How would a $15 minimum wage ACTUALLY affect a franchised business like McDonalds?

 

We hear this debate all the time, but nobody ever seems to have an actual conclusive answer what would happen to these businesses if it happened.

Everybody’s answers always seem vague or over generalizing – some say workers would have to be fired, others say prices would have to go up for consumers, others say CEOs would just have to take a profit cut.

 

Look, I know McDonalds is a franchise and it isn’t really the same as a company like WalMart, but what would actually happen to them at $15 minimum wage? Let me break it all down for you.
It really depends on the Franchise, and what percentage of gross sales go to payroll costs, but lets look at your McDonalds example. About 10% of the stores are corporate owned, & the other 90% are franchised locations. The Franchisees pay annual fees to McDonalds for “royalties” & national advertising campaigns, which are calculated as a percentage of gross sales. About 1/3 of McDonald’s corporate revenue is collected from Franchisees.

Here’s a sample income statement for an Average Mcdonalds franchise store based on typical figures.

“Crew”(non-managerial) Payroll costs amount to about 20% of sales. Most store-level Mcdonalds employees make anywhere between $7.25 – $9.25/hr – so lets assume employees at this location are making $8.25. If Minimum wages are hiked to $15 as proposed, that will equate to about an 82% wage hike. Assuming all sales stay the same, & no employees are fired, total crew payroll costs will rise to about 36.5% of sales. In the above example, that would equal about $442,800 per year more in payroll costs.

However, the company is only making $153,900 in net profit. If they made no other changes, this store would be operating at a $288,900 loss. That is obviously unsustainable.

The only way to recoup that lost income is either raising sales revenue, or cutting expenses. Most people in this situation say “Ok, just raise the price of food to increase revenue”. The problem is, McDonalds franchisees are already hemorrhaging due to competition & a changing market. In most cases with food, higher prices, will result in lower sales volume. Especially with low quality chains like MickyDs – nobody in the US is going to want to pay $5-$6 for a big mac – keep in mind that the only people immediately benefiting from a minimum wage hike are people making below the future $15 minimum wage – everybody else (over half the country) will be making the same amount until the rest of the economy catches up. (If McDonalds could charge more per burger & still make money, they would already be doing it.). Others say “You need to get higher food quality to charge more”. Fair, but higher food quality means lower margins per sale, so it wouldn’t necessarily help your bottom line – it also takes considerable time & money to implement drastic process changes like that.

So increasing revenue isn’t really a viable option – the only solution to stay in business is to cut expenses. McDonalds is a highly mature company, that has massive economies of scale…meaning most variable expenses are probably already as low as they can get at this point. The only expense you could really cut & still maintain sales, is Payroll. That means cutting hours, firing employees, or increasing automation.

It becomes clear, that many McDonalds will either have to shut down, or get rid of workers. Considering that many under-performing locations have probably already cut workers down to the lowest possible amount, the currently struggling stores would have no choice but to automate or get shut down. However, automation costs a lot of money up front though, so if the Franchisee doesn’t have the cash to shell out, they will be left with no other option but to close.

If store locations shut down, that means less franchise fees are going to the corporate entity. Currently, about 33% of McDonald’s Gross Revenues comes from Franchise Fees.

If 20% of franchised locations shut down, that would equate to $1.854 Billion in lost revenue. The operating expenses would also be reduced by 20% ($339 million). So Net Profit for the corporate entity would decrease by about $1.515 Billion – about a 30% loss in profits.

Loss in profits lead to falling share prices – they will also probably have to cut back dividend payments to issued to stockholders, which leads to a further drop in share price. Falling stock prices are generally a bad indicator for future investors & lenders. It would likely result in less interest from potential franchisees, as well as increased lending costs from banks who would see McDs as a greater risk.

Additionally, there are about 1.7 million McDonalds workers worldwide. About 440,000 of them in the US. So if 20% of the stores closed, that would be about 88,000 Americans losing their jobs.

Granted, most of the minimum wage hike programs being proposed would be rolled out over 3-4 years. So they would have a little bit of time to adapt their business model.

 

 

My Thoughts:

My prediction would be that companies like McDonalds would have to change their business models which rely on low wage employees producing low quality products, or they will fail. A lot of people would say “But all competition will raise prices too“.
Not every competing Fast Food or Fast Casual restaurant would have to increase prices by the same amount if minimum wages rose, depending on their individual business models.

You have to take into consideration the fact that each competing franchise has different operating & profit margins…Labor Costs can vary greatly from business to business. Some restaurants may be able to sustain their profits with a lower percentage increase in pricing than others. McDonalds is getting destroyed by “fast casual” chains like Chipoltle, Five Guys, Smash Burger, etc. Many of those fast casuals have similar sales per store as mcdonalds, but operate with fewer employees, fewer food SKUs to manage, & lower overall operating costs.

So lets say McDonalds has to raise the price of a Big Mac from $4 to $5.5 – a 37% increase. but Five Guys only has to raise the price of their Burger from $6 to $7, a 16% increase.

Most people would prefer a 5 Guys Burger to a McDonalds burger – the only limiting factor is cost. The cost difference between a big mac and a 5 guys burger was $2. Now the cost difference is only $1.5. That makes a 5 guys burger more of an enticing choice.

Some restaurants, especially non-franchised restaurants (Chipoltle for example), may have the cash reserves to be able to take a cut in profit margin from increased labor expense, not have to increase food costs at all, and sustain themselves long enough to undercut restaurants like McDonalds until they’re knocked out of the market. If McDonalds suddenly becomes the same price or more expensive than higher quality food options, where do you think people would go?

Also, why do you think there would be a “Massive Increase In Customer Sales”? Living expenses such as rent & utilities will not rise as dramatically as fast food prices would… that means the new $15 earners would be able to put a higher percentage of their income towards food. If they could spend more on food, they would most likely choose higher quality options than McDs.

The other thing you have to keep in mind that this is is a minimum wage hike – not a national wage hike. So everybody who is currently making above $15/hr (over 50% of the country) would be making the same amount for the time being. That means fast food would cost a higher percentage of their income, and many non-minimum wage earners would likely choose to not eat there when it is no longer the best Cost vs Quality option.

Everybody else’s wages would eventually rise if the minimum wage was set higher, but that would take time. In the mean time, I don’t think all of these stores will be able to survive a wage hike like that.

 

 

Some people would also say, “Why don’t the millionaire executives just take it out of their salaries?”.

In 2014, McDonalds dished out about $20.28 million in executive compensation. If you took every single executive’s salary down to 0, & distributed it to all 440,000 US workers, that would equate to about $46 per employee per year. If the average McDonalds employee works 20-30 hours per week (lets assume 25), and we don’t consider the full-time employees who would raise this number further, thats about 1200 hours per year. That would come out to about a $0.038 (3.8 cents) per hour raise per employee. You may not agree with the fact that the 1% are making so much more than everybody else, but really its just a drop in the bucket with companies this big.

 

 

You also can’t use Australia as an example (as a country with McDonalds stores that are already paying a $19-$21AUD wage (~$15.11USD direct exchange rate)) because first of all, when that number is adjusted for Purchasing Power Parity ratio (1.4) – the $21 AUD wage is only about $10.79 worth of goods in the US. Second of all, this argument is not really relevant to the US McDonalds market. You can’t compare the two Apples to Apples. Its a much different field of competition, many of the local Fast-Casual franchises have not made their way over there yet, & some of the Aussie stores have a very different business model, which produces higher quality food. Additionally, wages & costs of foods are higher everywhere in Australia.

 

 

But why can’t corporate just reduce its franchise/royalty fees?. In the above example total royalty fees/corporate rents are 14.5% of sales. To make up for the $288,900 deficit caused by the $15/hr raise, just for that store to break even, corporate would have to reduce fees by 74% if you didn’t want to cut payroll costs. 33% of Corporate Revenue comes from franchisee fees – about $9.272 Billion last year. If you cut down franchise revenues by 74%, that would reduce that number by $6,861,280,000. Total Corporate profit was $4.757 Billion last year. So they would be operating at a $2.1 billion loss – aka they’d go bankrupt if corporate took on the burden of cost through fee reductions. And thats just a break even figure.

 

 

Well, maybe it’s unsustainable to have 4 McDonalds within walking distance…

Twitter Digg Delicious Stumbleupon Technorati Facebook Email