The Labor Report: Unpack Your Labor Cost

The past few years have been some of the most trying times for restaurant operators. With the onslaught of increased regulation, higher wages, a tight labor market, and a record-high turnover rate, labor has quickly come into focus as the #1 problem for operators to solve in 2019.

The past 5 years have been a war for the restaurant industry to gain market share and repeat customers, which has been a boon for delivery and loyalty programs, but as we have seen with record store closings, great marketing just kills a bad operation faster. Now, restaurants are facing a new kind of war: a war to attract and retain talent. This report will walk you through the composition of labor cost dilemma, what to analyze in your operation, and propose solutions for these issues.

What is Affecting Labor Cost?

Compliance

The top 10 employment-related settlements in 2017 totaled $2.72 billion—up from $1.75 billion in 2016; a 55% increase. Workplace discrimination, employee benefits and wage and hour claims were among the top allegations. Even if the employer’s transgressions are minor, the business may still be liable for such fees and damages. These cases tend to settle quickly to avoid the financial strains and length of the litigation process.

The rise in wage and hour settlements is the number one risk for corporations heading into 2019. A dollar spent on risk management and compliance is better than a dollar spent on settling a class-action lawsuit. HR professionals and business executives should focus their efforts on prevention rather than cure.

Labor Lawsuits by State, 2017

Labor Lawsuits by State, 2017

The cost of employee lawsuits:

  • 318 days is the time it takes for the average claim to be resolved
  • 24% of matters resulted in costs for defense and settlement
  • $160,000 is the average cost for cases that resulted in a defense and settlement payment
  • 76% of cases resulted in no payment by the insurance company, highlighting the nuisance potential of employment charges; even if they are unfounded, allegations are invariably handled carefully.

Source

Supply of Labor

Supply of Labor 

With US unemployment falling to a 17-year low, a scarce labor market makes recruitment and retention even more difficult. The labor market has long posed a challenge to the hospitality industry, and now employees are forcing the issue.

Thousands of hotel workers voted in October to walk away from their posts at 21 Marriott properties across the U.S. in a bid for increased wages and benefits, job security and better health care. While this is nothing new for the industry, these demands show an increased desire for job satisfaction among hotel employees amid a favorable labor market.  In today’s employment environment, employees have more power to make their demands a reality.

Impact of Rising Minimum Wage

Minimum Wage Increases

Since most restaurants operate on  slim profit margins—between 3% and 5%—each increase in labor costs presents cumulative challenges to restaurant owners. As a result, they are forced to make  tough decisions such as reducing hours, eliminating staff positions, or closing altogether.

A 2018 HBS study found that a $1 increase in the minimum wage leads to a 14% increase in the likelihood of closure for a median 3.5-star restaurant, but no impact for 5-star restaurants.

 

Minimum wage increases closure, but more so for lower-rated restaurants

Minimum wage increases closure

Many restaurants have responded to wage inflation by raising menu prices, but that only works for some and there is a marginal utility in the price elasticity for consumers. If survival is dependent on  the ability to pass on higher labor costs to consumers through higher prices, then high-rated restaurants are expected to incur in this practice with more frequency.

EBITDA Could Deteriorate up to 19% Due to Wage Increases in 2019

EBITDA Decline

Source: Aaron Allen & Associates, Labor Law Center, industry sources *Notes: estimates based on typical unit economics and state minimum wages

When price is inelastic and price increase converts into customer loss, margin has to be expanded by cost control. While sales is the largest lever in labor-light concepts (i.e. coffee shops), labor cost control is the largest lever in any service-oriented business (i.e. full service, casual dining, fast casual).

Increase in Minimum Wage (% change) by State

Increase in Minimum Wage (% change) by State

Turnover

Employee turnover is a function of company culture, which follows the employee benefits programs, work-life balance, and personal development in of any organization. Employees are the most important difference between a highly productive business and an unprofitable business.

According to TDn2K research, management retention is the single most important factor in running a successful restaurant. With current turnover rates continuing to increase for hourly employees and restaurant management turnover at a historically high level, staff retention remains a top concern among operators.

Hospitality has a historically high turnover rate; 72% for hourly employees and 35% for management or salaried employees.

The hard costs of turnover:

  • Total cost of a churned hourly line-level employee: $5,864 (Cornell Center for Hospitality Research)
    • Pre-departure: $176 (3%)
    • Recruiting: $1,173 (20%)
    • Selection: $645 (11%)
    • Orientation & Training: $821 (14%)
    • Productivity Loss: $3,049 (52%)
  • Total cost of a churned management employee: $11,000

As restaurants already operate on a tight margin, finding a balance between wages, recruiting and retention costs is essential for survival.

What is your labor cost DNA?

Turnover Cost Calculator

Employee turnover tends to be the most concealed component of overall labor costs, however it is the most pervasive since it is not a line item expense where the actual cost is well-known. At Harri, we work arduously to help quantify employee turnover costs. Additionally, as part of our services, we provide clarity and transparency regarding the toll of employee turnover on the bottom line.

Calculate your turnover rate

Calculate Turnover Rate

7 ways to increase retention

  1. Find and cultivate high-potential managers
  2. Recognize top employees
  3. Do your research when it comes to pay
  4. Be conscious of hours
  5. Conduct exit interviews and learn from feedback
  6. Make learning and development a priority
  7. Know your numbers

The missing links to unpacking labor cost

Labor seems to be the missing link on most earnings calls, where a 2% meat price inflation is discussed and analyzed from every angle but an 8% wage inflation is stated matter-of-factly without further questioning to clearly define the problem and determine the optimal solution. Here are the labor-related questions that should be asked on earnings calls and board meetings:

High level data points

  • How do you correlate engagement with retention and productivity?
  • How are you gathering employee sentiment?
  • How much is paying the break premium actually costing you?
  • Have you gained efficiencies with your scheduling system?

Qualitative data

  • How do you correlate engagement with retention and productivity?
  • How are you attracting candidates?
  • How are you conducting exit surveys?

Hard concepts

  • What is your operations strategy to contain labor cost?
  • How are you mitigating the rising labor costs?
  • What is your labor compliance action plan?

Soft concepts

  • What is your plan to improve your employee turnover ratio?
  • What are you doing to increase employee productivity?
  • What is the 90-day training plan for new employees?

Takeaways

This analysis would be remiss without recommending solutions to these problems outlined. We recommend the following changes and additional research:

  • Analysts, investors, consultants: We believe analysts and investors should do more to understand the the complexities of labor cost as deeply as they understand meat prices. You are welcome to use the strategies we have outlined in both:
  • Restaurant operators: Harri has developed the Workforce OS™ specifically to suit your needs as an operator to easily attract and hire employees, reduce labor cost, and increase retention:

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