In today’s ‘challenging restaurant environment’ there’s no way to raise menu prices to offset minimum wage hikes

From Mark Perry.

"The CPI for Food at Home fell by 1.6% in July compared to the same month last year, marking the eighth straight month of annual food deflation at America’s grocery stores (see chart above). In contrast, the CPI for Food Away from Home (reflecting menu prices at restaurants) increased by 2.8% in the 12-month period through July – that was the 23rd straight month starting in September 2014 that the year-over-year increase in restaurant menu prices exceeded 2.5%. The 4.4 percentage point spread in annual food price changes (+2.8% for restaurants vs. -1.4% for groceries) is the biggest gap in nearly 7 years, going back to the end of recession in 2009.

 

The second chart (table) above shows 11 of the specific food items that have fallen the most in price over the last year (see BLS data here), led by a nearly 40% drop in egg prices, from $2.57 per dozen in July 2016 to $1.55 last month. The next biggest price decrease was for ground beef, which fell 12.1%, from $4.20 to $3.69 per pound, since last July.

So guess what’s happening when cost-conscious consumers on limited budgets decide whether to eat at home or dine out? A Crain’s Chicago Business article titled “What’s to blame for slower restaurant sales? Cheap food” explains:

As prices for beef, chicken, eggs, milk and cheese go down at the grocery store, people cook at home more and eat out less. That’s bad news for companies like McDonald’s, which stumbled in the second quarter after two straight quarters of surpassing expectations, disappointing investors looking for more robust results under CEO Steve Easterbrook’s turnaround plan.
The world’s largest burger chain had plenty of company. Of the 25 largest restaurant chains in the country, just one—Domino’s Pizza—reported a same-store sales increase of 5% or better in the most recent fiscal quarter, the worst showing so far this decade, says Mark Kalinowski, a New York-based restaurant analyst at Nomura. “For chain restaurants, it was a weak quarter, no doubt about it,” Kalinowski says. The primary reason: Prices at restaurants are rising, while prices at grocery stores are falling (see top chart above), causing some consumers to skip the Big Mac to grill a burger at home.
Six of the largest chains—Taco Bell, Burger King, Applebee’s, Chipotle, Chili’s and Buffalo Wild Wings—reported negative same-store sales figures for the quarter. Oak Brook-based McDonald’s fared slightly better, reporting that same-store sales rose 1.8% in the U.S. in the second quarter. But that was far below the 3.2% increase expected by analysts and the 5.4% rise it reported the previous quarter.
“Compared with 12 months ago, if you’re shopping at a grocery store and cooking at home, you’re giving yourself a (bigger) discount, on average, versus eating at a restaurant,” Kalinowski says. And consumers, particularly low-income and middle-class families on tight budgets, tend to notice even small changes in prices and act accordingly. That has created what restaurant industry executives call a “challenging restaurant environment.”
Wendy’s CEO Tedd Penegor said during an Aug. 10 earnings call that cheap grocery prices are hurting his burger chain’s sales, which inched up a paltry 0.4% on a same-store basis in the most recent quarter. “It’s gotten a lot cheaper, relatively speaking, to get fresh beef at your local butcher and go home and grill it. . . .The continued gap in the cost of eating at home and dining out is at the widest point since the recession.”
That difference rose to 4.4 percentage points in July, the biggest gulf in nearly seven years, according to Shane Higgins, a New York-based analyst at Deutsche Bank. Price declines in grocery stores are being led by categories like meat and dairy, the stock in trade of most fast-food outlets. Store prices fell last month for the seventh time in the past nine months, according to the Bureau of Labor Statistics. They’re now down 1.6% from 12 months ago. Prices at restaurants, meanwhile, are up 2.8% over the same time frame.
“If I’m a grocer and I see those trends, I’d do more prepared foods, deli items and grab-and-go to try to appeal to the time-starved consumer on the way home from work,” Higgins says. “Not only are these very profitable areas, but they’re also (potentially) replacing a restaurant trip.”
The numbers posted by restaurant companies seem to bear that out. Despite low gas prices, a bullish equities market, low unemployment and high consumer confidence, restaurant traffic was down nearly 4% in July from a year earlier. And there’s no immediate sign that things will get better. Higgins expects grocery prices to be deflationary through the second half of 2016. That’s happening as McDonald’s raised menu prices about 3% over the past 12 months and may continue passing along rising labor costs as more states and municipalities raise the minimum wage.

MP: There are some important economic lessons here, with major implications for the $15 an hour minimum law (both enacted and proposed):

1. Consumers live on limited incomes and and tight budgets, and are therefore very price-sensitive and cost conscious about food prices, and “tend to notice even small changes in prices and act accordingly.”
2. Eating at home and dining out at restaurants are very close substitutes for most consumers, and they switch from one option to the other based on relative prices and relative price changes for each alternative.
3. As restaurant prices increase relative to food prices at grocery stores, price-sensitive consumers naturally tend to eat out less and eat at home more.
4. Restaurants operate on very thin profit margins, e.g. 5%. Under the best of circumstances, the ability of restaurants to raise menu prices, maintain customer traffic, and stay profitable is very, very limited, given Lessons 1 to 3 above, especially now that eating at home is becoming less expensive and more affordable relative to dining out.

5. In cities and states where the minimum wage is being increased to $15 an hour, and in those areas where a $15 wage is being considered, those wage hikes represent increases in labor cost for minimum wage workers of more than 100% in some cases. It’s just a simple matter of economics that if restaurants can’t raise menu prices in today’s competitive and “challenging restaurant environment” without losing customers, there’s no way they’ll be able to raise menu prices anywhere close to the level required to offset higher labor costs from huge minimum wage hikes and remain profitable and stay in business. Higher menu prices following minimum wage hikes will simply drive even more customers than currently away from restaurants in favor of eating at home.

Bottom Line: In the end, the $15 an hour minimum wage comes down to basic math, economics and consumer behavior, not politics and social justice. And the restaurant and consumer math of a $15 an hour minimum wage is an arithmetic for restaurant failures and reduced employment opportunities, not restaurant survival and an expansion of entry-level job opportunities. As I wrote on a recent CD post, the defects of the $15 an hour minimum wage can easily be seen by looking at the many things that law cannot do; that is, by looking at the many inevitable and negative outcomes that a mandated minimum wage cannot prevent or stop from happening. I provided 15 of those adverse outcomes from the things a $15 an hour minimum wage can’t do, and said there are perhaps more.

Here’s one more: A $15 an hour minimum wage hike, followed by higher menu prices at restaurants to offset the higher labor costs, can’t stop cost-conscious, price-sensitive customers from avoiding restaurants and instead choosing to eat at home to save money. In other words, it’s those pesky, greedy, cost-saving consumers who will thwart, foil and doom the $15 minimum wage. After all, if consumers weren’t so damn sensitive to higher food prices, they wouldn’t mind significantly higher menu prices following minimum wage hikes of up to 100% or more and would continue eating out just as often. And if consumers didn’t have the option to eat at home instead of dining out, they would tolerate higher menu prices at restaurants following minimum wage hikes because of limited alternatives for eating. But because consumers are very sensitive to food prices and because they do have the option of eating at home instead of dining out, it’s consumer behavior (“consumer greed”) in the end that makes the $15 an hour minimum wage a public policy that is doomed to fail. If greedy, price-conscious consumers are staying away from restaurants now that food prices at grocery stores are falling, would they act any differently in the future if restaurants try to raise menu prices to offset minimum wage hikes? I think it’s pretty clear the answer is No."