Restaurant chains continue to pay higher prices for labor as they struggle to find good workers, which is pressuring profits amid weak same-store sales.
Chain executives in earnings calls thus far have frequently mentioned higher wage and labor costs as a major challenge and also suggested difficulties finding good workers in an environment of low unemployment.
“I would say the fight for talent continues,” McDonald’s CFO Kevin Ozan said last month. “It’s going to get increasingly challenging to attract the talent you want into your business, and then you go to work really hard through training and development to retain them.”
Restaurants have been adding workers at a higher-than-average rate for years, and as unemployment has fallen, the pool of available employees has dwindled—creating intense competition that is driving up wage rates.
Restaurants have added 250,000 jobs over the past 12 months, including 31,000 in January.
Wages for leisure and hospitality workers rose 3.9% in January. By comparison, average hourly earnings for all workers increased 2.9%, a data point that has triggered a massive selloff on Wall Street.
“The competition for labor is fierce,” Dunkin’ Brands CEO Nigel Travis said. “It’s not only this area, it’s construction workers, it’s placement. So the job market is at a very interesting inflection level. That’s what’s making it difficult to find people.”
In addition to the competition, rising minimum wages in many states are driving up labor costs for many companies.
These higher wage rates are putting pressure on restaurant companies to raise prices even as commodity costs remain stable. Restaurant menu prices increased 7.5% between December 2015 and December 2017. By comparison, grocery prices over that same period have fallen 1.5%.
To be sure, recent tax law changes are lowering the tax rates many chains are paying, which is offsetting the higher labor costs.
But franchisees operate more than three quarters of the restaurants in the largest chains, and not all of them are seeing the same tax benefit.
Company-run operations such as Olive Garden owner Darden, Starbucks and Chipotle have all announced plans to use some of the tax savings on employee investments. Starbucks and Chipotle are giving workers bonuses, while Darden is using funds on “retentive” investments.
“All of these enhancements are especially important in today’s low unemployment and highly competitive environment,” Chipotle CEO Steve Ells said of his company’s labor investments, which also include more benefits to workers.
The increase in labor costs is coming as same-store sales have been weak and traffic to existing restaurants has been weaker.
While same-store sales increased in each month in the fourth quarter, according to Black Box Intelligence, the increase was only modest each time. And same-store sales declined 0.3% in January.
Traffic, meanwhile, has been down consistently, and declined 3% in January, according to Black Box.
Ozan noted that same-store sales have to increase by a certain percentage for companies to maintain margins in an era of higher labor. He said that in the current environment, an increase of 2% to 3% “isn’t enough, mainly because of labor pressures.”
Chipotle is an example of the challenges companies face in trying to maintain restaurant margins at a time of weak traffic. Chipotle experienced steep declines in unit volumes in 2016 following food safety incidents the year before and has struggled to improve on those volumes since then.
This year, with its restaurant margins a full 10 percentage points lower than they were two years ago, the chain began taking price, gradually increasing prices by around 5% in more markets.
That has helped Chipotle generate modest same-store sales growth, but traffic is on the decline and is expected to fall through the first half of the year.
The company had 5% wage inflation in the fourth quarter. “The labor pressures will continue at this level because of wage inflation, softer transaction trends,” and increased benefits from the recently announced workforce investments, CFO Jack Hartung said this week.
They’re not the only ones. Margins declined 150 basis points at McDonald’s locations because of wage pressures, while inflation was 4% at Darden.
Companies feel it necessary, however, to make a lot of investments because of continued competition for workers.
“With unemployment low and with competing for the right kinds of talents, there’s going to be a need for us to invest in our partners,” Starbucks CEO Kevin Johnson said. “We know by investing in our partners that we’re able to attract the right people, and we’re able to have a lower attribution and longer tenure than others in the industry.”
But, for all of the challenges, the low unemployment rate means that the economy is strong, which naturally bodes well for sales over time.
“You’ve got the unemployment rate and some better numbers, and it’s playing out well in places like Texas and Oklahoma,” Wyman Roberts, CEO of Chili’s owner Brinker International, said on his company’s earnings call. “We’re starting to see that when you look at our mix of restaurants. We’re excited to see those markets stabilize and now start to move themselves back into growth mode.”