How to Cope With Minimum-Wage Increases

The recent minimum-wage hikes that became effective in a number of cities and states on the first of the year were probably no surprise to you. If any of your concepts are located in the affected regions, you were more than likely aware of the pending increases, and have been bracing for them.

Now what? In this article, we look at ways to respond to minimum-wage hikes. It is only a matter of time before the federal minimum-wage increases. There is no proverbial magic bullet; restaurant operators use multiple strategies to offset these wage increases. That said, here are ideas to consider as you look at ways to absorb these increases so that you can maintain your business's margins.

Re-evaluate Staffing Levels Before the Increase Takes Effect

The biggest challenge to operators when controlling labor costs is not hourly wage rates, but productivity. All too often there is a tendency to over-staff either because we feel we need to have enough staff during peak meal periods, or because we don't want to lose employees if they're not accruing 40 hours per week.

To strategically address current and proposed minimum-wage increases requires reviewing staff scheduling, price increases and pay scales for all your employees.

Regardless of the reason, productivity takes a nosedive whenever there are too many staff and not enough guests. Every restaurant should establish an ideal productivity target for the number of guests per labor hour worked.

Learn More at... Restaurant Labor Scheduling: Essential Practices to Control Cost & Deliver Great Service

To achieve this, many operators strive to maintain a healthy balance of part-time versus full-time employees. Ideally, a ratio of 33 percent to 50 percent part-time workers versus full-time for all job positions gives managers the flexibility to schedule for higher productivity.

In some cases, higher productivity can be achieved by realigning certain duties to off-peak times. You might consider having a few employees work mid-shifts that begin during the peak of one meal period (such as lunch) and extend through the peak of the next. The time in between is used for tasks such as prep, cleaning and maintenance.

Cross-training is another effective measure to combat over-staffing. For instance, prep cooks can be trained to assume certain line cook positions during the peak rush. Once the rush is over, they return to their primary duties.

Another way to achieve greater productivity is to purchase labor-saving equipment that shortens prep hours and speeds service. POS systems, food processors, drink machines, and higher-capacity cooking equipment can have a huge effect on productivity. While the details are beyond the scope of this article, a return on investment (ROI) analysis can help you determine if the anticipate labor savings is worth the capital investment.

If you don't know how to analyze the ROI of an asset, and you are located near a university business school, consider reaching out to faculty to seek assistance from MBA or finance students. Business students receive training how to estimate the present value of anticipated operating cash flow generated by investments in assets, and they enjoy the opportunity to apply their education.

Assess the Effect of a Wage Increase throughout the House

Once ideal labor scheduling is achieved, you will need to determine how much you need to increase your wages for all staff. Of course, for minimum wage earners this is established by law; but what about the rest of your staff? You need to consider all of your employees.

For instance, a minimum wage earner making $7.25 per hour would get a $2.85-per-hour increase if the new minimum wage is set at $10.10 per hour.

But what about the staff you have making $8 or $9 per hour? For example, consider the line cook that has been with you for three years, who began working for you at $7.25 per hour and is now making $10 per hour. If the new guy's wage is $10.10, he will want a pay increase that reflects his experience.

Increases in the minimum wage will influence labor costs throughout the business. The challenge for the restaurant operator is to minimize those increases without losing experienced and loyal staff.

There is not a one-fits-all formula that can be used for restructuring a competitive pay scale; moreover, history has shown that competitive pay rates for designated job positions will be realigned as the dust settles from the economic effect of the minimum-wage increase.

In the meantime, there is a methodology that can help you during the initial stages. First, decide on a maximum break point for which you will give an increase. In other words, at what point will you decide not to increase the hourly rate? Will the maximum be $12, $13, $14, $15?

Typically, the higher the average wage you pay the less effect a minimum wage increase should have. Just because the minimum wage increases by $2.85 doesn't mean that everyone gets an increase of $2.85. The higher the wage, the smaller the increase; and at the maximum break point there will be no increase.

The objective is to selectively raise prices in a fashion that will drive guests to order profitable items - and get rid of items that drag down your profit.

Next, decide on a minimum break point. The minimum break point is actually the maximum rate- for which you will increase by the same margin as the differential between the old and the new minimum wage. In other words, if the minimum wage is going up by $2.85, then all rates at or below the minimum break point will be increased by $2.85 too.

For the same reasons the cook that has been with you for three years; it may be ill-perceived by staff members that were making just above minimum wage to now find themselves back at minimum wage - the same as less experienced staff.

Let's say you have a dishwasher making $8.50 per hour. You could raise him to $10.10, the new minimum wage, and you'd think they'd be happy to get a $1.60-per-hour raise. Instead, don't be surprised when they are upset because the new hire is making the same amount.

You need to decide on a minimum break point, in other words the point at which you'll start decreasing the wage differential. Now you have a method for dealing with amounts above and below the break points. But this is where it gets a little tricky. You must now decide how you will incrementally decrease the raise amounts for each pay level that falls between the minimum and maximum break points. The closer the pay level is to the minimum break point, the bigger the increase; likewise, the closer it is to the maximum, the smaller the increase.

Table 1

For instance, in keeping with our previous examples, let's assume that the minimum wage is increasing from $7.25 to $10.10 per hour, a $2.85 increase. And, you've decided that your minimum break point is $8 and your maximum is $15 per hour. You now need a declining scale that starts with $2.85 ($8/hour) and ends with zero ($15.25/hour).

One method of achieving this declining scale is demonstrated in the table on the left. Note that the table shows the previous wage in the left column, the proposed wage increase in the middle, and the newly proposed wage in the right column. As you can see, the table reflects the previous wage column in 25-cent increments, resulting in 29 pay scales from $8 to $15.

The second column shows that at $10.85 (new wage), the amount of increase in wages is incrementally decreased by 10 cents. This method allows you to increase wages in a manner that would be acceptable as you move up the pay scale, but keep your labor costs in check better than would an across-the-board wage hike of $2.85.

Of course there is no absolutely right method for determining these increments, which might vary. The point is that you should have a system for how you will handle the wage increase. You should make adjustments as you see fit for your operation. While all may not agree, employees will at least see there is a systematic way to deal with the increase, and therefore will have less reason to dispute their pay rate.

Determining the True Cost

Now that you have established your anticipated hourly wage increases, it's time to calculate the increase in labor cost dollars you can expect. Using a recent week's schedule, calculate the hourly payroll cost for the week, based on the existing pay scale (see below left). Add to this total the additional payroll taxes and workers' compensation costs to arrive at the total labor dollars.

Next, using the same schedule, plug in the new rates to see what the new hourly payroll cost will be for the same schedule. Now subtract the weekly cost for the old pay rate from that using the new rates. The difference will be your anticipated increase in labor dollars. This amount will come directly off the bottom line.

Is It Time to Raise Prices?

Whether or not you need to raise prices depends on how much the extra labor is going to cost you. You may be forced to raise prices if the increase is substantial. On the other hand, you may find that you can absorb the increased costs rather than risk losing guests because of a price hike. Bear in mind that the public will be keenly aware of a hike in the minimum wage. And, they have been educated by the media to brace for price increases on just about everything they purchase. So there may be no better time to adjust your pricing than when a minimum-wage increase takes effect.

Table 3

The natural inclination is to increase prices enough to make up for the cost differential, but not so much that price-sensitive guests are turned off; however, an operator must maintain profitability if they are to be successful.

Some operators address wage increases by attempting to maintain a constant labor cost percentage. In other words, if your labor cost is 30 percent before the minimum-wage increase, then prices must be raised enough so that the labor cost percentage will still be 30 percent afterward. The risk to this approach is that you may end up raising prices to the point that you lose guests and/or guests order fewer items.

A more reliable approach to maintaining profitability is to keep your prime cost intact. Prime cost is calculated by combining the cost of sales with total labor cost, including hourly and management, plus payroll taxes and benefits.

As a rule, to be profitable, full-service restaurants should maintain a prime cost of 60 percent to 65 percent or less, while limited-service restaurants should have a goal of 55 percent to 60 percent or less. You might be surprised to learn that some of the most profitable restaurants have a food cost in excess of 40 percent.

However, profitability is achieved because the higher-than-industry-standard food cost is offset by a lower-than- industry standard labor cost. The table below illustrates how to determine your increase in labor cost. On the other hand, restaurants that maintain a low food cost, can often afford higher-than-average labor costs.

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Do the Math

Using the figures shown in the above table, let's assume this restaurant has a prime cost of 60 percent before the minimum-wage increase, and that there is an equally divided ratio of 30 percent cost of sales compared with 30 percent total labor cost. The $749 increase in weekly labor cost would raise the labor cost percentage from 30 percent to 36 percent, and the prime cost from 60 percent to 66 percent, as indicated in Table 3 above.

Cost of Increase
Total Dollars Increase $749
Weekly Sales $12,000
Labor Cost % Increase 6.2%

To return to the same cost percentages you had before, you must now increase revenue without increasing the cost, hence prices increase. The formula for determining the additional revenue needed to cover the increased labor cost is as follows:

Revenue Increase = Increased labor cost
÷ Targeted cost percentage

Using the previous labor cost of 30 percent as a target, this would mean that we would have to increase revenue (i.e., raise prices) by $2,495 (i.e., $749 ÷ 30% = $2,495 in additional sales), a 21 percent increase in price is necessary to maintain a 30 percent labor cost.

But wait; take a look at the new prime cost ratio indicated in the table below. It is now 55 percent because the cost of sales percentage dropped from 30 percent to 25 percent. From a profit margin standpoint this would seem like good news. But in reality you may be increasing prices too much, and therefore risk erosion of the price/value perception by your guests.

Conversely, using prime cost as the basis, menu prices would need an increase of only $1,248 ($7,949 ÷ 60% = $13,248 in total sales), a 10 percent increase to maintain a 60 percent prime cost. That's half the increase compared with using labor cost percentage as a basis.

If you're like most restaurant operators, you probably cringe at the thought of raising prices. Thus, if you have to increase prices you certainly want to increase them enough so you won't have to do it again anytime soon. After all, minimum wage increases eventually affect the entire economy, meaning you can expect other expenses to increase over time, though perhaps not to the extent of the labor increase.

Let's look at the proposed price increase of 10 percent used in our example. Of the $1,248 we hope to get in additional revenue for the week, $749 will be used to pay the immediate increase in labor. That leaves us with $499 that will go directly to the bottom line.

But what if you have other expenses based on a percentage of revenue such as percentage rent, franchise royalties, or insurance premiums? As time goes on, rising expenses will most likely chip away at the remaining $499, but since the price increase was based on prime cost, you can be reasonably confident that there will still be enough left to add to your bottom line profit.

Creating a Profitable Restaurant Begins - and Ends - with the Menu

Across-the-menu price increases are seldom well-received. Furthermore, they tend to alter the sales mix significantly, often causing guests to order less expensive, lower-profit items. Before you raise prices, evaluate your current menu's performance, a process called "menu engineering." The objective is to selectively raise prices in a fashion that will drive guests to order profitable items - and get rid of items that drag down your profit.

Learn More at... Menu Engineering Basics How to Make Your Menu Your Top Salesperson

You need to be selective in raising prices, carefully evaluating each item for gross profit potential and popularity. Highly popular, profitable menu items, referred to as stars- within the menu engineering process, will most likely remain popular with guests - if the price doesn't jump too much.

Then again, you may have items on your menu commonly referred to as "challenges," highly profitable menu items that just haven't been that popular. Or you may have "workhorses," popular items that have a less than ideal profit margin. Raising the prices on your workhorses can be a good strategy given that the guest will either continue to choose that item because of its popularity, or they may opt for one of the challenges.

The objective is to selectively raise prices in a fashion that will drive guests to order profitable items - and get rid of items that drag down your profit. Speaking of getting rid of items, there is no better time to change prices as when you redo your entire menu. Adding new items, changing or upgrading old ones, or simply changing the design of your menu will help camouflage the increase.

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