Minimum wage changes could have dramatic impacts
on a franchise’s profitability, ability to invest or even its viability.
By Cramer Soebbing
Minimum wage has been a hotly debated topic for franchisees over the last few years. More poignantly, the discussion concerns the effect that impending minimum wage changes will have on franchisees’ cash flow, their employees and their capital expenditures. Depending on where they are located, franchisees could be paying their employees anywhere from $7.25 to $13 an hour at the minimum wage.
Cash flow is essential to any business owner, including franchisees. The most prevalent concern revealed by clients is the effect minimum wage changes will have on their cash flow.
Let’s take a generic example of a franchise that operates with an average of five employees working at a time, open 18 hours a day, seven days a week. All other things being equal, over the course of a year, a $1 increase in the minimum wage will lead to a decrease in cash flow to that franchise of $32,760. If this is a multi-unit franchisee with four stores, that number balloons to over $130,000!
This significant effect on cash flow ultimately impacts decisions on staffing, capital investments, additional franchise purchases – and even the long-term viability of the franchise. As an example, a recent study by Michael Luca at Harvard Business School and Dara Lee Luca at Mathematica Policy Research (“Survival of the Fittest: The Impact of the Minimum Wage on Firm Exit”) found that a $1 hike in the minimum wage brings a 14 percent increase in the likelihood that a 3.5-star restaurant, as rated by Yelp, will close.
At the State Level
Geographic location is a major factor when it comes to minimum wage laws. According to the National Conference of State Legislatures, 19 states began 2017 with higher minimum wages than in 2016. Seven states (Alaska, Florida, Missouri, Montana, New Jersey, Ohio and South Dakota) automatically increased their rates based on the cost of living while five states (Arizona, Arkansas, Colorado, Maine and Washington) increased their rates through ballot initiatives previously approved by voters.
Seven states (California, Connecticut, Hawaii, Massachusetts, Michigan, New York and Vermont) did so as a result of legislation passed in prior sessions. Washington D.C., Maryland and Oregon raised their minimum wages on July 1, 2017, due to previously enacted legislation.
We’ve found that individuals looking to become franchisees, and existing franchisees looking to expand across geographic lines, are giving more consideration to the legal status of this issue in the geographic areas they are considering. Some are even moving to different parts of the country to open their businesses.
States are taking various approaches to minimum wage. Oregon’s minimum wage law is phased, with increases over six years. By 2022, the minimum wage will be $14.75 an hour in Portland, $13.50 in midsize counties and $12.50 in rural areas. A franchisee in Oregon may look at this regional approach and decide to expand or not expand into certain areas based on the law’s implementation. In contrast, California, the nation’s most populous state, voted last year to increase the minimum wage to $15 an hour by 2022 across the entirety of the state. New York is also on a path to $15 an hour by 2022.
However, the geographic impacts go even deeper than states. Some cities across the country have begun instituting their own minimum wages above and beyond what their states or the federal government are doing. New York City is accelerating its push to $15 an hour ahead of the rest of the state of New York.
Seattle is one of the most aggressive cities in the country in raising the minimum wages. The effects of these changes have been felt by business owners and are now being felt by their employees, too. Recent data shows that low-wage workers on average now clock nine percent fewer hours and earn $125 less each month than before Seattle set the new minimum wages.
Illinois has a minimum wage of $8.25 but Chicago has a current minimum wage of $11 per hour with a 50-cent raise every July 1 through 2019 and a target of $13 an hour. Illinois franchisees are beginning to look across borderlines to Indiana or Wisconsin. While not as economically attractive as the Chicago metropolitan area from a pure revenue standpoint, the margins that are captured in the neighboring areas with a $7.25 minimum wage are much more attractive in certain scenarios when comparing the cash flow opportunities.
Impact on Investment
Companies built on the franchisor/franchisee model are also feeling the pressure to integrate technology and digital offerings more effectively. For example, investments in innovative infrastructure could range from $5,000 to $700,000. This reinvestment is necessary for franchises to better serve customers and survive in a tech-forward society.
In our experience of working with franchisees, we have found that franchisees are more willing to make the capital investments on the front end if they know that their margins will appreciate on the back end. However, increased margins can diminish with rising minimum wage levels. This is something all business owners should consider when evaluating capital expenditures. These larger investments have pushed owners to sell when they are not willing or able to reinvest in their businesses.
It is important for franchisees to have a deep understanding of not only the existing minimum wages in their geographic locations, but also the potential for future changes that could undermine their growth plans. This applies to multiple facets of their businesses, including employees, their reinvestment back into their businesses and, most importantly, the cash flow their businesses create for them to succeed, prosper and ultimately retire.
Cramer Soebbing is a wealth advisor at Mariner Wealth Advisors’ Chicago office.