alternative financing labour cost

The impact of increasing labour costs

By Geoff Wilson and Andrew Waddington, fsSTRATEGY Inc.

There is no question that profit margins in restaurants are sensitive to changes in labour cost. As a prime cost, labour cost comprises nearly one-third of revenue; second only to (in fact, sometimes greater than) cost of goods sold. The degree to which a restaurant may shoulder changes in labour costs varies and is determined largely by the relationship between operating ratios for labour cost and profit. In general, operations with greater labour cost ratios and lower profit ratios are more sensitive to changes in labour costs.

The following table shows typical labour cost and profit ratios as a percentage of sales and corresponding sensitivity expressed as a break-even threshold (i.e., the percentage by which labour may increase before profit is zero) for each Canadian Food Services and Drinking Place segment.

1. Special food services include food service contractors, caterers and mobile food services. Source: Statistics Canada. Table 355-0008 Food services and drinking places, summary statistics, annual (2015)

As shown, on average, Full-Service Restaurant labour may only increase by 9.8 per cent (i.e., increase to 34.9 per cent of sales) before the profit is eliminated. Limited-Service Eating Place labour may only increase by 16.0 per cent before profit is eliminated. Special Food Services have the greatest insulation from labour cost changes, not because of labour cost, which is the greatest of the commercial foodservice segments, but because they also enjoy the greatest profit margins. Understanding this sensitivity is important; however, working for no profit is obviously not acceptable.

Naturally, Commercial Foodservice operators view increases in labour costs as threats to their profitability. Labour controls should be implemented with the same care and attention to standards given to food cost. Operators should analyze labour efficiency and develop labour matrices on a regular basis to ensure the efficient use of labour. When increases are beyond the control of operators (i.e., an increase in provincial minimum wage), operators must consider such increases as targets for gross margin improvement. On the surface, raising prices may appear to be the simplest way to accommodate cost increases; however, this is not always possible, especially in competitive markets. A variety of other strategies exist to enhance margin, including:

  • More effective purchasing;
  • Recipe reformulation;
  • Use of less expensive ingredients;
  • Evaluation of the use of value-added products intended to reduce labour costs;
  • Marketing to increase traffic to slower periods when labour capacity is underutilized;
  • Implementation of labour-saving technologies and/or;
  • Menu optimization

Operators should be selective as to which strategies will work in their situation. Moreover, operators should remember to review dollars not just percentages.  Both are important but dollars go to the bank.

About the authors:

fsSTRATEGY is a niche consulting firm specializing in strategy in the hospitality industry with an emphasis on the foodservice sector. For additional information on operations analysis and menu optimization, contact us at [email protected] or 416-229-2290.