The economic illiteracy of Americans — including most who have taken one or more college Economics classes — can be breathtaking. But instead of always complaining about this malady, I decided that with this article, I’d here offer a one-lesson business accounting course that SHOULD be taught in high school (if not at home).
Herewith, a cram course on the fundamental math of a retail business — specifically a fast-food establishment. And why almost all such culinary establishments will be cutting back their hours of operation — making that late-night fast-food eatery largely a thing of the past.
Every business has two kinds of costs:
1. Fixed Costs — These are costs that don’t change much from month to month. At the top of the list of fixed costs is usually property costs — mortgage (or rent), taxes, insurance. Add to that franchise fees, accounting cost, some insurance costs, etc.
2. Variable Costs — These costs primarily consist of the cost of goods sold, utilities, franchise percentage payments and — what’s becoming a bigger and bigger component of variable costs — labor. Remember that labor costs include a lot more than wages. There are employee benefits (especially healthcare for full-time employees), payroll taxes, workers comp and the legal risks proportionate to the number of employees hired — and the number of hours that they work for you.
Fortunately, one doesn’t have to go to college to understand such economics. You don’t even have to observe a business in operation. Online learning provides such knowledge. Google and Bing are our friends.
If you want to earn extra credit in my class, here’s a good explanation of these two types of costs:
Fixed vs. Variable Cost: What’s the Difference? (thebalancemoney.com)
I need to emphasize one point: Businesses do not pay taxes. They COLLECT taxes from customers. Same for mandated costs such as minimum wage, maternity leave etc. CA has approved a new mandate that ensures that fast-food workers are paid a minimum wage of $21 an hour.
These are “pass through” costs that are buried in the bill that patrons pay when they frequent that business. If these costs make the price of their products too high, their patrons will visit less often, finding substitutes.
In the case of fast-food eateries, we’ll see more and more box lunches and “bottled” drinks brought from home. Who knows — even the lunch pail may make a comeback.
But I digress. Back to fixed vs. variable costs. Consider this SIMPLE business example for a restaurant (not necessarily matching percentages with current experience):
Monthly fixed costs: Say, $30,000.
Monthly variable costs: 80% of gross revenue ON AVERAGE. But that percent varies. During peak times the economy of scale might reduce the variable costs percentage to 70% of revenue — or even lower. But in the off hours, the labor percentage rises, even with some cutting of the labor force. For an all-night restaurant, in the later hours the total variable costs can approach or EXCEED the gross revenues.
When a business can’t cover its VARIABLE costs, normally it closes its doors for the day/evening. As long as it’s making enough to at least help cover the fixed cost “nut,” it makes sense to stay open (from a strictly financial standpoint).
Now increase the hourly labor rate (and attendant costs) 50% with a higher minimum wage. Labor costs currently constitute roughly 30% of an eatery’s TOTAL costs — probably half or more of the VARIABLE costs. With a 50% average labor cost increase (let’s assume across the board), the point at which the sales volume is exceeded by the variable costs comes quicker. So, unless a restaurant attempts “surge” (time of day) pricing a la Uber/Lyft — unlikely since there’s no customer surge in the off-hours — the owner will have to shorten the hours of operation in both the evening and the morning.
Doubtless a handful of food establishments will remain open, but normally in a few high-volume areas, and only because customers have fewer options (much of the competition will be closed).
This labor wage mandate translates into three problems not being discussed by advocates:
1. More employees finding their hours shortened.
2. Fewer options for the public “after hours.”
3 With fewer hours of operation, the covering of the business’s fixed costs will become more difficult, and doubtless will result in some (additional) restaurants failing — they operate on VERY thin profit margins (generally 2%-6% of revenue). Historically, two out of three new restaurants fail within 3 years.
Longer term, the damage to employment will be more permanent. Such a dramatic rise in variable costs will more likely exceed the expense of fixed-cost automation of many business functions now performed by low-skilled labor — making it sensible to convert variable costs into fixed costs.
McDonald’s has already opened “no employee” robot food outlets in Ft Worth, Denver and Las Vegas.
This increase in automation will NOT appear in employment right away, but will be phased in over a few years. And once such automation is put in place, it will reduce employment for ALL the business hours — not just the slow periods.
Sadly, the proponents will look at the first few months of a new costly mandate and then eagerly announce that the negative effect of the additional cost (such as a higher minimum wage) was less than predicted. They will fail to consider the reduced hours of employees — looking at only the number of employees employed.
The press will be delighted to report this premature “settled science.” Only later will the full negative effects set in, and few will be talking about this, or connect the dots.