Fast food chains are coping with their labor cost problem

Nicole Sinclair
Markets Correspondent
More pressure to wage minimum wages has put strains on restaurant and quick-serve profits (Photo by Jeff Curry/Getty Images)

Quick-serve and fast-casual restaurants from Domino’s (DPZ) to McDonald’s (MCD) are feeling the pressure of rising wages. But it might not necessarily spell bad news for results, especially in the long-term.

In Domino’s second-quarter conference call this week, CEO Patrick Doyle pointed to wage pressure as a concern, albeit one he was happy to have.

“There is pressure out there on wages in general as the labor market continues to strengthen, and that’s a really high-class problem,” Doyle said. “When strength in the labor market is putting pressure on rates, that’s the way you want to see it working.”

While the federal minimum wage has been stuck at $7.25 since 2009, increased pressure on governments and states—particularly amid a tighter job market—has boosted wages for many low-income Americans. In fact, Bernstein analysts estimate 3-4% wage inflation for the average restaurant, based on anticipated minimum wage increases from 15 states this year.

And though wage growth has been the missing ingredient through most of the labor recovery story, there have been some recent signs of improvement. In June, wage growth accelerated to 2.5% year over year from 2.4% in May. This marks an acceleration from the 2% growth throughout the economic recovery, according to Moody’s Mark Zandi. “Wage growth has definitively picked up,” he said at the ADP Labor Market Summit.

And those pressures are showing up in the results of some of the biggest names in quick-serve. In its most recent quarter, McDonald’s saw operating margins decline 30 basis points to 16.5%, as positive comparable store sales were offset by higher labor costs, notably from rising wages. And Buffalo Wild Wings (BWLD) posted cost of labor at 32.4% of sales in its most recent quarter, 40 basis points above the same quarter last year, also largely because of higher wages.

Managing through labor pressures

Not all companies are seeing profit margins fall. Chipotle (CMG), while running into food-safety concerns, managed to offset rising wages with other efficiencies in its most recent quarter. Labor costs came in at 26.2% of sales, a 160 basis point improvement over last year despite 4% wage inflation.

And in the end, overall the wage increases may be just what the economy needs. “Wage growth is key to the near-term economic outlook,” Zandi said at the ADP conference. “Income growth is the fodder for consumer spending. And the consumer is still the key to economic growth.”

Plus, a boost in wages on the lowest-income earners is unlikely to negatively impact overall labor market improvement, according to economist Alan Krueger. “Modest increases in the minimum wage don’t have noticeable effects on employment levels but they do reduce inequality and they do help to boost consumption,” he said at the ADP conference.

Automation risk for workers

Nonetheless, risks do remain for workers, particularly when it comes to cost-saving measures and automation.

Middleby Corp (MIDD), a restaurant equipment supplier, recently suggested that increased wage pressure could lead to more automation.

“We have more and more chains coming to us looking at how to resolve labor issue, how do we offset the higher cost of labor through automation,” CEO Selim Bassoul said during the company’s May conference call.

Perhaps, though, wage pressure can encourage both automation and labor growth. Panera co-founder and CEO Ron Shaich told Yahoo Finance last year the company has incorporated both. “We’ve been able to take hours and shift them from low customer centric activities like order-input where it’s just an extension of a cash register into high customer centric, high experience initiatives like getting your food right, having the production capabilities and actually delivering the food to you,” he said.

One thing’s for sure: Customer satisfaction is increasingly in focus for restaurants, and they will do what they need to do in an increasingly competitive environment.

Nicole Sinclair is markets correspondent for Yahoo Finance

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