Ontario's New Minimum Wage - Impact on Profits of the Restaurant Industry

Introduction

On January 1, 2018, the minimum wage in Ontario government changed from $11.60 to $14.00. It is scheduled to rise to $15.00 in 2019.

The move has provoked negative reactions from business groups. For example, according to Restaurants Canada:

“These aggressive changes to labour legislation will have severe and immediate consequences for the foodservice industry and the customers they serve every day. Prices for consumers will go up. Jobs will be lost, it’s as simple as that." A recent story in the Globe and Mail contains different reactions from restaurant owners; some are unfazed, others somewhat less so.

This issue is also of interest to business valuators such as myself. Valuations of established businesses are often based on the future anticipated profits or cash flows of a business. These are typically projected based on an analysis of the business's historical results, adjusted for forecasted changes. Valuators need to understand how the change to the minimum wage will impact profitability going forward.

The Data

Somewhat surprisingly, when we look at average labour costs for limited service restaurants (as a percentage of revenue) for the period 2001 to 2012, we see surprisingly little change:

The chart (which is based on data from Statistics Canada, CANSIM Table 355-0005) includes several periods where the minimum wage stayed constant in nominal dollars.

For example, in BC the rate was stagnant at $8.00 per hour from November 2001 until May 2011.  During that period, the CPI for restaurant food grew by 35%. Assuming that the average restaurant has 75% of its employees making the minimum wage, one would have expected the average cost of labour at BC restaurants to fall to 23% of revenue. Yet that did not happen.

The chart also includes periods in which the minimum wage grew very quickly. Again looking at BC, the minimum wage in 2010 was $8.00; in 2012, the average was approximately $10, an increase of 25% (slightly higher than the proposed Ontario change). A restaurant with 75% of its employees making the minimum wage would expect to see its cost of labour rise from 29% to 33%. Yet that did not happen.

Some (Tentative) Theories

What should one make of the data?

One theory might be that restaurants are able to pass along wage increases to consumers in the form of higher prices; the Globe and Mail article gives some examples of restaurants that are planning to do precisely this. Unlike, say, a manufacturing plant, restaurants cannot really be moved to other jurisdictions with more favorable labour laws. A change affecting all restaurants will therefore result in higher prices for consumers.

Another possibility is that the aggregate data shown above masks significant changes.

Imagine for a moment that there are two types of restaurants: prosperous ones who have an average wage cost of 25%, and less efficient ones whose average cost is 35%. The former have profit margins of 15%, the latter have profit margins of 5%. A rapid hike in wage costs equal to 5% of revenue will mean that the less prosperous firms will no longer be viable; they will be forced to close.  The more prosperous firms, meanwhile, will see an increase in their labour cost, such that the industry average will remain 30%.

A third possibility is that the increase in third-party wage costs results in owners (many of whom pay themselves via a salary) being forced to reduce their own wages.