Harvard Study Shows Again, Strong Ops Key to Combat Rising Wages


A new study from the Harvard Business School attempts to get to the core of how the rising minimum wage affects restaurant closures, and shows yet again that the best restaurants can manage through.

With a hint toward the results, the report was titled “Survival of the Fittest: The Impact of Minimum Wage on Firm Exit.” Overall, the authors saw that a $1 increase in wages precipitated a 4% to 10% increase in firm exit.

But to see which restaurants exactly were at the highest risk of minimum wage pressures, the authors looked to determine quality. Using Yelp ratings as a proxy for quality among 35,173 restaurants in the Bay Area where 5% of restaurants go out of business each year. They chose the expensive region because it has no tip credit, so restaurants bear the full brunt of the wage increase. During the study, researchers observed 21 local wage changes from 2008 to 2016.

Researchers found that “lower quality restaurants are disproportionately affected by minimum wage increases.” That’s no shock; poorly run restaurants always have one foot in rough waters. But a small increase in quality (or another star) is pretty dramatic.

“A one-star increase in rating is associated with more than 50% decrease in the likelihood of going out of business. This qualitative relationship holds both with and without restaurant effects,” wrote the researchers, who described other restaurant effects as turnover, demand, time trends etc.

They found that restaurants with a 3.5-star rating were 14% more likely to close with each $1 bump in the minimum wage. But for five-star restaurants, the impact falls to zero.

Yet again, the study shows that while rising wages are a challenge for operators, great operations find a way to mange through the rough waters. The Habit Burger Grill, Red Robin and Del Taco—which all have high exposure to the rising minimum wages in the same area covered by the study and had some relatively good earnings spoke to the wage pressures. Each also sit solidly in that 3 to 4.5-star Yelp range in the Bay Area.

Habit (NASDAQ: HABT) reported a .9% same-store sales increase in the first quarter. CFO Ira Fils talked through the pressure in the first-quarter earnings call. He said labor bumped up 110 basis points in the first quarter compared to Q1 2016—90 points of direct wages and 20 points of related expenses like healthcare. Overall, hourly rates increased a little over 6% year-over-year; and costs will continue at about that pace, he projected.

“We continue to expect our average wage rate to increase 6% to 8% in 2017. On a positive note, we have been working on labor productivity initiatives that we believe will help to offset some of the short-term commodity inflation,” said Fils.

He said tweaking the schedule is one tactic, and one that researchers noted: Restaurants aren’t generally cutting staff counts, but they are slimming hours.

“The tactics that we are putting in place really are not meant to affect the customer experience at all. That's first and foremost of how we think,” said Fils. “Our operating team is looking at a way to save an hour or so a day during the times when there are not customers in the restaurant. These would be the times before we open or when we close the doors and are in close down mode.”

Technology and logistics is another way to free up managers to manage and interact with customers.

“We continue to make significant strides with technology and systems that have always been designed to provide the management people in our stores the ability to spend more time with employees and customers and less time on administrative tasks,” said Fils.

At Red Robin (NASDAQ:RRGB); which announced a big earnings beat and a 1.2% same-store sales growth, COO Carin Stutz said they had a slew of initiatives in the works to mange through the strain.

“Look, we're watching this trajectory on this line and we know that it's just not sustainable to see these rates of increases,” said Stutz. “Where I will give credit is to the teams in the restaurant they are managing productivity, I mean just really I can't ask for more from them with the labor model that we have. Our labor model is fairly sophisticated, connectivity based labor model. So everything that our teams do is really accounted for.”

Beyond that model, she said they were looking at things menu and prep simplification through 2017 as the boon of low commodities will likely evaporate.

“While we have had the benefit of lower cost of goods for some time now, we know this will not sustain and the hourly labor cost growth remains a major headwind. That said, when the wind is not at your back you better get out of paddle. And I can assure you that Carin carries a very big paddle,” said Stutz. “What makes me most proud is that the frontline team is continuing to improve the guest experience as measured by our net promoter score and speed to table.”

Driving ticket times down has been a big focus. Already the brand has been able to halve the number of guests who wait 16 minutes or more, the limit of what she hopes for in wait times. The brand aims for 11 minutes for both drive-ins, dine-in and to go orders. Slimming labor costs by tackling turnover is another lever Stutz is pulling.

“While the casual dining industry is experiencing some of the highest rates of turnover in history, Red Robin turnover is down to our lowest levels in years. Retention means more-consistent, high-skilled team members capable of delivering higher sales per labor hour, that's a win all the way around,” said Stutz. Less turnover also means less time and money spent on recruitment and training.

Steve Brake, CFO at Del Taco (NASDAQ: TACO), didn’t speak directly to remedies for the growing labor line, but the QSR taco concept is already a pretty lean operation. Though a price bump helped.

“Labor and related expenses as a percentage of company restaurant sales increased approximately 100 basis points to 32.8% from 31.8%. This was primarily driven by the California minimum wage increased to $10.50 an hour as well as increased worker's compensation expense, partially offset by the impact of menu price increases,” said Brake in the only reference to labor costs during the Q1 earnings call.

That’s another benefit of being a highly rated or high-quality restaurant; passing on some of those labor costs won’t scare customers away. Habit raised prices by 2.2%, Red Robin added 1.6% and Del Taco added 1.9%.

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