Scott Lawton isn’t a big fan of many of the service charges he’s been seeing, at restaurants and in other industries. And yet bartaco, the 37-unit chain where he’s the CEO, added an 18% surcharge at its location in Denver last year.
To Lawton, he didn’t have much of a choice. When the minimum wage in Denver increased to $17.29 per hour from just under $16 in January, labor costs at the chain’s restaurant in the city took off.
And every other restaurant in the area added one. “We took a beating for a couple of months,” he said on a recent episode of the Restaurant Business podcast “A Deeper Dive.” “We waited to see how the market was going to react and what people were going to do. We certainly didn’t want to be the first one throwing a fee on.”
Service fees, surcharges, junk fees or whatever you want to call them have taken off of late inside the restaurant industry.
Once the purview of banks or cable services, these fees have spread aggressively in hospitality as costs soared, minimum wages increased and states and cities got rid of the tip credit.
In the process, however, restaurants are running the risk of running afoul of not only state and federal regulators that are taking a closer look at what President Biden labels “junk fees,” but of litigation attorneys and, perhaps most importantly, customers themselves.
“Do you recall a time when restaurants advertised openly that they were raising prices in the form of a service fee?” said Rich Shank, senior principal with Restaurant Business sister company Technomic. “They could have just taken price and most likely not raised a stink about it.”
The fees run the gamut of names and uses. Most are called “service fees” or “service charges” and add 15% to 20% for the cost of employees. Xoco, the Rick Bayless restaurant in Chicago, adds a 15% service charge “to help us pay more equitably.”
Other restaurants add charges for healthcare, or for other things they might have covered in the past, such as water or credit card processing. Or they just give the charge a different name, such as “kitchen appreciation fee.” The cost of those types of fees can vary but are typically around 5%.
Parlour Bar in St. Paul, Minn., is one of the restaurants that charge 5% for employee healthcare. But it also charged $1 on a recent visit to provide customers with “extra crackers” to go with the restaurant’s Creamy Artichoke Dip.
According to the National Restaurant Association, 15% of operators charge such a fee.
The fees are not just limited to full-service restaurants grappling with the end of the tip credit. All segments add the fees, including 13% of fast-food restaurants and 19% of family-dining concepts. And they will likely be permanent: 81% of operators told the association they expect such charges to be on the bill for a year or longer.
Inflation drove much of it. A lack of available workers and rising minimum wage rates drove labor costs higher in 2021 and 2022. Many restaurants were hesitant to simply apply charges to their menu, instead opting to add an extra charge to the overall bill at the end.
At bartaco in Denver, labor costs went from 35% to 44% after the city increased its minimum wage this year. The company has a unique service model that uses table service but without traditional servers. Tips are shared among front and back of house. But the higher minimum wage and the pooled tips made the finances too difficult.
“The math doesn’t work anymore,” Lawton said. “The challenge is, do you start charging instead of $3 for a taco, $7? I mean, that just doesn’t make sense.”
By adding a service charge, bartaco ultimately took out some of what customers would have paid in a tip to pay the higher hourly wage. Customers can still tip, though the request is smaller. “We ended up taking it out of some of the tip by creating a service fee that really was the tip. So it felt almost cost-neutral to those customers, other than if they decide to throw an extra 10%.”
Yet by creating such fees, restaurants run the risk of alienating customers. Many customers are already facing higher menu prices after two years of generationally high inflation. And more of them are paying tips at a broader number of restaurants as limited-service concepts use them to attract workers.
Customers clearly dislike such fees. Half of customers told Technomic in a survey last year that they would be less likely to return to a restaurant charging a 20% service fee, and 41% said they’d be less likely to recommend that restaurant.
Fees also add complexity to what is an increasingly confusing transaction. By adding a service fee, customers do not know whether they should tip, or how much. Wait staff often has to explain the fees to the customer.
It is also opening restaurants to legal liability. Employees in several instances have sued restaurants that have added service fees, arguing that the fees were not properly disclosed, led to a decrease in tips and were not equally distributed among workers.
Restaurants that don’t follow proper local rules, meanwhile, run the risk of being fined. In Washington, D.C., where the end of a tip credit has led to a spike in the number of restaurants charging such a fee, operators could be fined up to $5,000 under local consumer protection laws. In that city, restaurants have to clearly disclose before the ordering process how much could be charged, describe the reason for the charge and use any fees for that purpose.
Shank doesn’t believe restaurants should add the fees at all. He said the fees can cannibalize tips. And he believes customers may ultimately decide that location is not affordable and shift their spending.
“Take the price you need, but make sure the quality is there,” he said. “If you’re worried about taking it all at once, take it in chunks. Your goal is to get the money you need out of your profit margin so you can take care of your staff. And if you’re smart about it, you’re not having your customers talk about it.”
Still, at bartaco, the fee in Denver has gone without a hitch. The restaurant pools tips at all its restaurants and they’re shared with the kitchen staff. Customers are still paying about 10% in tips with the service charge. And 20% of the service fee is added to the tip pool.
The restaurant’s finances, meanwhile, have recovered. “As scared as we were to do it, we didn’t know another way without making the prices outrageous,” Lawton said. There have been “very limited complaints” and guest sentiment has stayed the same.
More to the point: Customers are still coming to the restaurant. A recent visit to the Denver location on a weeknight found almost every table full and workers busy. The parent company may now expand the idea to other restaurants.
“I’m not saying we’re going to do it everywhere because we’re not,” Lawton said. “But when we’re put in a position where the laws have changed in a way that our model doesn’t work. This has been the best thing we could come up with. And so far, it seems to be working.”
Customers may say they don’t like fees. But they appear to be paying them.
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