In the tables below we have compiled the impact of rising labor costs on the public companies earnings per share (EPS). The tables have been sorted from worst to best for those companies who report labor payroll and associated costs separately. We have segmented the tables into Casual & Family Dining and QSR & Fast casual, for segment comparison purposes. We utilized the EPS format as our metric because it has a direct impact on the valuation of companies and can easily be compared to their actual earnings as reported.
Only 3 of the 26 companies that have reported earnings to date (May 5th, 2017) had flat or positive labor impacts. Nearly all of the 13 Casual & Family Dining Companies had negative impacts from higher labor. The average negative basis point (bps) change was 90+. Nearly half of them had negative comparisons of over 100 bps. The biggest loser in the 1Q17 was Buffalo Wild Wings (BWLD) with a nominal same-store sales gain of 0.5%, and a $0.17 negative impact from 80bps in labor erosion. Six other companies had significantly larger erosion in terms of basis points, but not in terms of EPS. Only one (Darden) had a positive labor cost comparison.
Of the 13 QSR & Fast Casual companies that reported earnings, only 1 had a large positive impact (Chipotle) and the other was flat (YUM Brands). The remaining 11 had an average negative impact of 120+ bps. Of those 11, 8 had double digit negative impacts from higher labor costs in the 1stQ2017. Unbelievably, 2 companies had negative labor comparisons in excess of 200 bps. This is surprising because one thinks of these concepts as being more efficient and nimble. Panera, however, wins as the biggest loser in the 1Q17 labor results with a negative $0.25 EPS impact. PNRA had slightly above average negative impact in bps terms, but had the largest sales among those with negative labor comparisons. The serious issue here is that this enormous negative impact was in spite of the largest positive comp in the quarter of 5.3% and more than 11%+ SSS over the last two years combined. Its shareholders won big as the Company announced the sale to JAB. Chipotle had a large positive SSS impact as labor costs fell 400 bps.
Labor costs can rise for many reasons. Of course, higher wage rates are usually the driver, but changes in wage rates are often known in advance and should be mitigated by management decisions prior to the impact. Either dictated by a government entity, federal, state, or municipality, these changes are often made with months of lead time.
Another reason is same-store sales (SSS) deleveraging the fixed portion of labor. This happened to Chipotle over the last year; and, Shake Shack this year. Shake Shack posted the worst labor impact of the quarter with 240 bps negative change in labor costs. However, SSS at Shake Shack was only down (2.5%), which should have been easily anticipated and managed appropriately. The inverse of this deleveraging was also witnessed in the 1Q17 with a huge increase in SSS (up 17.8%) at Chipotle, which posted a 400 bps reduction in labor costs.
However, deleveraging of this magnitude is often the result of management not responding effectively. Unit managers and their supervisors need to acknowledge, and then adjust to the changing reality on the ground. Adjusting labor costs, either the fixed, the indirect variable, or the variable components of labor, is required. However, what to change where and when is a tough question. Often, when these changes are made, there is a disproportionate impact on the front-of-the-house (FOH), rather than the Heart-of-the-House (HOH) or Back-of-the-House.
The other result of ineffective management response is the accountability issue. Where labor controls are in place, are they utilized to hold managers accountable? If not, then why have the controls? These guard rails should be known in advance by the unit managers and they must be held to them by their immediate supervisors. However, good accountability requires systems that are trusted within the culture of the organization. Every organization and their systems are different. Without this trust, the cultural acclimatization to accountability is very difficult.
Good labor management starts with good forecasts. Adjusting to the realities reflected in trends, and other consumer drivers, such as events, weather, competition, etc. Good forecasts permit good schedules to be written. Then, when actual sales do not coincide with the anticipated sales levels, having managers trained and given the leadership to respond effectively is a prerequisite.
National Retail Concept Partners, LLC is a full-service consultancy based in Denver, CO. working with a variety of industries, including the automotive, retail, restaurant and hospitality industries. Partners Larry DeVries and Dean Haskell wrote the preceding post. These recurring posts can be accessed at their LinkedIn profiles. NRCP recently shared its labor optimization success at the Restaurant Finance Conference. The partners can be reached by email at ldevries@nrcpartners.comand dhaskell@nrcpartners.com. Mr. DeVries is based in Denver, and Mr. Haskell is based in Nashville, Tennessee.