Evie Liu
Alex Johnson, a franchisee who runs 10 Auntie Anne's and Cinnabon stores near San Francisco, is having a tough time. Sales are down, rent and other costs keep rising, and soon, he'll have to pay more for labor.
Starting in April, fast-food restaurants doing business in the Golden State will pay their employees at least $20 an hour, a much higher rate than its already nation-leading minimum wage of $16.
The raised floor would cost him half a million dollars every year, says Johnson. "We're facing expenses from all angles," he told Barron's, "The looming minimum wage increase feels like the straw that broke the camel's back."
The new rule, signed into law last September, was a compromise between California Governor Gavin Newsom, major industry groups, and a powerful union representing hundreds of thousands of fast-food workers in the state.
Rising labor costs could push the fast-food industry, including its thousands of franchisees, to further raise prices in the state that already has some of the highest living expenses in the nation.
But higher prices can be a tough choice in an economy with already-sensitive consumers. Fast food, especially, remains one of the areas with stubbornly high inflation rates, even as grocery prices have cooled down.
"We've already had to raise prices a few times over the past three to four years," says Johnson. "Every time we do that, it hurts business." Focus Brands, the parent company of Auntie Anne's and Cinnabon, didn't immediately respond to a request for comment.
Losing Customers
Since the new minimum wage only applies to fast-food workers, restaurants will also see less benefits from the higher incomes and stronger consumption that typically occur when states raise minimum wages across the board.
Many major chains have already noted decline in traffic, especially among low-income households. To avoid further losing customers over high prices, companies will need to cut costs either in labor or somewhere else.
Last year, two major franchisees of Pizza Hut, owned by Yum! Brands, said that they would layoff 1,200 delivery drivers. Smaller operators might be doing so more quietly. Johnson, for one, said he'll freeze hiring and won't fill the empty positions if existing workers leave.
Among the major fast-food brands in the U.S., El Pollo Loco Holdings has the largest presence in California, with nearly 80% of its stores in the state, according to Gordon Haskett Research Advisors.
Management said menu prices would likely increase by mid- to high-single-digit in 2024, but the firm has various initiatives underway to mitigate labor costs, including in-store ordering kiosks, new dish-washing machines, and cutting its salsa offering from two to one. El Pollo Loco said it has no additional comment.
San Diego-based Jack in the Box has 43% of its burger joints in California, according to Gordon Haskett's estimates. It also owns Mexican-inspired chain Del Taco, which has 60% stores in the state.
The company said last year that wage rates at company-owned stores are expected to increase 10% to 12% in 2024, and menu prices to go up by 6% to 8%. Higher labor costs in California alone would contribute to 3 to 4 percentage points of the hike, according to the firm.
Scaling Up
Still, California's new minimum wage hasn't changed the franchisees' appetite to open more new stores in the state, said Jack in the Box. The company is looking to help its California operators save costs by 2% by mid-year 2024.
"For many of the operators that are already in California, they know how to navigate these types of changes," said CFO Brian Scott at a January conference, "Having more scale is actually better for them."
Despite the planned price hikes, the company expects earnings to increase at least 3.5% in fiscal 2024 that ends in September. The stock has been tumbling since last summer, but recovered some of the loss in recent months.
Other fast-food chains with over 15% exposure to California include Wingstop, Starbucks, and Chipotle Mexican Grill, according to Gordon Haskett. Chipotle said price increases will likely come at mid- to high-single-digit. Wingstop is looking at somewhere around 4% to 5%.
Starbucks said it plans to offset the impact through near-term price increases and measures to improve efficiencies, including a new in-store system that helps baristas work faster during peak hours.
Some firms are looking to gain from the situation by providing more support to their franchisees, including advertising spending, product innovations, and technology updates.
"This is an opportunity for us to gain share, because this is an impact that's going to hit all of our competitors," McDonald's CEO Chris Kempczinski said last year in an earnings call, "We believe we're in a better position than our competitors to weather this."
McDonald's has about 9% of its U.S. stores in California, according to Gordon Haskett. The company didn't provide additional comment.
Beyond Fast Food
Raising the minimum wage isn't new. But California's new rules are groundbreaking since it's the first in the U.S. to solely focus on one industry. Economists are scratching their heads about how this could affect the overall labor market in the state.
Although the new rules only apply to fast-food chains with more than 60 locations, it might force other full-service restaurants and small businesses to raise their pay as well as compete for labor, said David Smith, a professor of economics at Pepperdine University.
Small business owners might have the most to lose, said Smith, since they don't have a large portfolio to spread the impact of the cost increase. "For the owners of just a single restaurant, this could be detrimental," he said.
Still, full-service restaurants likely won't see a massive spike in labor costs since workers there usually make more than $20 an hour already -- and the tipped staff, even more. With the expected price increases in fast food, consumers might find casual dining a better deal.
"[The new rules] make us a little bit more competitive," Gregory Levin, CEO of California-based restaurant chain BJ's Restaurants, said at a conference in November, "I think it's a net benefit for us." BJ's couldn't immediately be reached for further comment.
If fast-food chains cut jobs on a large scale to offset the costs, however, there will be a larger labor supply, and wages could actually move lower in sectors not covered by the new rules, said David Neumark, an economics professor at University of California Irvine.
"Within the same industry, you can be flipping burgers at McDonald's and make more than those flipping burgers at a diner," said Neumark, pointing to examples in other countries when one particular sector was protected over others.
Write to Evie Liu at evie.liu@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
March 25, 2024 13:10 ET (17:10 GMT)
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