Even using this inflated measure of profitability, it is clear that each percentage point increase in payroll expenses would have an enormous impact on overall profitability. For instance, an increase of just one percentage point of Burger King Worldwide Inc (NYSE:BKW)’s payroll as a percentage of sales would cause its bottom line to shrink by close to 9% (11.27% profit margin falls to 10.27%, an 8.8% decrease).
Moreover, even McDonald’s Corporation (NYSE:MCD) would have difficulty sustaining a large increase in wages; a 20% wage increase would decrease McDonald’s net profit by 17%. This assumes that wages account for just half of total payroll and benefits — likely a conservative estimate — and that franchisee income would decline by the same amount as company-owned store income.
| 2012 | 20% Wage Increase | |
| Company-owned store revenue | $18.6 billion | $18.6 billion |
| Payroll & benefits | ($4.7 billion) | ($5.17 billion) |
| Other company-owned store expenses | ($10.5 billion) | ($10.5 billion) |
| Company-owned store profit | $3.4 billion | $2.93 billion |
| + Franchise Fees | $7.4 billion | $6.38 billion |
| – SG&A and other corporate expenses | $2.21 billion | $2.21 billion |
| McDonald’s Net Income | $8.6 billion | $7.1 billion |
In essence, since wages are such a high percentage of fast food companies’ cost structures, each percentage hike in wages accounts for nearly the same drop in net income. This strong, inverse relationship between wages and profits makes it difficult for fast food companies to raise wages, much less double them.
Of course, McDonald’s et al could simply raise their prices. But I’m pretty sure the chains are already milking their customers for as much money as they can get. If Burger King Worldwide Inc (NYSE:BKW) could sell just as many Whoppers for $1 more than it sells for today, it would. But competition makes low prices a necessity, so price increases would cause sales volumes to fall, adding even more pressure to profits.
Even worse, the people who work at fast-food chains tend to be in the demographic that frequents them the most. A 20% price increase to offset higher wages means 17% higher food prices for the poorest consumers in the American economy. This is hardly the path to digging oneself out of poverty and joining the middle class.
Aside from higher food prices, higher wages would likely mean lower employment. If McDonald’s cannot sustain a 20% wage hike without a significant hit to its profitability, it will have to increase its efficiency in order to maintain a respectable profit margin. This means hiring fewer workers and requiring the ones it has to do more.
Bottom line
Despite apparently enormous profits, most fast-food chains operate on a tightrope; even a slight increase in costs has a huge impact on profits. If the federal minimum wage is raised by more than, say, 10%, investors should abandon Burger King Worldwide Inc (NYSE:BKW) and Jack in the Box Inc. (NASDAQ:JACK) and remain cautious with McDonald’s. These companies simply cannot tolerate large increases in costs and maintain anything close to their current levels of profitability.
The article Can Fast-Food Chains Survive a Wage Hike? originally appeared on Fool.com and is written by Ted Cooper.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald’s. The Motley Fool owns shares of McDonald’s.
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