords: Minimum Wage, Limited-service Restaurant, Competitive Wage, Affordable Care/ ObamaCare, Prices of Product, and Costs of Product. According to the NRA, the median number of full-time equivalent employees (FTE) in limited-service restaurants serving only food is 9, and sales are $626,796 (median). This suggests that most can be considered small businesses. Because of this, many limited-service restaurant food service workers are versatile in that they often greet customers at counters and/or drivethrough windows and cook and assemble orders, depending on the restaurant concept, may even Address correspondence to Jing Ma, PhD student, School of Hospitality and Tourism Management. Purdue University, 900 W. State Street, West Lafayette, IN, 47906 USA. Email: mjing@purdue.edu 1 Minimum wage in Limited-Service Restaurants 2 serve the customers at the table. Moreover, working conditions can be difficult. Employees are continuously on their feet and under pressure to serve customers quickly and efficiently. No specific educational requirements for food service workers exist and many are young: 59% of food service workers are under the age of 34 (BLS, 2014a). For many, the job may be an immediate source of income rather than a career. Perhaps as a result, the pay tends to be lower. See table 1. Table 1. Demographics of food service workers compared to all occupations (BLS, 2014a) Fast food 100% 16-19 years 30% Food service 100% 17% 26% 16% 13% 16% 9% 3% 29.2 All occupations 100% 3% 9% 22% 21% 23% 16% 5% 42.3 Total 20-24 years 31% 25-34 years a 35-44 years a 45-54 years a 55-64 years b 65 years and over b Median age N/A a: 25-54: 36.4% b: over 55: 2.9% Turnover in the foodservice industry has been one of the most troublesome problems to manage. Historically, limited-service restaurants have experienced the highest rates. In many of these operations, in particular those that have no table service, tipping is not practiced, and employees receive (at the very least) the minimum wage. Further, rate of pay, has been recognized as one of the most important factors for leaving one restaurant to go to another (Murphy & Williams, 2004). Also, poor supervision and work environment have been identified as primary reasons for employee turnover (Hinkin & Bruce Tracey, 2000). Within the limitedservice sector, turnover seems to vary both by affiliation and type of ownership (NRA, 2013). In 2013 franchised establishments experienced the highest turnover rate at 93%. Food service employers have recognized the magnitude of this difficult situation (DiPietro & Milman, 2004), and food service managers have indicated that turnover is more of a problem than other employee behaviors such as absenteeism (Ghiselli, La Lopa, & Bai, 2001). Although many 2 Minimum wage in Limited-Service Restaurants 3 organizations seem to accept turnover as an inevitable fact, and the result of employing people, some organizations have seen this as an unnecessary cost and have developed strategies to encourage staff retention (Barlow & Gerald, 2003). A case in point is Starbucks - a profitable company that has attributed its success to good-human relations, including an emphasis on employee retention (Barlow & Gerald, 2003). This is not to say that positive changes in the restaurant industry have not taken place in the last several years. Figure 1 suggests that during the past decade, average turnover rate for hourly employees in limited-service restaurants has declined while total payroll and benefits/FTE has increased. Figure 1. Limited-service Restaurant Turnover and Payroll/Benefits for FTE Limited Service Restaurant Turnover % 140% $20,000 120% 100% $15,000 80% $10,000 60% 40% $5,000 20% 0% Payroll/Benefit FTE $25,000 160% $- Year Turnover % Payroll/Benefits FTE Turnover can be expensive: the cost of replacing employees includes advertising, recruitment, selection (background checks, drug screening) and training. As might be expected, 3 Minimum wage in Limited-Service Restaurants 4 an employee’s position within the organization is an important factor. In foodservice settings, for example, the cost to hire an hourly line position has been estimated to be $1,500, and for a salaried staff member, $3,000 (Hinkin & Tracey, 2000). There are also indirect costs associated with turnover. The cost of separation includes vacancy costs, i.e. the cost of having other employees cover the schedule - which may entail overtime. There are other costs that may be more difficult - if not impossible - to identify and quantify monetarily, for example, the loss of productivity as inexperienced employees replace more skilled ones. Also, if turnover persists and/or is prevalent, employee morale may diminish impacting overall efficiency and customer service. In December 2013, US fast-food workers went on strike over wages. Thousands of demonstrators across the country clamored for the minimum wage to be increased to $15 per hour (Gabbatt, 2013; Yahoo! News, 2013). Be that as it may, food service establishments, especially fast food and/or limited-service restaurants compete on price and convenience and in order to stay competitive, restaurants may not be able to raise wages to the level desired by employees. Indeed, it is frequently debated whether the benefits outweigh the costs of adopting a “living wage.” While proponents of a living wage ordinance promote the benefits such as improved employee morale and motivation, opponents argue that the costs (such as reduced employment, higher contract prices, and firm relocations to cities without a living wage ordinance) outweigh the benefits. Several studies (e.g., Neumark & Adams, 2000; Schoenberger, 2000) have measured the costs and benefits associated with the living wage in various cities. Other studies have shown that the living wage rate is particularly sensitive to per capita manufacturing income, fair market rent, the minimum wage in the state the business is located, and the city in which the business is located (Dickson & Myatt, 2002; Gallet, 2004; Waltman & 4 Minimum wage in Limited-Service Restaurants 5 Pittman, 2002). This study takes a slightly different approach and examines the effect of increasing wages on product cost and price. Another urgent issue facing limited-service restaurant operators is employee health care as the new health care law takes effect. Based on research conducted by the National Restaurant Association, no payroll regulation has had more of an impact on payroll processing than the Affordable Care Act, or ObamaCare, as it is commonly called. The health care law, enacted in 2010, is prompting many restaurant operators to seek outside payroll providers and utilize knowledge and expertise of those providers to cope with the complexities of the industry’s human resource challenges (National Restaurant Association and Deloitte & Touche, 2014). One of the requirements for employers with 50 or more full-time equivalent employees is to purchase health insurance for their workers or pay a penalty (by 2015). But for small businesses with the equivalent of less than 25 full-time workers, ObamaCare offers incentives, such as tax breaks and tax credits via the SHOP Exchange, to help them provide health benefits to employees (Obama Care Facts, 2014). This study examines the effect of new health care regulations (new premiums and possible tax benefits) on product and price in limited-service restaurants. In sum, the purpose of this paper is to examine the effects of increasing wages to a competitive level, and to estimate the effects that new health care requirements could have on costs and prices. One of the premises is that current compensation levels do little to mitigate turnover, and that more competitive wages in the industry - in particular the limited-service segment - could reduce it. 5 Minimum wage in Limited-Service Restaurants 6 Current Wage Rates Even though the NRA reports medians (instead of averages), a reasonable measure of wages can be obtained by dividing the total amount of payroll and benefits per full-time equivalent employee (FTE) by the number of hours worked in the year. This latter amount can be estimated by multiplying the number of FTE employees and the number of hours the NRA assigns to full-time equivalency. 1. Full-time equivalency Number of weeks/ year x 2. Number of hours/year = 30 hour* 52 1,560 Total payroll & benefits/FTE Number of hours/year (FTE) Estimate of total compensation/hour ÷ $19,961 = 1,560 $12.80 *Note 1: While NRA regarded jobs that required 30 hours or more as full-time jobs, BLS used 35 hours as the cut point. So in order to make data comparable, this study used 30 hours as full time equivalency in calculations. Then, an hourly amount without benefits can be calculated by backing benefits out of total payroll & benefits/FTE. In the accommodation and food services industry, benefits on average represent 20.3% of payroll (BLS, 2013, p. 383). 3. Estimate of total compensation/hour $12.80 Amount over wages ÷ Estimate of pay/hour = 1.203 $10.64 This amount compares favorably with the amount earned by eating and drinking place 6 Minimum wage in Limited-Service Restaurants 7 workers as reported by the Bureau of Labor Statistics in 2012, $8.84 /hour (BLS, 2014c). As a percent of total sales, median salaries and wages (including employee benefits) for limitedservice restaurants represented approximately 28.5% in 2013 (National Restaurant Association and Deloitte & Touche, 2013). Offering Competitive Wages Suppose that food service wages were more competitive and were comparable to the average wage for all private industry employees; in 2012 this was $22.01/hour (BLS, 2012). Average wages are the straight-time hourly wages or salaries paid to employees. They include incentive pay, cost-of-living adjustments, and hazard pay. Excluded are premium pay for overtime, vacations, and holidays, non-production bonuses, and tips (BLS, 2012). Plugging this amount into the above, an estimate of yearly wages per FTE can be obtained. 4. Wages/hour x Full-time equivalency $22.01 x Number of weeks/year 30 = 52 Estimate of wages/year $34,336 Assuming the relationship between wages and benefits remains the same, an estimate of compensation per FTE can be obtained. 5. Estimate of wages/year (FTE) $34,336 x Multiplier to include benefits 1.203 = Estimate of total compensation/FTE $41,305.73 If current profit levels are satisfactory at 6.3% of sales for all limited-service restaurants and they are to be maintained, and labor levels are close to the minimum required amount, two 7 Minimum wage in Limited-Service Restaurants 8 approaches can be used to assess the effect of increasing wages: 1. The effect on price. 2. The effect on product. The Effect on Price -- The Cost of a Burger If only food is sold, and sales remain steady - both in volume and menu mix - what would be the effect on price(s)? That is, what should the selling price be if the same products are to be provided? In essence, if wages are increased and sales remain as they are, what would be the effect on price? - How much is the burger? Any (substantial) increase in costs would inevitably lead to an increase in prices. Since volume is assumed to remain steady, however, food cost and all other expenses would remain constant in terms of dollars spent -- not in relation to sales. But the relation of these items to sales would diminish because of the increase in prices and resulting increase in total sales revenue. From the information provided by the NRA, dollar amounts can be computed for operating expenses and food cost using median percentages and total sales. An estimate for total sales can be calculated based on the median number of Full-Time Equivalent Employees and the median amount of sales generated per FTE. In particular, the median number of employees in limited-service restaurants (food only) in 2013 was 9*, and the amount of sales generated per FTE was $69,644 (National Restaurant Association and Deloitte & Touche, 2013). Multiplying these two provides a measure (of central tendency) that somewhat reflects the limited-service segment as a whole, and enables preliminary analysis of the effect that changes may entail. 8 Minimum wage in Limited-Service Restaurants 6. Median number FTEs 9 x Total sales/FTE (median) $69,644 = 9 Estimate of Total Sales for Limited-service Restaurants $626,796 Using this figure, annual dollar amounts can be calculated for the operating expenses by using the median percentage of an expense multiplied by the estimated total sales for limited*Note 2: According to the National Restaurant Association’s Operations Report 2013-14, limited-service restaurants (all restaurants) operate with 10 full-time equivalent employees; in those that sell food only there are 9 FTEs (median). The latter will be used in this analysis. service restaurants. Food cost can be calculated in a like manner. Finally, an estimate of payroll and benefits assuming competitive wages can be included. The sum of these gives an indication of the amount that will be needed in sales to cover all costs while providing a wage that is more in line with the average of all jobs in the private sector. As previously computed, if wages in the food service industry were equivalent to the average amount in the private sector, then the annual compensation per FTE would be $41,306 (wage rate = $22.01/hour). In order to obtain a rate of return comparable to the amount that was earned in 2013 (at current or unadjusted wage rates), income before taxes must be included as a "cost." In 2013 this amount was 6.3% of total sales for all restaurants (National Restaurant Association and Deloitte & Touche, 2013). 9 Minimum wage in Limited-Service Restaurants 7. Total Cost & Expenses i. $731,532 ii. $731,532 iii. + Profit = 6.3% * (Total Sales / Restaurant) 10 Total Sales / Restaurant Total Sales / Restaurant 93.7% * (Total Sales / Restaurant) Total Sales / Restaurant $780,718 Table 2. Derived Sales Calculations – Increased Wages Costs & Expenses Current Median % of Total Sales (2013) $ Amount $15/hour $22.01/hour $ Amount $ Amount Food cost* 33.0% $206,843 $206,843 $206,843 Direct Operating Expense 5.8 $36,354 $36,354 $36,354 $$$Music & Entertainment Marketing 2.1 $13,163 $13,163 $13,163 2.6 $16,297 $16,297 $16,297 Utility Services Occupancy Costs 6.4 $40,115 $40,115 $40,115 R&M 1.3 $8,148 $8,148 $8,148 Depreciation 1.7 $10,656 $10,656 $10,656 2.1 $13,163 $13,163 $13,163 General & Administrative Corporate Overhead 1.9 $11,909 $11,909 $11,909 $$$Other Expenses .3 $1,880 $1,880 $1,880 Interest Expense Equipment leases .2 $1,254 $1,254 $1,254 Cost & Expenses (before Payroll & Benefits) Wage & Benefits per FTE $28,150 $41,306 FTE 9 9 Total Payroll & Benefits $253,352 $371,752 Total Costs & Expenses $613,133 $731,532 Income before taxes 6.3 $41,225 $49,185 Derived sales $654,357 $780,718 Current sales (median) $626,796 $626,796 $27,561 $153,922 Additional revenue needed Price change needed 4% 25% *Food costs assumed to remain the same as the portion size/sales volume/menu mix are assumed to remain the same. 10 Minimum wage in Limited-Service Restaurants 11 The difference between this amount and current costs is the extra amount that must be charged in order to pay for increased wages. 8. Total Cost & Expenses & Profit (Competitive Wages) - Total Cost & Expenses & Profit (Current Wages) $780,718 $626,796 = Additional Revenue Needed $153,922 In order to provide a more competitive wage, higher prices would have to be charged. On a per dollar basis, for each dollar currently generated, 125% would have to be charged. For a burger that costs $ 2.00, the price would be $2.49, and an average meal (check) that costs $7.00 would cost $8.72. In a like manner, using $15 as the new wage level, $27,561 additional revenue would be required to compensate for the increase in wages. So prices would be 104% of the original price; for a burger that costs $2.00, the price would be $2.09, and an average meal (check) that costs $7.00 would cost $7.31. The Effect on Product -- The Size of a Burger If only food is sold, and sales remain constant – both in volume and menu mix - what would be the effect on product size (and food cost)? That is, if wages were increased, current costs and prices remained the same relative to sales, how would that effect portion size? - In essence, how big is the burger? Since sales are constant, all other costs or expenses except food would remain the same in relation to sales. Using total compensation per full-time equivalent employee as computed above 11 Minimum wage in Limited-Service Restaurants 12 and the total sales amount per FTE (median) for limited-service restaurants - $69,644 - payroll and benefits would consume 59.3% of sales, compared to the current 28.5% of sales (median). Because labor costs and other expenses are generally related to total sales, they can be regarded as the amounts that are spent out of each dollar that is generated. That is, if labor costs represent 59.3% of sales, for each dollar received $.593 is spent on labor. Similarly, the other expenses can be represented as the amounts that are spent or consumed to generate one dollar in sales. These costs and expenses can be tallied and the amount that remains for food can be determined by subtracting the sum from $1.00. In other words, to pay higher wages and to keep prices at their current levels, food costs would have to be about 10% of sales compared to the current level of 33% (median). This suggests that portion cost (and size) would have to be scaled back by about 70%. See table 3. And if we do the same calculation assuming wages increase to $15 as demanded by recent protesters - payroll costs would be 40.4% compared to current 28.5% (median); in this case, food costs would have to be 28.9% compared to the current 33% (median). This suggests that portion sizes would have to be reduced by 12%. 12 Minimum wage in Limited-Service Restaurants 13 Table 3. Derived Food Cost Calculations – Constant Sales. Costs & Expenses Per Dollar Sales Median % of Total Sales $15/hour $22.01/hour (2013) Payroll & Benefits (estimated) Direct Operating Expense Music & Entertainment Marketing Utility Services Occupancy Costs R&M Depreciation General & Administrative Expenses Corporate Overhead Other Expenses Interest Expense Equipment leases Income before Taxes Total before food Derived Food Cost Current food cost % Change in food cost (or portion size) 0.285 0.058 0.000 0.021 0.026 0.064 0.013 0.017 0.021 0.019 0.000 0.003 0.002 0.063 0.404 0.058 0.000 0.021 0.026 0.064 0.013 0.017 0.021 0.019 0.000 0.003 0.002 0.063 0.593 0.058 0.000 0.021 0.026 0.064 0.013 0.017 0.021 0.019 0.000 0.003 0.002 0.063 0.711 0.900 0.289 0.330 0.100 0.330 12% 70% Affordable Care Act/ ObamaCare Under the Affordable Care Act (ACA), limited-service restaurants with fewer than 50 FTEs in a calendar year are considered small employers for the following calendar year and are not required to offer employees health benefits. Further, they will not face tax penalties if any employees get federal tax subsidies to help them buy private health insurance through public 13 Minimum wage in Limited-Service Restaurants 14 exchanges. If employers decide to provide health care for employees, how much might it cost? The data suggest that limited-service restaurants employ on average fewer than 25 FTEs, and that average wages are below $50,000 (National Restaurant Association and Deloitte & Touche, 2013). As such they would be classified as small businesses (NRA, 2013). IRS regulations indicate the amount of tax credit a small business can receive works on a sliding scale: the smaller the business, the bigger the credit. Accordingly, businesses that employ equal or less than 10 full-time equivalent employees, and pay less than $25,000 per full-time equivalent employee per year, qualify for most tax credits. Since limited-service restaurants (food only) employ 9 FTEs and pay $19,961 per FTE on average, they would be qualified to receive the largest tax credit: 50% of premiums paid (IRS, 2013b, 2013c). Food service establishments currently spend about 4.4% of payroll on employee health benefits (BLS, 2013), or $7,905/year. If a restaurant with 9 employees (average FTEs) purchases health insurance for them through the Small Business Health Options Program (SHOP) – assuming their ages are similar to those who work in limited-service restaurants and that the business is operated in a particular county in Indiana – it will cost a minimum of $2,543/month (Bronze), or $30,516/year (healthcare.gov, 2014). The difference (between $30,516 and $7,905) $22,611 will be treated as an additional expense. Tax credits However, if a restaurant buys health insurance for its employees through the SHOP exchange and pays at least 50% of their health premiums, it may be eligible for federal tax credits (NRA, 2013). In particular, an employer that pays $30,516/year in premiums will receive 14 Minimum wage in Limited-Service Restaurants 15 a tax credit up to $10,681 in 2013. This is because the tax credit for the first year is 35%. For tax years beginning in 2014 and beyond, the maximum credit will increase to 50% of premiums paid. If premiums remain the same, the tax credit will be $15,258. The impact of the new health care law will be two fold. First, the tax credit will reduce taxes payable and thus have impact on the amount restaurants have to pay to provide health insurance for their employees; second, the change in health care premium will have an impact on restaurants’ net income. For example, assuming a restaurant pays 100% of the premiums for all of its employees, the additional out of pocket expense will be $22,611; this is the difference between premiums through SHOP, $30,516, and the current cost of health insurance, $7,905. As a result, NIBT (Net income before taxes) will decrease by $22,611. This decrease will result in reduction in taxes payable by $7,914. Additionally, there is a tax credit of $15,258 (assuming appropriate tax levels). The net effect is $561, indicating that the new health care law will have minimum impact on restaurants that are eligible for the full tax credit. See table 4. If an employer pays only 50% of the premium, the minimum amount to qualify for a tax credit, the additional expense of buying health insurance will reduce NIBT by $7,353. The decrease in taxes payable and tax credit available will result in a net effect of $2,849. Again the impact appears to be minor. 15 Minimum wage in Limited-Service Restaurants 16 Table 4. Amounts need to be compensated for in price, paying different portions of the premium With Tax credits Health care premium ($) 100% premium 50% premium 0% premium Current Health Care Costs (estimates) 7,905 7,905 7,905 Tax ($) Net difference Needed Price Increase Costs under SHOP (estimates) Impact on NIBT Tax effect of difference in premiums* Tax credit Impact on NIBT Net impact on NI % (30,516) (15,258) - (22,611) (7,353) 7,905 7,914 2,574 (2,767) 15,258 7,629 - 23,172 10,203 (2,767) 561 2,849 5,138 - Net difference Needed Price Increase No Tax credits Health care premium ($) 100% premium 50% premium 0% premium Current Health Care Costs (estimates) 7,905 7,905 7,905 Tax ($) Costs under SHOP (estimates) Impact on NIBT Tax effect of difference in premiums* Tax credit Impact on NIBT Net impact on NI % (30,516) (15,258) - (22,611) (7,353) 7,905 7,914 2,574 (2,767) - 7,914 2,574 (2,767) (14,697) (4,780) 5,138 2% 1% - *1: applying 35% tax rate *2:It is overly complicated and not realistic trying to figure out a precise tax rate. As annual revenue for a limited-service restaurant based on calculation is $626,796, falls in the range of $100,000–$10 million, 35% will be used as a general rate for calculation (Avant, 2011; IRS, 2013a). 16 Minimum wage in Limited-Service Restaurants 17 The alternative Limited-service restaurants, due to their size, may not be required to purchase health insurance for their employees. Unless they pay 50% or more of their employees’ health insurance premiums, they will not receive a tax credit. Moreover, since restaurants may not need to pay for health care for their employees, the amount they currently pay, 4.4% of payroll or $7,904 will be saved. This saving will increase NIBT by the same amount, $7,904, and taxes will have to be paid on this amount. The net effect is $5,138. Without tax credits As it stands now, tax credits will be available to eligible employers for only two consecutive taxable years, after that there may be changes. For example, assuming there are no credits, for those employers that pay 100% of employees’ premiums, NI will decrease by $14,697. In this case, the price of the burger would have to be increased by 2% to maintain the same margins. Then, a $7 meal would cost $7.15. Paying 50% of the premiums will result in a $4,780 decrease in NI, and in order to maintain the same rate of return, the price of a burger would have to be increased by 1%, and a $7 meal would cost $7.07. If restaurants do not buy health insurance for their employees through the company (0% premium), the net impact on NI will be $5,138. If this is the case, no price increase is necessary. See table 4. Higher Wages + Health Insurance Premium Combing the effects of both factors, the tax credits that available in the first two years offset the increase in health care expenses, and the overall price changes would be driven only by 17 Minimum wage in Limited-Service Restaurants 18 any wage increases. Starting in year three, and assuming 0 tax credits, a burger would be 127% more expensive than it is today ($22.01 and 100% premium); for other possibilities, 125% ($22.01 and 50% premium), 107% ($15 and 100% premium), or 105% ($15 and 50% premium) of its original price in order to maintain the same margin. If restaurants do not provide insurance but raise wages, the price of a burger will increase by 25% ($22.01) or 4% ($15). If adjustments are made to portion sizes, for the first two taxable years, since the new health care law has minimal impact, the combined effect will be the same as if only increasing wages is considered. Beginning in year three, a burger has to be 76% ($22.01 and 100% premium), 73% ($22.01 and 50% premium), 70% ($22.01 and 0% premium), 19% ($15 and 100% premium), 16% ($15 and 50% premium), and 12% ($15 and 0% premium) smaller. See table 5. Conclusions To minimize the impact of increased costs on business competitiveness, restaurants should assist their employees in identifying possible options through SHOP but not provide health care through the company. The above calculations are based on two assumptions: 1. There is no increase in the costs of other restaurant inputs (food, supplies, linens, cleaning, etc.), which would be highly unlikely if the minimum wage rose to competitive levels since the prices of all basic goods and services would go up. 2. A restaurant wouldn’t lose any business after increasing its prices. This is also unlikely. Because of the tax credits provided by the government for small businesses, providing health care will not significantly increase the pressure to raise prices. Since not providing any health insurance may lead to disgruntled employees, restaurants can utilize the tax credit as a 18 Minimum wage in Limited-Service Restaurants 19 buffer and gradually reduce the amount provided while assisting employees find better options through SHOP. Additionally, one important consideration employers have to keep in mind is that the tax credits will be available to eligible employers for only two consecutive taxable years. After the two years, the costs will creep back up. As indicated above, one of the difficulties with this approach is the competitive nature of the industry. Projected increases in the number of families and a more affluent, 55-year-andolder population may result in more restaurants offering table service, and more varied menus putting pressure on the limited-service restaurants to keep pricing stable (BLS 2014b). Increasing employee wages may not be a winning strategy. That is, instead of being considered a leader, such a move would most likely drive business elsewhere. Raising wages to competitive levels may be too costly, but increasing wages to $15 may be achievable. Further analyses needs to be conducted to confirm whether higher wages would indeed reduce turnover before definitive conclusions can be reached. Considering both the indirect costs of turnover, as well as the lost of consistency, managing turnover is a critical issue. Unless procedures are highly standardized and require relative low skills, management will spend more time than it already does training and/or filling in for a highly transient workforce. Because turnover may be very demanding, management may be willing to cut corners in order to do the normal tasks required to perform his/her own job. High turnover and reduced preparation to perform the highly personal tasks will inevitably lead to inconsistencies in product quality and service, and with them customer dissatisfaction. With 19 Minimum wage in Limited-Service Restaurants 20 this in mind, it makes business sense for managers to strive to reduce turnover even at the price of incurring additional costs. However, careful evaluation of how to balance the two so that the overall competitiveness of the restaurant will be improved has to be clarified. Assuming that paying employees a competitive rate is a desired end, the question becomes can higher wages lead to greater consistency, develop brand loyalty to the extent that higher prices can be charged and deliver customer satisfaction. Restaurants need to carefully assess whether improved product and service quality would be enough to sustain the business in a highly competitive and undifferentiated market. There are a number of standard approaches that are used to calculate a menu item’s selling price. Often they are based on food cost. That is, the price is based on the cost of food alone with a desired margin added to cover all other known or anticipated costs. Labor must inevitably figure into the calculation, particularly if competitive wages are to be considered. If restaurants decide to increase wages, they can either reduce product size or raise the price to maintain margins. While reducing size has its limitations (customer acceptance may be low), new technologies may enable businesses to engage in revenue and yield management in order to increase revenues. Also, some might suggest that another solution to the turnover dilemma would be using machines to replace people. Even though limited-service restaurants have attempted to engineer labor out of the operation, relative to other expenses it remains on par with food cost. There are a number of disadvantages with the current approach to labor in foodservice. One of the most troubling aspects is the pay; current levels are such that many do not consider 20 Minimum wage in Limited-Service Restaurants 21 food service a viable working alternative or a career path. This may be one of the factors driving the high turnover in the industry. Also, pay may affect employees’ perceptions of their jobs. Specifically, employees may sense their wages correlate with the value management places on their positions or the job they perform. If they discern that their jobs are unimportant or trivial, or that management doesn’t care, why should they? Because commitment to an organization may be influenced by pay, it is not hard to imagine that their time is worth more than the amount their employer is willing to pay. Further, employees stay with organizations because effective human resources practices provide a supportive work environment that affords opportunities to grow and develop. These positive outcomes are founded on a philosophy that people are an asset, and investing in them will bring increased benefits for the entire organization. There are a number of advantages to paying higher wages. One is the reduction of (excessively high) turnover rates in the industry. As Figure 1 suggests, turnover rates have declined when compensation has increased. A more stable, skilled and committed workforce would help eliminate the inadequate and poor service that often results because of high turnover. Also, attention on performance will focus both employers and employees on the standards and behaviors that drive the operation -- which will enable both groups to help meet the long run goals of the organization. 21 Minimum wage in Limited-Service Restaurants 22 Table 5. Effect of Higher Wages + Health Insurance Premium With Tax Credit Wage level Adjust price (% more expensive) Adjust portion size (% smaller) Health care premium paid Health care premium paid 100% 50% 0% $22.01 25% 25% 25% $15 4% 4% 4% Wage level 100% 50% 0% $22.01 70% 70% 70% $15 12% 12% 12% No Tax Credit Wage level Adjust price (% more expensive) Adjust portion size (% smaller) Health care premium paid Health care premium paid 100% 50% 0% $22.01 27% 25% 25% $15 7% 5% 4% Wage level 100% 50% 0% $22.01 76% 73% 70% $15 19% 16% 12% 22 Minimum wage in Limited-Service Restaurants 23 References Avant, M. (2011). Top 10 Taxes and Fees - These 10 items can account for a big chunk of quick serves’ expenses. qsrmagazine. Retrieved from http://www.qsrmagazine.com/executiveinsights/top-10-taxes-and-fees Barlow, & Gerald, L. (2003). Putting a Price on Staff Turnover: A Case Study. Paper presented at the Production & Operations Management Society BLS. (2012). May 2012 National Occupational Employment and Wage Estimates United States. Bureau of Labor Statistics Retrieved from http://www.bls.gov/oes/current/oes_nat.htm - 35-0000. BLS. (2013). Employer Costs for Employee Compensation Historical Listing March 2004 – September 2013. United States Department of Labor. BLS. (2014a). Labor Force Statistics from the Current Population Survey. United States Department of Labor Retrieved from http://www.bls.gov/cps/demographics.htm - age. BLS. (2014b). Labor Force Statistics from the Current Population Survey: Demographics. Bureau of Labor Statistics: US Department of Labor Retrieved from http://www.bls.gov/cps/demographics.htm. BLS. (2014c). Occupational Outlook: Food and Beverage Serving and Related Workers. U.S. Department of Labor. 23 Minimum wage in Limited-Service Restaurants 24 Dickson, V., & Myatt, T. (2002). The determinants of provincial minimum wages in Canada. Journal of Labor Research, 23, 57–65. DiPietro, R. B., & Milman, A. (2004). Hourly Employee Retention Factors in the Quick Service Restaurant Industry. International Journal of Hospitality & Tourism Administration, 5(4), 31-51. doi: 10.1300/J149v05n0402 Gabbatt, A. (2013). US fast-food workers strike over low wages in nationwide protests. The Guardian. Retrieved from http://www.theguardian.com/world/2013/dec/05/fast-foodworkers-strike-minimum-wage Gallet, C. A. (2004). The determinants of living wage rates. The Social Science Journal, 41(4), 661-666. doi: http://dx.doi.org/10.1016/j.soscij.2004.08.005 Ghiselli, R., La Lopa, J., & Bai, B. (2001). Job satisfaction, life satisfaction, and turnover intent among food-service managers. The Cornell Hotel and Restaurant Administration Quarterly, 42(2), 28-37. doi: http://dx.doi.org/10.1016/S0010-8804(01)80036-7 HealthCare.gov (Producer). (2014). Retrieved from https://http://www.healthcare.gov/findpremium-estimates/ - results/&aud=sbiz&type=med&state=IN&county=Tippecanoe&age0=18&age1=21&age 2=22&age3=26&age4=32&age5=36&age6=47&age7=58&age8=19 Hinkin, T. R., & Bruce Tracey, J. (2000). The cost of turnover: Putting a price on the learning curve. The Cornell Hotel and Restaurant Administration Quarterly, 41(3), 14-14. doi: http://dx.doi.org/10.1016/S0010-8804(00)80013-0 24 Minimum wage in Limited-Service Restaurants 25 Hinkin, T. R., & Tracey, B. J. (2000). The cost of turnover: Putting a price on the learning curve. The Cornell Hotel and Restaurant Administration Quarterly, 41(3), 14-14. doi: http://dx.doi.org/10.1016/S0010-8804(00)80013-0 IRS. (2013a). Business Taxes for Hotels, Motels & Restaurants. Department of the Treasury Retrieved from http://www.irs.gov. IRS. (2013b). Credit for Small Employer Health Insurance Premiums. Department of the Treasury Retrieved from http://www.irs.gov/pub/irs-pdf/f8941.pdf. IRS. (2013c). Instructions for Form 8941 . Department of the Treasury Retrieved from http://www.irs.gov/pub/irs-pdf/i8941.pdf. Murphy, K. S., & Williams, J. A. (2004). The Impact of Compensation on the Turnover Intentions of Outback Steakhouse Managers. Journal of Foodservice Business Research, 7(1), 63-80. doi: 10.1 300/J369v07n01-05 National Restaurant Association and Deloitte & Touche. (1995). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (1996). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (1997). Restaurant Operations Report Washington DC. 25 Minimum wage in Limited-Service Restaurants 26 National Restaurant Association and Deloitte & Touche. (1998). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (1999). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2000). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2001). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2002). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2003). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2004). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2005). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2006). Restaurant Operations Report Washington DC. 26 Minimum wage in Limited-Service Restaurants 27 National Restaurant Association and Deloitte & Touche. (2008). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2013). Restaurant Operations Report Washington DC. National Restaurant Association and Deloitte & Touche. (2014). Payroll in the age of the Affordable Care Act. from http://www.restaurant.org/Manage-My- Restaurant/Workforce-Management/Managing-Once-Hired/Payroll-in-the-age-of-theAffordable-Care-Act Neumark, D., & Adams, S. (2000). Do living wage ordinances reduce urban poverty? . NBER Working Paper No. 7606. Cambridge, MA. NRA. (2013). Health Care Law Toolkit- What You Need to Know Now What you need to do now. National Restaurant Association. Obama Care Facts. (2014). Obama Care Facts Dispelling the myths. Retrieved Jan 12, 2014, from http://obamacarefacts.com Schoenberger, E. (2000). The living wage in Baltimore: Impacts and reflections. Review of Radical Political Economics, 32, 428–436. Waltman, J., & Pittman, S. (2002). The determinants of state minimum wage rates: A public policy approach. Journal of Labor Research, 23, pp. 51–56. 27 Minimum wage in Limited-Service Restaurants 28 Yahoo! News. (2013, December 5, 2013). Fast-food strikes return amid push for wage hikes. Yahoo! News. Retrieved from http://news.yahoo.com/fast-food-strikes-return-amid-pushwage-hikes-114457533--finance.html 28 Minimum wage in Limited-Service Restaurants 1 The Minimum wage, A Competitive Wage and the Price of a Burger: Can Competitive Wages be Offered in Limited-Service Restaurants? RICHARD GHISELLI School of Hospitality and Tourism Management at Purdue University, West Lafayette, IN, USA JING MA School of Hospitality and Tourism Management at Purdue University, West Lafayette, IN, USA Abstract The purpose of this paper was to examine the effect that higher wages and health care benefits have on costs and prices in limited-service restaurants. In order to compensate for higher wages, prices would have to increase between 4% and 25% and/or product size would have to be scaled back between 12% and 70%. With tax credits that are available in the nest few years, the Affordable Care Act will have minimal effect on limited-service restaurants with fewer than 25FTEs. The extent to which higher wages and more benefits will help ameliorate turnover must be balanced with the cost of turnover and the potential effect on sales. Keywords: Minimum Wage, Limited-service Restaurant, Competitive Wage, Affordable Care/ ObamaCare, Prices of Product, and Costs of Product. According to the NRA, the median number of full-time equivalent employees (FTE) in limited-service restaurants serving only food is 9, and sales are $626,796 (median). This suggests that most can be considered small businesses. Because of this, many limited-service restaurant food service workers are versatile in that they often greet customers at counters and/or drivethrough windows and cook and assemble orders, depending on the restaurant concept, may even Address correspondence to Jing Ma, PhD student, School of Hospitality and Tourism Management. Purdue University, 900 W. State Street, West Lafayette, IN, 47906 USA. Email: mjing@purdue.edu 1 Minimum wage in Limited-Service Restaurants 2 serve the customers at the table. Moreover, working conditions can be difficult. Employees are continuously on their feet and under pressure to serve customers quickly and efficiently. No specific educational requirements for food service workers exist and many are young: 59% of food service workers are under the age of 34 (BLS, 2014a). For many, the job may be an immediate source of income rather than a career. Perhaps as a result, the pay tends to be lower. See table 1. Table 1. Demographics of food service workers compared to all occupations (BLS, 2014a) Fast food 100% 16-19 years 30% Food service 100% 17% 26% 16% 13% 16% 9% 3% 29.2 All occupations 100% 3% 9% 22% 21% 23% 16% 5% 42.3 Total 20-24 years 31% 25-34 years a 35-44 years a 45-54 years a 55-64 years b 65 years and over b Median age N/A a: 25-54: 36.4% b: over 55: 2.9% Turnover in the foodservice industry has been one of the most troublesome problems to manage. Historically, limited-service restaurants have experienced the highest rates. In many of these operations, in particular those that have no table service, tipping is not practiced, and employees receive (at the very least) the minimum wage. Further, rate of pay, has been recognized as one of the most important factors for leaving one restaurant to go to another (Murphy & Williams, 2004). Also, poor supervision and work environment have been identified as primary reasons for employee turnover (Hinkin & Bruce Tracey, 2000). Within the limitedservice sector, turnover seems to vary both by affiliation and type of ownership (NRA, 2013). In 2013 franchised establishments experienced the highest turnover rate at 93%. Food service employers have recognized the magnitude of this difficult situation (DiPietro & Milman, 2004), and food service managers have indicated that turnover is more of a problem than other employee behaviors such as absenteeism (Ghiselli, La Lopa, & Bai, 2001). Although many 2 Minimum wage in Limited-Service Restaurants 3 organizations seem to accept turnover as an inevitable fact, and the result of employing people, some organizations have seen this as an unnecessary cost and have developed strategies to encourage staff retention (Barlow & Gerald, 2003). A case in point is Starbucks - a profitable company that has attributed its success to good-human relations, including an emphasis on employee retention (Barlow & Gerald, 2003). This is not to say that positive changes in the restaurant industry have not taken place in the last several years. Figure 1 suggests that during the past decade, average turnover rate for hourly employees in limited-service restaurants has declined while total payroll and benefits/FTE has increased. Figure 1. Limited-service Restaurant Turnover and Payroll/Benefits for FTE Limited Service Restaurant Turnover % 140% $20,000 120% 100% $15,000 80% $10,000 60% 40% $5,000 20% 0% Payroll/Benefit FTE $25,000 160% $- Year Turnover % Payroll/Benefits FTE Turnover can be expensive: the cost of replacing employees includes advertising, recruitment, selection (background checks, drug screening) and training. As might be expected, 3 Minimum wage in Limited-Service Restaurants 4 an employee’s position within the organization is an important factor. In foodservice settings, for example, the cost to hire an hourly line position has been estimated to be $1,500, and for a salaried staff member, $3,000 (Hinkin & Tracey, 2000). There are also indirect costs associated with turnover. The cost of separation includes vacancy costs, i.e. the cost of having other employees cover the schedule - which may entail overtime. There are other costs that may be more difficult - if not impossible - to identify and quantify monetarily, for example, the loss of productivity as inexperienced employees replace more skilled ones. Also, if turnover persists and/or is prevalent, employee morale may diminish impacting overall efficiency and customer service. In December 2013, US fast-food workers went on strike over wages. Thousands of demonstrators across the country clamored for the minimum wage to be increased to $15 per hour (Gabbatt, 2013; Yahoo! News, 2013). Be that as it may, food service establishments, especially fast food and/or limited-service restaurants compete on price and convenience and in order to stay competitive, restaurants may not be able to raise wages to the level desired by employees. Indeed, it is frequently debated whether the benefits outweigh the costs of adopting a “living wage.” While proponents of a living wage ordinance promote the benefits such as improved employee morale and motivation, opponents argue that the costs (such as reduced employment, higher contract prices, and firm relocations to cities without a living wage ordinance) outweigh the benefits. Several studies (e.g., Neumark & Adams, 2000; Schoenberger, 2000) have measured the costs and benefits associated with the living wage in various cities. Other studies have shown that the living wage rate is particularly sensitive to per capita manufacturing income, fair market rent, the minimum wage in the state the business is located, and the city in which the business is located (Dickson & Myatt, 2002; Gallet, 2004; Waltman & 4 Minimum wage in Limited-Service Restaurants 5 Pittman, 2002). This study takes a slightly different approach and examines the effect of increasing wages on product cost and price. Another urgent issue facing limited-service restaurant operators is employee health care as the new health care law takes effect. Based on research conducted by the National Restaurant Association, no payroll regulation has had more of an impact on payroll processing than the Affordable Care Act, or ObamaCare, as it is commonly called. The health care law, enacted in 2010, is prompting many restaurant operators to seek outside payroll providers and utilize knowledge and expertise of those providers to cope with the complexities of the industry’s human resource challenges (National Restaurant Association and Deloitte & Touche, 2014). One of the requirements for employers with 50 or more full-time equivalent employees is to purchase health insurance for their workers or pay a penalty (by 2015). But for small businesses with the equivalent of less than 25 full-time workers, ObamaCare offers incentives, such as tax breaks and tax credits via the SHOP Exchange, to help them provide health benefits to employees (Obama Care Facts, 2014). This study examines the effect of new health care regulations (new premiums and possible tax benefits) on product and price in limited-service restaurants. In sum, the purpose of this paper is to examine the effects of increasing wages to a competitive level, and to estimate the effects that new health care requirements could have on costs and prices. One of the premises is that current compensation levels do little to mitigate turnover, and that more competitive wages in the industry - in particular the limited-service segment - could reduce it. 5 Minimum wage in Limited-Service Restaurants 6 Current Wage Rates Even though the NRA reports medians (instead of averages), a reasonable measure of wages can be obtained by dividing the total amount of payroll and benefits per full-time equivalent employee (FTE) by the number of hours worked in the year. This latter amount can be estimated by multiplying the number of FTE employees and the number of hours the NRA assigns to full-time equivalency. 1. Full-time equivalency Number of weeks/ year x 2. Number of hours/year = 30 hour* 52 1,560 Total payroll & benefits/FTE Number of hours/year (FTE) Estimate of total compensation/hour ÷ $19,961 = 1,560 $12.80 *Note 1: While NRA regarded jobs that required 30 hours or more as full-time jobs, BLS used 35 hours as the cut point. So in order to make data comparable, this study used 30 hours as full time equivalency in calculations. Then, an hourly amount without benefits can be calculated by backing benefits out of total payroll & benefits/FTE. In the accommodation and food services industry, benefits on average represent 20.3% of payroll (BLS, 2013, p. 383). 3. Estimate of total compensation/hour $12.80 Amount over wages ÷ Estimate of pay/hour = 1.203 $10.64 This amount compares favorably with the amount earned by eating and drinking place 6 Minimum wage in Limited-Service Restaurants 7 workers as reported by the Bureau of Labor Statistics in 2012, $8.84 /hour (BLS, 2014c). As a percent of total sales, median salaries and wages (including employee benefits) for limitedservice restaurants represented approximately 28.5% in 2013 (National Restaurant Association and Deloitte & Touche, 2013). Offering Competitive Wages Suppose that food service wages were more competitive and were comparable to the average wage for all private industry employees; in 2012 this was $22.01/hour (BLS, 2012). Average wages are the straight-time hourly wages or salaries paid to employees. They include incentive pay, cost-of-living adjustments, and hazard pay. Excluded are premium pay for overtime, vacations, and holidays, non-production bonuses, and tips (BLS, 2012). Plugging this amount into the above, an estimate of yearly wages per FTE can be obtained. 4. Wages/hour x Full-time equivalency $22.01 x Number of weeks/year 30 = 52 Estimate of wages/year $34,336 Assuming the relationship between wages and benefits remains the same, an estimate of compensation per FTE can be obtained. 5. Estimate of wages/year (FTE) $34,336 x Multiplier to include benefits 1.203 = Estimate of total compensation/FTE $41,305.73 If current profit levels are satisfactory at 6.3% of sales for all limited-service restaurants and they are to be maintained, and labor levels are close to the minimum required amount, two 7 Minimum wage in Limited-Service Restaurants 8 approaches can be used to assess the effect of increasing wages: 1. The effect on price. 2. The effect on product. The Effect on Price -- The Cost of a Burger If only food is sold, and sales remain steady - both in volume and menu mix - what would be the effect on price(s)? That is, what should the selling price be if the same products are to be provided? In essence, if wages are increased and sales remain as they are, what would be the effect on price? - How much is the burger? Any (substantial) increase in costs would inevitably lead to an increase in prices. Since volume is assumed to remain steady, however, food cost and all other expenses would remain constant in terms of dollars spent -- not in relation to sales. But the relation of these items to sales would diminish because of the increase in prices and resulting increase in total sales revenue. From the information provided by the NRA, dollar amounts can be computed for operating expenses and food cost using median percentages and total sales. An estimate for total sales can be calculated based on the median number of Full-Time Equivalent Employees and the median amount of sales generated per FTE. In particular, the median number of employees in limited-service restaurants (food only) in 2013 was 9*, and the amount of sales generated per FTE was $69,644 (National Restaurant Association and Deloitte & Touche, 2013). Multiplying these two provides a measure (of central tendency) that somewhat reflects the limited-service segment as a whole, and enables preliminary analysis of the effect that changes may entail. 8 Minimum wage in Limited-Service Restaurants 6. Median number FTEs 9 x Total sales/FTE (median) $69,644 = 9 Estimate of Total Sales for Limited-service Restaurants $626,796 Using this figure, annual dollar amounts can be calculated for the operating expenses by using the median percentage of an expense multiplied by the estimated total sales for limited*Note 2: According to the National Restaurant Association’s Operations Report 2013-14, limited-service restaurants (all restaurants) operate with 10 full-time equivalent employees; in those that sell food only there are 9 FTEs (median). The latter will be used in this analysis. service restaurants. Food cost can be calculated in a like manner. Finally, an estimate of payroll and benefits assuming competitive wages can be included. The sum of these gives an indication of the amount that will be needed in sales to cover all costs while providing a wage that is more in line with the average of all jobs in the private sector. As previously computed, if wages in the food service industry were equivalent to the average amount in the private sector, then the annual compensation per FTE would be $41,306 (wage rate = $22.01/hour). In order to obtain a rate of return comparable to the amount that was earned in 2013 (at current or unadjusted wage rates), income before taxes must be included as a "cost." In 2013 this amount was 6.3% of total sales for all restaurants (National Restaurant Association and Deloitte & Touche, 2013). 9 Minimum wage in Limited-Service Restaurants 7. Total Cost & Expenses i. $731,532 ii. $731,532 iii. + Profit = 6.3% * (Total Sales / Restaurant) 10 Total Sales / Restaurant Total Sales / Restaurant 93.7% * (Total Sales / Restaurant) Total Sales / Restaurant $780,718 Table 2. Derived Sales Calculations – Increased Wages Costs & Expenses Current Median % of Total Sales (2013) $ Amount $15/hour $22.01/hour $ Amount $ Amount Food cost* 33.0% $206,843 $206,843 $206,843 Direct Operating Expense 5.8 $36,354 $36,354 $36,354 $$$Music & Entertainment Marketing 2.1 $13,163 $13,163 $13,163 2.6 $16,297 $16,297 $16,297 Utility Services Occupancy Costs 6.4 $40,115 $40,115 $40,115 R&M 1.3 $8,148 $8,148 $8,148 Depreciation 1.7 $10,656 $10,656 $10,656 2.1 $13,163 $13,163 $13,163 General & Administrative Corporate Overhead 1.9 $11,909 $11,909 $11,909 $$$Other Expenses .3 $1,880 $1,880 $1,880 Interest Expense Equipment leases .2 $1,254 $1,254 $1,254 Cost & Expenses (before Payroll & Benefits) Wage & Benefits per FTE $28,150 $41,306 FTE 9 9 Total Payroll & Benefits $253,352 $371,752 Total Costs & Expenses $613,133 $731,532 Income before taxes 6.3 $41,225 $49,185 Derived sales $654,357 $780,718 Current sales (median) $626,796 $626,796 $27,561 $153,922 Additional revenue needed Price change needed 4% 25% *Food costs assumed to remain the same as the portion size/sales volume/menu mix are assumed to remain the same. 10 Minimum wage in Limited-Service Restaurants 11 The difference between this amount and current costs is the extra amount that must be charged in order to pay for increased wages. 8. Total Cost & Expenses & Profit (Competitive Wages) - Total Cost & Expenses & Profit (Current Wages) $780,718 $626,796 = Additional Revenue Needed $153,922 In order to provide a more competitive wage, higher prices would have to be charged. On a per dollar basis, for each dollar currently generated, 125% would have to be charged. For a burger that costs $ 2.00, the price would be $2.49, and an average meal (check) that costs $7.00 would cost $8.72. In a like manner, using $15 as the new wage level, $27,561 additional revenue would be required to compensate for the increase in wages. So prices would be 104% of the original price; for a burger that costs $2.00, the price would be $2.09, and an average meal (check) that costs $7.00 would cost $7.31. The Effect on Product -- The Size of a Burger If only food is sold, and sales remain constant – both in volume and menu mix - what would be the effect on product size (and food cost)? That is, if wages were increased, current costs and prices remained the same relative to sales, how would that effect portion size? - In essence, how big is the burger? Since sales are constant, all other costs or expenses except food would remain the same in relation to sales. Using total compensation per full-time equivalent employee as computed above 11 Minimum wage in Limited-Service Restaurants 12 and the total sales amount per FTE (median) for limited-service restaurants - $69,644 - payroll and benefits would consume 59.3% of sales, compared to the current 28.5% of sales (median). Because labor costs and other expenses are generally related to total sales, they can be regarded as the amounts that are spent out of each dollar that is generated. That is, if labor costs represent 59.3% of sales, for each dollar received $.593 is spent on labor. Similarly, the other expenses can be represented as the amounts that are spent or consumed to generate one dollar in sales. These costs and expenses can be tallied and the amount that remains for food can be determined by subtracting the sum from $1.00. In other words, to pay higher wages and to keep prices at their current levels, food costs would have to be about 10% of sales compared to the current level of 33% (median). This suggests that portion cost (and size) would have to be scaled back by about 70%. See table 3. And if we do the same calculation assuming wages increase to $15 as demanded by recent protesters - payroll costs would be 40.4% compared to current 28.5% (median); in this case, food costs would have to be 28.9% compared to the current 33% (median). This suggests that portion sizes would have to be reduced by 12%. 12 Minimum wage in Limited-Service Restaurants 13 Table 3. Derived Food Cost Calculations – Constant Sales. Costs & Expenses Per Dollar Sales Median % of Total Sales $15/hour $22.01/hour (2013) Payroll & Benefits (estimated) Direct Operating Expense Music & Entertainment Marketing Utility Services Occupancy Costs R&M Depreciation General & Administrative Expenses Corporate Overhead Other Expenses Interest Expense Equipment leases Income before Taxes Total before food Derived Food Cost Current food cost % Change in food cost (or portion size) 0.285 0.058 0.000 0.021 0.026 0.064 0.013 0.017 0.021 0.019 0.000 0.003 0.002 0.063 0.404 0.058 0.000 0.021 0.026 0.064 0.013 0.017 0.021 0.019 0.000 0.003 0.002 0.063 0.593 0.058 0.000 0.021 0.026 0.064 0.013 0.017 0.021 0.019 0.000 0.003 0.002 0.063 0.711 0.900 0.289 0.330 0.100 0.330 12% 70% Affordable Care Act/ ObamaCare Under the Affordable Care Act (ACA), limited-service restaurants with fewer than 50 FTEs in a calendar year are considered small employers for the following calendar year and are not required to offer employees health benefits. Further, they will not face tax penalties if any employees get federal tax subsidies to help them buy private health insurance through public 13 Minimum wage in Limited-Service Restaurants 14 exchanges. If employers decide to provide health care for employees, how much might it cost? The data suggest that limited-service restaurants employ on average fewer than 25 FTEs, and that average wages are below $50,000 (National Restaurant Association and Deloitte & Touche, 2013). As such they would be classified as small businesses (NRA, 2013). IRS regulations indicate the amount of tax credit a small business can receive works on a sliding scale: the smaller the business, the bigger the credit. Accordingly, businesses that employ equal or less than 10 full-time equivalent employees, and pay less than $25,000 per full-time equivalent employee per year, qualify for most tax credits. Since limited-service restaurants (food only) employ 9 FTEs and pay $19,961 per FTE on average, they would be qualified to receive the largest tax credit: 50% of premiums paid (IRS, 2013b, 2013c). Food service establishments currently spend about 4.4% of payroll on employee health benefits (BLS, 2013), or $7,905/year. If a restaurant with 9 employees (average FTEs) purchases health insurance for them through the Small Business Health Options Program (SHOP) – assuming their ages are similar to those who work in limited-service restaurants and that the business is operated in a particular county in Indiana – it will cost a minimum of $2,543/month (Bronze), or $30,516/year (healthcare.gov, 2014). The difference (between $30,516 and $7,905) $22,611 will be treated as an additional expense. Tax credits However, if a restaurant buys health insurance for its employees through the SHOP exchange and pays at least 50% of their health premiums, it may be eligible for federal tax credits (NRA, 2013). In particular, an employer that pays $30,516/year in premiums will receive 14 Minimum wage in Limited-Service Restaurants 15 a tax credit up to $10,681 in 2013. This is because the tax credit for the first year is 35%. For tax years beginning in 2014 and beyond, the maximum credit will increase to 50% of premiums paid. If premiums remain the same, the tax credit will be $15,258. The impact of the new health care law will be two fold. First, the tax credit will reduce taxes payable and thus have impact on the amount restaurants have to pay to provide health insurance for their employees; second, the change in health care premium will have an impact on restaurants’ net income. For example, assuming a restaurant pays 100% of the premiums for all of its employees, the additional out of pocket expense will be $22,611; this is the difference between premiums through SHOP, $30,516, and the current cost of health insurance, $7,905. As a result, NIBT (Net income before taxes) will decrease by $22,611. This decrease will result in reduction in taxes payable by $7,914. Additionally, there is a tax credit of $15,258 (assuming appropriate tax levels). The net effect is $561, indicating that the new health care law will have minimum impact on restaurants that are eligible for the full tax credit. See table 4. If an employer pays only 50% of the premium, the minimum amount to qualify for a tax credit, the additional expense of buying health insurance will reduce NIBT by $7,353. The decrease in taxes payable and tax credit available will result in a net effect of $2,849. Again the impact appears to be minor. 15 Minimum wage in Limited-Service Restaurants 16 Table 4. Amounts need to be compensated for in price, paying different portions of the premium With Tax credits Health care premium ($) 100% premium 50% premium 0% premium Current Health Care Costs (estimates) 7,905 7,905 7,905 Tax ($) Net difference Needed Price Increase Costs under SHOP (estimates) Impact on NIBT Tax effect of difference in premiums* Tax credit Impact on NIBT Net impact on NI % (30,516) (15,258) - (22,611) (7,353) 7,905 7,914 2,574 (2,767) 15,258 7,629 - 23,172 10,203 (2,767) 561 2,849 5,138 - Net difference Needed Price Increase No Tax credits Health care premium ($) 100% premium 50% premium 0% premium Current Health Care Costs (estimates) 7,905 7,905 7,905 Tax ($) Costs under SHOP (estimates) Impact on NIBT Tax effect of difference in premiums* Tax credit Impact on NIBT Net impact on NI % (30,516) (15,258) - (22,611) (7,353) 7,905 7,914 2,574 (2,767) - 7,914 2,574 (2,767) (14,697) (4,780) 5,138 2% 1% - *1: applying 35% tax rate *2:It is overly complicated and not realistic trying to figure out a precise tax rate. As annual revenue for a limited-service restaurant based on calculation is $626,796, falls in the range of $100,000–$10 million, 35% will be used as a general rate for calculation (Avant, 2011; IRS, 2013a). 16 Minimum wage in Limited-Service Restaurants 17 The alternative Limited-service restaurants, due to their size, may not be required to purchase health insurance for their employees. Unless they pay 50% or more of their employees’ health insurance premiums, they will not receive a tax credit. Moreover, since restaurants may not need to pay for health care for their employees, the amount they currently pay, 4.4% of payroll or $7,904 will be saved. This saving will increase NIBT by the same amount, $7,904, and taxes will have to be paid on this amount. The net effect is $5,138. Without tax credits As it stands now, tax credits will be available to eligible employers for only two consecutive taxable years, after that there may be changes. For example, assuming there are no credits, for those employers that pay 100% of employees’ premiums, NI will decrease by $14,697. In this case, the price of the burger would have to be increased by 2% to maintain the same margins. Then, a $7 meal would cost $7.15. Paying 50% of the premiums will result in a $4,780 decrease in NI, and in order to maintain the same rate of return, the price of a burger would have to be increased by 1%, and a $7 meal would cost $7.07. If restaurants do not buy health insurance for their employees through the company (0% premium), the net impact on NI will be $5,138. If this is the case, no price increase is necessary. See table 4. Higher Wages + Health Insurance Premium Combing the effects of both factors, the tax credits that available in the first two years offset the increase in health care expenses, and the overall price changes would be driven only by 17 Minimum wage in Limited-Service Restaurants 18 any wage increases. Starting in year three, and assuming 0 tax credits, a burger would be 127% more expensive than it is today ($22.01 and 100% premium); for other possibilities, 125% ($22.01 and 50% premium), 107% ($15 and 100% premium), or 105% ($15 and 50% premium) of its original price in order to maintain the same margin. If restaurants do not provide insurance but raise wages, the price of a burger will increase by 25% ($22.01) or 4% ($15). If adjustments are made to portion sizes, for the first two taxable years, since the new health care law has minimal impact, the combined effect will be the same as if only increasing wages is considered. Beginning in year three, a burger has to be 76% ($22.01 and 100% premium), 73% ($22.01 and 50% premium), 70% ($22.01 and 0% premium), 19% ($15 and 100% premium), 16% ($15 and 50% premium), and 12% ($15 and 0% premium) smaller. See table 5. Conclusions To minimize the impact of increased costs on business competitiveness, restaurants should assist their employees in identifying possible options through SHOP but not provide health care through the company. The above calculations are based on two assumptions: 1. There is no increase in the costs of other restaurant inputs (food, supplies, linens, cleaning, etc.), which would be highly unlikely if the minimum wage rose to competitive levels since the prices of all basic goods and services would go up. 2. A restaurant wouldn’t lose any business after increasing its prices. This is also unlikely. Because of the tax credits provided by the government for small businesses, providing health care will not significantly increase the pressure to raise prices. Since not providing any health insurance may lead to disgruntled employees, restaurants can utilize the tax credit as a 18 Minimum wage in Limited-Service Restaurants 19 buffer and gradually reduce the amount provided while assisting employees find better options through SHOP. Additionally, one important consideration employers have to keep in mind is that the tax credits will be available to eligible employers for only two consecutive taxable years. After the two years, the costs will creep back up. As indicated above, one of the difficulties with this approach is the competitive nature of the industry. Projected increases in the number of families and a more affluent, 55-year-andolder population may result in more restaurants offering table service, and more varied menus putting pressure on the limited-service restaurants to keep pricing stable (BLS 2014b). Increasing employee wages may not be a winning strategy. That is, instead of being considered a leader, such a move would most likely drive business elsewhere. Raising wages to competitive levels may be too costly, but increasing wages to $15 may be achievable. Further analyses needs to be conducted to confirm whether higher wages would indeed reduce turnover before definitive conclusions can be reached. Considering both the indirect costs of turnover, as well as the lost of consistency, managing turnover is a critical issue. Unless procedures are highly standardized and require relative low skills, management will spend more time than it already does training and/or filling in for a highly transient workforce. Because turnover may be very demanding, management may be willing to cut corners in order to do the normal tasks required to perform his/her own job. High turnover and reduced preparation to perform the highly personal tasks will inevitably lead to inconsistencies in product quality and service, and with them customer dissatisfaction. With 19 Minimum wage in Limited-Service Restaurants 20 this in mind, it makes business sense for managers to strive to reduce turnover even at the price of incurring additional costs. However, careful evaluation of how to balance the two so that the overall competitiveness of the restaurant will be improved has to be clarified. Assuming that paying employees a competitive rate is a desired end, the question becomes can higher wages lead to greater consistency, develop brand loyalty to the extent that higher prices can be charged and deliver customer satisfaction. Restaurants need to carefully assess whether improved product and service quality would be enough to sustain the business in a highly competitive and undifferentiated market. There are a number of standard approaches that are used to calculate a menu item’s selling price. Often they are based on food cost. That is, the price is based on the cost of food alone with a desired margin added to cover all other known or anticipated costs. Labor must inevitably figure into the calculation, particularly if competitive wages are to be considered. If restaurants decide to increase wages, they can either reduce product size or raise the price to maintain margins. While reducing size has its limitations (customer acceptance may be low), new technologies may enable businesses to engage in revenue and yield management in order to increase revenues. Also, some might suggest that another solution to the turnover dilemma would be using machines to replace people. Even though limited-service restaurants have attempted to engineer labor out of the operation, relative to other expenses it remains on par with food cost. There are a number of disadvantages with the current approach to labor in foodservice. One of the most troubling aspects is the pay; current levels are such that many do not consider 20 Minimum wage in Limited-Service Restaurants 21 food service a viable working alternative or a career path. This may be one of the factors driving the high turnover in the industry. Also, pay may affect employees’ perceptions of their jobs. Specifically, employees may sense their wages correlate with the value management places on their positions or the job they perform. If they discern that their jobs are unimportant or trivial, or that management doesn’t care, why should they? Because commitment to an organization may be influenced by pay, it is not hard to imagine that their time is worth more than the amount their employer is willing to pay. Further, employees stay with organizations because effective human resources practices provide a supportive work environment that affords opportunities to grow and develop. These positive outcomes are founded on a philosophy that people are an asset, and investing in them will bring increased benefits for the entire organization. There are a number of advantages to paying higher wages. One is the reduction of (excessively high) turnover rates in the industry. As Figure 1 suggests, turnover rates have declined when compensation has increased. A more stable, skilled and committed workforce would help eliminate the inadequate and poor service that often results because of high turnover. Also, attention on performance will focus both employers and employees on the standards and behaviors that drive the operation -- which will enable both groups to help meet the long run goals of the organization. 21 Minimum wage in Limited-Service Restaurants 22 Table 5. Effect of Higher Wages + Health Insurance Premium With Tax Credit Wage level Adjust price (% more expensive) Adjust portion size (% smaller) Health care premium paid Health care premium paid 100% 50% 0% $22.01 25% 25% 25% $15 4% 4% 4% Wage level 100% 50% 0% $22.01 70% 70% 70% $15 12% 12% 12% No Tax Credit Wage level Adjust price (% more expensive) Adjust portion size (% smaller) Health care premium paid Health care premium paid 100% 50% 0% $22.01 27% 25% 25% $15 7% 5% 4% Wage level 100% 50% 0% $22.01 76% 73% 70% $15 19% 16% 12% 22 Minimum wage in Limited-Service Restaurants 23 References Avant, M. (2011). Top 10 Taxes and Fees - These 10 items can account for a big chunk of quick serves’ expenses. qsrmagazine. Retrieved from http://www.qsrmagazine.com/executiveinsights/top-10-taxes-and-fees Barlow, & Gerald, L. (2003). Putting a Price on Staff Turnover: A Case Study. Paper presented at the Production & Operations Management Society BLS. (2012). 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