The debate over raising the minimum wage is likely to heat up as the bill becomes more relevant. The current minimum wage is set at $7.25 per hour; under new current bill, known as the “Fair Minimum Wage Act of 2013,” within two years the minimum wage will increase to $10.10 per hour on a federal level. Such a wage bump raises the concerns of many business owners and investors that it will lead to a rise in unemployment, which is already high, and cut the profit margins of businesses (or even worse, close companies). How will raising the minimum wage affect the big fast food companies?
I recall debating this issue with my former boss; he stuck to the basic notion from economics 101 that raising the minimum wage will cause an increase in unemployment. When considering this simplistic point of view, that makes sense at least two problems come to mind:
1. It doesn’t consider the positive effect of an increase in minimum wage may have on the economy
2. It assumes there are no market-failures – and in real life there are always market failures
When a minimum wage is raised, it doesn’t only affect the labor market, it also has an effect on other markets, including consumer goods. After all, who are the people eating in McDonald’s Corporation (NYSE:MCD) or Taco Bell? Young people. Who will benefit from a wage increase? Young people! So a wage increase could actually lead to a rise in revenues for fast food companies.
If there is one thing I did learn from all my studies in economies (and there aren’t too many) it’s that in almost any market there is a market failure that prevents the simple economic outcome from realizing. This is mostly true in the labor market where such factors as imperfect information, bargaining power and many more can lead to a market failure.
But let’s put these issues aside and examine several fast-food companies that are likely to be affected by raising the minimum wage. Let’s see the impact it could have on their profitability, and let’s also consider the worst case scenarios, i.e. only a negative impact on wages with no growth in revenues. I will also assume that the big fast food companies only pay the federal minimum wage, while in certain states the minimum wage is higher than the federal’s.
McDonald’s Corporation (NYSE:MCD)
McDonald’s Corporation (NYSE:MCD) U.S sales account for nearly 32% of the company’s total revenues in 2012 (opens pdf). This rate was slightly lower in 2011, which means the market share of U.S in the company’s total revenues remains stable.
McDonald’s Corporation (NYSE:MCD) revenues are divided between its operated sales and its franchise sales. The franchise sales accounted for nearly 32% of its revenues. The franchise revenues are based on property rent and royalties, which are derived from a percentage of sales, fees and rent payments. So the rise in labor expenses might not affect McDonald’s Corporation (NYSE:MCD) franchise revenues or its operating profitability.
Regarding the company’s operated sales, they accounted for 68% of its total revenues in 2012 and nearly 67.3% in the first quarter of 2013. The share of revenues from the U.S was only 16.4% out of total revenues. The company’s operating profitability from the U.S operated sales was 19.5%.
Assuming the labor costs account for 25% of its operated sales and assuming most of these labor costs are for minimum wage employees, then raising the minimum wage from $7.25 per hour to 9.19 per hour in 2013 – a 26.7% bump – means the labor cost will rise to 31.5%, so that the profit margin in the U.S will drop from 19.5% in 2012 to 13% in 2013.
The operating profitability of the company’s entire operations will decline from 31.2% in 2012 to 30.1% – roughly a 1 percent point drop.
Yum! Brands
This company is comprised of Taco Bell, KFC and Pizza Hut restaurants. Its franchise operations account for a much smaller percentage of its total revenues than McDonald’s: in 2012 (opens pdf), its revenues from franchised restaurants were only 13% of its total revenues. Its payroll and employees benefits provision accounted for 22% of its company sales (sans franchise revenues). The company re-franchised 468 restaurants in the U.S, so there are currently fewer restaurants the company operates. As of the end of 2012 the company operated 1,733 restaurants, which account for only 23% of its total number of restaurants. The company’s sales in the U.S were $2.55 billion; the labor costs were $751 million, so an increase of 26.7% in the wages will raise the labor cost (assuming all other equal) to $951 million – a nearly $200 million gain, which will reduce the company’s U.S profit margin from 16.3% in 2012 to 8.4%. But the company’s total operating profitability will decline from 16.8% in 2012 to 15.3% – a nearly 1.5 percent point drop.
Unlike the previously mentioned companies, Burger King Worldwide Inc (NYSE:BKW) didn’t have a great year as its revenues dropped by almost 16% in 2012 (y-o-y). One of the reasons for the drop in sales was the company’s cut in number of restaurants in U.S and Canada: the number fell from 939 by the end of 2011 to 183 by the end of 2012. On the other hand, its franchised restaurants grew by 732 to reach 7,293. This shift from operated restaurants to franchised restaurants in the U.S is likely to reduce the adverse impact a raise minimum wage will have on the company.
In 2012 the payroll and employee benefits accounted for almost 30% of the company’s restaurants revenues. Since the company’s restaurants in the U.S & Canada account for 43% of its total number of restaurants, assuming a 26.7% gain in payroll expense in U.S & Canada, the total operating profitability of the company will drop from 21.2% in 2012 to 20.3% – again around a 1 pp decline. But if Burger King Worldwide Inc (NYSE:BKW) will continue to close its operated restaurants in the U.S and shift them to franchised restaurants this could lower the company’s risks related to wages (and other risks), so this 1pp drop could be even smaller.
I think that it’s too early to predict how raising the minimum wage will affect the economy in general and the fast food market in particular. It might lead to a slight drop in the profit margins of leading fast food companies, but this change could also lead to growth in revenues that will cut the adverse impact of a wage increase.
The article Will a Minimum Wage Hike Hurt McDonald’s? originally appeared on Fool.com is written by Lior Cohen.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
