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QSR Feature
Minimum Wage Hikes
Next month the second of three staged federally mandated wage hikes will raise minimum wage to $6.55 an hour from its current $5.85.
Increases in federal minimum wage loom large for restaurant owners.

Some say the latest pending national minimum wage increase is the final element in what adds up to a perfect storm.

The second of three staged federally mandated wage hikes kicks in this summer, when the national base wage rises to $6.55 an hour from its current level of $5.85.

That pressure—coupled with higher energy costs and rising wholesale prices for wheat, dairy, meat, and other commodities—adds up to a big squeeze on quick-serves’ already-tight operating margins, which typically run around 5 percent pre-tax.

“Labor costs have definitely risen in the hierarchy of challenges in the past year,” says Hudson Riehle, senior vice president of research and information services for the National Restaurant Association (nra), which has lobbied against the federal wage increases.

“For quick-service, because their workforce is a higher proportion of lower hourly wage employees, the recent increase, plus the two upcoming increases, really do put a strain on the cost structure,” he says.

The association estimates that 29 cents of every fast-food dollar goes toward wages and benefits. Add in food and beverage costs and nearly two-thirds of every greenback is spoken for. Labor costs have been steadily rising, with average hourly rates for nonsupervisory restaurant staff up 6.3 percent last year on top of a 4.2 percent gain in 2006, according to NRA data.

Operators large and small are seeking ways to offset these wage pressures: reining in costs, hunting for operational efficiencies, and most significantly, boosting menu prices as much as their markets will bear.

“When you have what we refer to as hard-wired increases in your operating costs, you have to take menu pricing,” says Robert Derrington, an equities analyst at Morgan Keegan & Co. “The question is, how much menu pricing will you take and how much traffic can you afford to lose?”

Much of that will be determined by the wage rate in each individual state, which varies, making for a complex U.S. system driven by local politics and a variety of other factors.

In July, when the federal wage increase takes effect, restaurant operators in Texas, Louisiana, Alabama, Georgia, Kansas, and Nebraska—as well as a dozen other states primarily in the South and Midwest regions of the country—will brace for the impact. Meanwhile, some 32 states have already set their minimum hourly wages above the federally mandated level. Many of those will adjust in 2009, when the last of the three staged federal increases pushes the wage floor to $7.25 per hour, making for a 41 percent total increase in the minimum wage, the largest boost in U.S. history. Others among those states, including California, Oregon, Washington, and Illinois, already offer $7.50 an hour or higher.

Large publicly traded quick-serves such as Denver-based Chipotle Mexican Grill Inc., Oklahoma City-based Sonic Corp., and St. Louis-based Panera Bread Co., have instituted price hikes to offset the pressure, even as broader consumer confidence wanes.

For instance, Panera, hurt by the escalating cost of wheat, which has reached record highs recently, is banking on an average price hike of at least 5 percent. The company disclosed to Wall Street that its menu price hikes could account for 1 to 2 percent in lost traffic, notes Derrington, a sacrifice necessary to keep margins healthy.

Independent quick-serves in hard-hit states, arguably the most vulnerable to labor hikes because of their smaller scale and lack of geographic diversity, are taking price increases as well, but they’re often using creative methods to mitigate reaction from customers.

Russo’s New York Pizzeria, a chain of about 30 franchised fast-casual Italian restaurants operating primarily in Houston and the surrounding suburbs, worked price increases of 10 to 15 percent into a plan to upgrade its menu of rustic pizzas, entrées, fresh pastas, soups, and salads.

“Minimum wage has gone up, so I redesigned my whole menu and I enhanced it with more quality ingredients,” says Anthony Russo, founder of the franchise and an operator of four restaurants. “I’ve added new entrées, some new dishes. Customers won’t notice it as much.”

Like many in the industry, Russo says he also faces recruitment and retention issues, so he is compelled to start many of his employees slightly above Texas’ current minimum wage of $5.85 per hour.

On a positive note, analysts note that consumers, who have seen escalating prices for milk and other staples on grocery store shelves go up, might not react with high degrees of sticker shock when they see prices at their favorite restaurants increase as well.

In addition, the NRA notes that momentum for additional minimum wage legislation put forth by individual states seems to have stalled, a likely reflection of the broader pressures on the national economy in an election year. Some 31 states, including Pennsylvania, Michigan, and New York, have bills pending before Congress, but none has gained traction.

In the meantime, operators like David Barranco, co-owner of the family run Chappy’s Deli, a chain of five restaurants in Montgomery, Birmingham, and Auburn, Alabama, says much of the secret to staying healthy during these tough times will be holding his staff to higher standards.

“In the past we’ve been a little more forgiving with those who have lacked the necessary skills,” says Barranco, who will raise menu prices twice this year. “Now you can’t afford to do that.”