The oncoming $20 minimum wage for fast-food restaurants in California doesn’t appear to be keeping Ike’s Love and Sandwiches from building more locations in the state. When we spoke with CEO and founder Ike Shehadeh in early February, his chain had opened two new locations that day. “They’re both in California,” he said.
But that doesn’t mean the company won’t change the way it grows there. Ike’s may be less likely to take on stores in smaller communities or those designed to take pressure off a busier location, because of the higher wage and the profit challenges it could bring.
“We’re only signing A-plus-plus sites in California,” Shehadeh said. “If we don’t think it’s going to be an A-plus-plus site, we won’t do it. It takes the same amount of resources to do a $1 million store as a $2 million store, so you might as well pick the best ones.”
In April, the state will begin requiring fast-food chain restaurants that have at least 60 U.S. locations to start paying workers $20 per hour, the result of a compromise reached last year between labor advocates in the state and the restaurant industry.
Ike’s Love and Sandwiches is thinking of upgrading its ingredients to make its menu more worth the higher prices. | Photo courtesy of Ike’s Love and Sandwiches.
That’s a 25% increase over the state’s minimum wage and a 20% increase over the median wage for fast-food workers in the state, according to data from the U.S. Bureau of Labor Statistics. Fast-food workers comprise just over 2% of employees in California.
It’s also a substantial hit to the bottom line. McDonald’s franchisees estimated last year that the increase would cost a typical restaurant in the state $250,000.
Operators’ expectations for the increase range from the outright scared to the complete refusal to grow in California to overtly confident in their ability to not only withstand the increase but to thrive in its aftermath.
Generally, however, operators believe price increases are inevitable. And that could present problems, as consumers are clearly wary of fast-food price hikes. Many brands will search for labor efficiencies, technology and other strategies to keep the increases to a minimum. Some hold out hope that this will make restaurants a more desirable employer, which helps them find and keep good workers.
Regardless, everybody agrees this is uncharted territory. “The reality is,” Jack in the Box CEO Darin Harris said in November, “most in the industry are not exactly sure how it’s going to perform.”
A big employer
California is a big state with a lot of people, a lot of businesses and a massive economy. It has a gross domestic product of $3.9 trillion and a labor force of 19.3 million. It accounts for more than 14% of the nation’s economy. Restaurants ignore the state at their own peril.
The state has 400,000 fast-food workers, more than any other in the nation.
The regulation passed last year, AB1228, creates a fast-food council made up of industry and labor activists and government appointees. It creates regulations for fast-food restaurants with 60 or more nationwide locations. There are 185 such chains that have 50 or more locations and operate restaurants in California. We expanded the estimate, assuming that chains with 50 locations want to get to 60 relatively soon.
Several of the nation’s biggest brands have hundreds or thousands of locations there, led by the big three: Starbucks, which operates more than 3,000 locations; Subway, which has more than 2,000; and McDonald’s, which operates more than 1,200. And some big chains operate most of their locations in the state, including In-N-Out (71%), Carl’s Jr. (62%) and Del Taco (61%).
But most of them are smaller concepts. Ike’s, for instance, has 117 restaurants, nearly 90 of which are in California.
The minimum wage in the state is currently $16 per hour. The typical fast-food worker gets a bit more than that, according to data from the U.S. Bureau of Labor Statistics.
“There’s certain areas in California which are going to have to go up a lot,” Katherine Fogerty, CFO for Shake Shack, said in November, according to a transcript on the financial services site AlphaSense.
McDonald’s expects wage inflation this year in the U.S. to be in the mid-to-higher single-digit range. “Part of that is because of what we’re going to have to work through in California,” CFO Ian Borden said.
Higher prices
Restaurants spend about 30% of their revenues on labor, on average. The kind of an increase in costs heading for California typically requires price increases.
El Pollo Loco, based in Costa Mesa, Calif., operates 80% of its 490 locations in California. The company plans to take incremental cost increases this year to offset the higher wages. “Pricing is important,” CFO Ira Fils said at the ICR Conference last month. He suggested the company would raise prices in the “mid-single digits.”
Jack in the Box, which owns both its flagship brand and the Mexican chain Del Taco, both of which have a heavy presence in California, said it is working with franchisees in the state to examine stores market by market on what prices work for those specific areas.
“We know we have to take price,” Harris said. “But it’s pretty alarming that we’ve never done this before.”
About 15% of the locations of Chipotle Mexican Grill are in California. Company executives told analysts this week that they expect to raise prices in the 2.5% to 3% range in the first quarter, but plan to take a wait-and-see approach the rest of the year to determine the final amount. “We know we have to take something of a significant increase when you talk about a 20%-ish increase in wages,” CFO Jack Hartung told analysts, according to a transcript on AlphaSense.
Jack in the Box and sister chain Del Taco operate at least 40% of their restaurants in California. | Photo courtesy of Jack in the Box.
The problem with price hikes, however, is much of the fast-food sector has taken a lot of them already.
Over the past three years, limited-service restaurants have raised prices by 22%, based on an analysis of federal data. That includes a 5.9% increase over the past year. There’s already concern that restaurant sales are shifting to supermarkets. “Eating at home has become much more affordable,” McDonald’s CEO Chris Kempczinski said this week, acknowledging that his chain is losing business to grocers.
Many operators are worried that this will get worse when the wages go to $20 and prices go up accordingly. “There’s no way anyone is going to pay $17 for a sandwich,” one Subway operator said, explaining why that company and its franchisees have created a task force to find strategies for operators to combat that higher wage without relying exclusively on price hikes.
Franchisees’ “fear is more about how can the consumer absorb another 8% to 10% after we just took that last year,” Harris said.
So restaurant chains are looking in other directions.
Finding efficiencies
Brands are taking steps to be able to make their restaurants more efficient. Technology will be one major area of investment. “We are rolling out self-ordering kiosks to our locations,” El Pollo Loco’s Fils said.
To be sure, technology has been a major target for investment throughout the industry in recent years, driven by consumer changes as well as labor challenges. Brands have invested more in robotics, artificial intelligence and machine learning as well as kiosks and other pieces of equipment.
But brands are also examining strategies to combat the higher wages. Jack in the Box, working to improve profit margins in part to convince more owners to expand, is looking at everything. One franchisee recently convinced the company to shrink its receipt sizes. The result will save the system $400,000 per year.
El Pollo Loco is simplifying its salsa-making procedures and is reducing the number of tomato-based salsas it offers from two to one. It is also looking at its labor tables to find efficiencies. “We’re using those initiatives to soften the impact of what we’re going to take from a pricing standpoint,” Fils said. “There’s a handful of other labor initiatives that will help us take less price, I think, than maybe some of the other brands in California.”
El Pollo Loco is considering strategies to make labor more efficient, such as changing salsa-making processes. | Photo courtesy of El Pollo Loco.
Subway gathered a group of California franchisees to examine strategies for easing costs in a bid to prevent operators from dramatically raising prices again. Many operators in the state fear the impact of the $20 wage, given the brand operates with low volumes.
Some estimate that many of the chain’s locations in the state could ultimately close. One operator in Northern California recently walked away from his 10 locations, resulting in their closure last month, because they couldn’t generate a profit based on their rent costs. Subway is currently working to convince franchisees to reopen the stores, the company confirmed in an email.
The Subway situation also illustrates the often-delicate conversations that have emerged with AB1228. Franchisees want breaks on some of the company’s requirements, such as one that forces them to take discounts or another that they remodel stores. The company has yet to agree to such requests, however.
Higher expectations
Ike Shehadeh expects he’ll raise prices because of the higher wages. But if he’s going to do that, he is going to get something out of it, and so will the customers.
For one thing, he expects to have better employees. “You need to be worth $20 an hour,” Shehadeh said. “We’re looking at this as a win-win. We wish we could get everybody at the store with a high level of ownership and productivity and production. There’s nobody that sucks. They win, they’re more empowered, they have more skills and they can grow.”
He added that the company may be less likely to take on employees that only come in a couple of days a week, because those people may not be worth $20 an hour.
Shehadeh acknowledges he’ll have to raise prices, but he is not necessarily worried about the impact it will have on his business, because Ike’s has a strong reputation for quality and customers may be willing to pay higher prices.
But he also believes if he is going to raise prices, then perhaps he’ll make the sandwiches even more worthy of those prices. So, the company is considering upgrades to its ingredients. “I don’t want people to spend $20 for a sandwich if it’s only worth $17,” he said. “So how can we make it worth $20?”