It’s very tempting to write about what the market conditions for restaurant stocks are likely to be over the next several months, especially with the market experiencing a high level of volatility and having undergone a significant correction, if not the beginning of a bear market.
Having lived through at least three traumatic periods in the market — the crash of 1987, the end of the dot-com era bear market in the early 2000s, and the credit-induced meltdown in 2008 — as well as several bull markets with sustained high valuations, I have learned that trying to predict what the immediate future will bring for restaurant stocks is virtually impossible. What I do know is that, until recently at least, valuations have been very high for an extended period of time. It is logical to expect that, over time, valuations will come down to historical averages and probably go below those averages. I don’t know whether we are at the start of that move or if recent activity is simply a short-term event and valuations will remain high. To paraphrase “The Shadow,” an old radio show, “Who knows what performance lurks in the future for stocks? Only the market knows.”
The cost of labor also is topical, and is something to which operators have some ability to respond, in contrast to moves in the market. Chipotle is planning a national hiring day on Sept. 9, with a target to hire 4,000 employees, representing an addition of nearly 7 percent to the workforce. I don’t recall any restaurant company undertaking a similar mass hiring. This action is undoubtedly the result of difficulty in adequately staffing the company’s restaurants, something that increasingly appears to be a challenge operators face.
Several public companies have flagged labor cost pressure on recent conference calls, and a couple of anecdotal examples further support this as an issue. I know of one operator who is opening a restaurant in Pittsburgh, who has had very little response to his ads for employment, even though the starting wage is well above the minimum. A significant number of the potential employees who responded to his ads never showed up for the interview. He tells me that virtually every restaurant on his street has a hiring sign in front. I learned of another situation in a Minnesota town where a well-known national brand had to close for lunch for two days because of a staffing shortage.
One can speculate as to the cause of these situations. In one case, the operator thinks that currently unemployed potential workers responded to his ad, but didn’t show up for the interview, to keep their unemployment benefits by demonstrating they were looking for work. Another theory is that E-Verify is working, reducing the supply of workers willing to apply to low-wage positions. A third theory is that the unemployment rate is falling, reducing the potential supply of workers.
Operators must prepare for labor cost pressure
Regardless of the reason, the reality is that labor costs are going up on multiple fronts, from the actual wage paid to the cost of benefits (i.e. health care). A serious issue for operators is how to respond to this reality and its impact on investors. The simplest response by operators is to raise prices. That, however, is easier said than done. Overall inflation remains low, and many consumers continue to feel squeezed financially. While some companies have sufficient pricing power to offset higher costs, many don’t, and run the risk of driving customers away if they raise menu prices. Furthermore, those that have pricing power today may not in the future. So, while price increases have to be considered, they should be thoughtfully evaluated and used sparingly.
There has been some press regarding operators’ use of technology as a way to combat rising labor costs. Anything from tablets and ordering kiosks to automating aspects of the cooking process is being considered by operators. Even the Washington Post ran an article recently citing the higher minimum wage as a catalyst toward this trend with the consequence of lower labor hours required to operate a location. This is definitely a trend that is here to stay. Operators need to be mindful, however, that a personal touch can be important to an eating experience, especially for front-of-the-house interactions. Millennials may feel comfortable communicating through a device, but other generations may not. Flexibility to accommodate a guest’s preference is important.
Technology can enhance the guest experience though, regardless of the generational appeal. Tablets may increase speed of service, especially at the end of a meal, if the guest can use it to pay the check, both increasing throughput and guest satisfaction. More automated cooking might eliminate human-caused variances — a medium rare burger would be medium rare every time. Tying an order from the point of sale directly to an oven or grill would likely reduce waste and associated costs.
How is your restaurant handling wage pressures? Join the conversation in the comments below.
There has been much rhetoric from restaurant operators and other retailers that higher wages are valuable investments and the right thing to do. This is undoubtedly correct because of the law of supply and demand — there will be a greater demand for a job ultimately if it pays more. What isn’t getting adequate attention though, in my view, are the consequences of higher wages, including reductions in labor hours, lower margins and cash flow leading to, at the margin, slower unit growth and higher prices for consumers. Markets will go up and go down and are virtually impossible to predict. Labor costs, on the other hand, appear to be in the early stage of a sustained increase. Operators and investors need to prepare themselves for the pressure on returns.
This article has been revised to reflect the following correction:
Correction: Sep. 4, 2015 Due to an editing error, an earlier version of this article used an incorrect title for Steve Rockwell.
