Manage rising labor costs to maintain restaurant profitability

January 4 2019

For most restaurants, labor costs are the first or second highest cost of operations. Anticipated changes in state and federal wage and overtime rules could drive those costs even higher, making overall financial discipline a high priority. Overall the restaurant industry employs about 10 percent of the U.S. workforce.

Restaurant consultants say labor costs should be 20 to 30 percent of your overall costs, which along with food cost should equal about 60 percent of gross revenues. Of course, the type of restaurant will be a factor in labor. Full-service dining operations will typically employ more people and pay higher wages than fast casual or quick-serve locations.

In some areas, restaurants have already been hit by local minimum wage hikes. At the federal level, the overtime rules and the restaurant minimum wage are under scrutiny as part of the Fair Labor Standards Act. As of 2018, the federal minimum wage is $7.25 an hour, but it’s higher in at least 29 states. The restaurant minimum wage for establishments where workers can collect tips is $2.13, except where it’s higher due to state laws.

Starting in January 2018, 18 states raised their minimum wages from 35 cents an hour in Michigan to $1 per hour in Maine. In California, a trendsetter for the nation, the minimum wage and tipped minimum wage were raised to $11.00 per hour.

Grass roots efforts are attempting to do away with the tipped minimum wage altogether, requiring restaurants to pay the general minimum wage to all employees.

Rising labor costs have forced some restaurant operators to change their operations. In Oakland, California, the AlaMar full-service restaurant switched to a counter-service format when the minimum wage rose. Chef Nelson German told it was the only choice to keep the doors open.

However, the switch resulted in higher sales with lower costs because menu prices were reduced 30 to 50%, increasing traffic. Also, back-of-house staff can participate in tips whereas they were prohibited under the old format.

Conventional wisdom is that higher labor costs will lower restaurants’ net margins and potentially force some establishments to lay off many workers or even close their doors.

Seattle has been another test case, where the minimum wage was upped to $15 per hour in 2014. Rather than raise menu prices, the Tom Douglas Seattle Kitchen chain transitioned from tipping to adding a 20% service charge on all checks. Overall, labor costs rose about 3%.

One study of the San Francisco market found that a 10% increase in minimum wage led to a 7% increase in restaurant closure. However, the study found a correlation between closures and poor Yelp reviews. There’s strong indication that the restaurants that shut down were also failing in quality and customer service.

Rising labor costs don’t have to mean the end of your restaurant operations. You can increase oversight of other costs including food and beverage purchases to manage the impact on your P&L.

When evaluating labor costs, divide your staff into groups so that you can see how the groups compare. List front-of-house staff, including servers, hosts and bartenders. Then look at kitchen staff, including cooks and dishwashers. Managers are in another group. Group by hourly and salary as well. Looking at staff expenses by category helps identify where you’re spending the most. Then you’re well informed to adjust labor costs to reflect revenues based on expected traffic.

Tracking all costs can reveal new opportunities for profitability as well. Reducing spend for leasing, utilities, food costs can offset labor increases while maintaining your customer service satisfaction.

A successful restaurant means managing the margins so that long-term sustainability is possible even in this era of rising costs.