Tuesday, April 14, 2015

The McDonald's Problem

The movement to raise the minimum wage has been gaining some momentum. Naturally you can't just snap your fingers and do it. There are costs involved, both short term and long term. One of the things that frequently comes up is that fast food franchises, McDonald's for instance, can't just raise what they pay their employees because they're barely squeaky by as it is and have no control over the price of their products. A private business can pass that new cost along to the consumer, if acceptable. So let's dive into some faux-math on owning a burger restaurant, shall we?

Before we begin, I make no claim that these numbers are based in any fact. They are over simplified, fictional numbers to prove a quick and dirty point.

Karl Dilkington opens a burger joint. We're going to keep this simple so that the math is nice and easy to understand. Pay is straight wage x hour worked, I'm not taking insurance and other things into consideration. Instead of breaking down the cost of a burger, fries, and a drink separately we're just going with the average cost of a food item.

  • Minimum wage is $8.00, and that's what Karl pays his employees (the cheapskate!)
  • Not counting Karl, the restaurant has 10 full time employees working 40 hours per week, which works out to $640 per day in salaries
  • On average they sell 2000 items per day.
  • Burger restaurant supplies cost $1000 per day
  • Rent, electric, gas, and all other facilities bills work out to $500 per day
  • Karl is no dummy, he wants to set some money aside for future equipment replacement and in case they hit a rough patch. He sets aside $500 per day before profits.
  • Karl needs to feed himself and his family so he sets aside $200 per day for himself (it works out to about $52K per year)
  • Two friends helped get Karl off the ground with the initial investment. For the first year he needs to pay them each $1500 per week ($600 per day), after that he's clear of debt

So how much does each food item cost him?

Supplies  $      0.50
Equipment  $      0.25
Staff  $      0.32
Future   $      0.25
Bossman  $      0.50
Investors  $      0.30
 $      2.12

I just took the costs from the bullets above and divided by 2000 since that the number of items sold per day.

So for Karl to break even he needs to charge $2.12 per item. People tend to buy 3 items, that works out to $6.36 he needs to charge for a meal, again, just to break even.

Capitalism dictates that everything is worth what the consumer is willing to pay. Karl starts at $2.15 and rolls the price up until he finds the sweet spot: $2.50 per item, $7.50 for the meal deal.

Karl finds himself in an interesting position. At $2.50 per item he's now earning $760 per day in profit. That's an extra $197,000 per year.

As a private business Karl can do all kinds of things with the extra money, but he plans to set it aside and invest in opening more restaurants.

Now wouldn't you know it? Some lefty pinko liberal comes along and says it's not fair for Karl to pay his employees $8 per hour. Son of a bitch wants to raise the minimum wage to $10 per hour.

The only thing that changes is the line item for staff. It goes from $ 0.32 per item to $ 0.40 per item.

Cost per item now totals $2.20, cutting into Karl's profits by over $40,000 (he now only earns $157,000 per year in profit).

He can accept the loss in profit and carry on business as usual, just taking longer to open his next restaurant, or he can raise prices to compensate. After all, what's $ 0.10 or $ 0.20 to the consumer if he's "doing a good thing" by paying his staff more money?

Now to the McDonald's problem. Instead of Karl opening his own restaurant he decides to get a franchise.

For simplicity sake we keep most of the original numbers, but the name of one item needs to change. There is now a franchise fee for Karl to make the food items of his parent company, but conveniently it's the same as he was setting aside for his investors before. Staff are back to making $8 per hour (before the minimum wage hike), and Karl is still making $52K per year:

Supplies  $ 0.50
Equipment  $ 0.25
Staff  $ 0.32
Future   $ 0.25
Bossman  $ 0.50
Franchise Fee  $ 0.30
 $ 2.12

Unlike with his own restaurant, Karl is backed into a corner. He can't charge more than $2.33 per item. The parent company wants to control pricing. "The $6.99 meal deal!" is their claim to fame.

Karl is making $ 0.21 on every item, selling 2000 items per day, and coming clear $109,000 in profit per year. His only chance of making more money is to sell more items in a market already extremely saturated with burger competition.

Along come the lefties again... $10 per hour. The staff line item changes to $ 0.40 per item.

It now costs Karl $2.20 per item and he can still only sell it for $2.33. His profits are now down to $67,600 per year.

What can Karl do??? He can't increase his price. He's barely making anything himself, he can't lower his own salary so that he can make more profit to invest in future restaurants. The parent company doesn't want to budge on the per-item price, it's already a lot to begin with.

What can be done?

Let's look at another bit of math, shall we?

The parent office operates 10,000 restaurants across the country. Each of these franchisees pays $ 0.30 on the food item for the right to sell their highly desirable food. 2000 items per day works out to $600 per day... $156,000 per year times 10,000 restaurants means $1.56 Billion in franchise revenue for the parent office.

They, of course have their own costs.

5000 people work for the parent office across the country, averaging $65,000 per year. That works out to $325,000,000 in salaries. 

Those corporate offices aren't cheap, nor is the equipment and software to run the business. Another $500,000,000 in operating costs hacked right out of that $1.56 B.

That leaves a mere $735,000,000 in franchise fee income to split between the executives and other "top people". A company with 5000 employees has a lot of "top people" and investors: 50 total. That leaves only a tiny $14,700,000 average per top level employee and investor. A pittance, some would say, considering the insurmountable risk these titans put into their burger empire.

So... what happens if the parent office drops that franchise fee to $ 0.20 per item?

  • Karl goes up to making $119,000 per year in profit to invest in future restaurants, which grows the business footprint
  • The parent company drops to $1 B in profit in the short term
  • After salaries in operating costs the parent office is left with a mere $215,000,000 in profit. Split between the 50 industrial titans that comes to only $4,300,000 per year. Good, Christ, who can live on that???
  • Oh and did I fail to mention increasing 100,000 employees base salary from $8 to $10 per hour puts over $400,000,000 into the economy at its lowest levels?

No, no, best to just squeeze Karl for all he's worth, keep lobbying hundreds of millions to keep the minimum wage down, but eventually relent and allow the franchises to raise the per-item cost to $2.45 to offset the increased operating cost, but keep parent company profits reasonable.

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