Note: This article has been edited, and re-edited for clarity and to clear up confusions.
As a second generation Chinese American, I’ve always felt like a product of the American dream: immigrant comes to America in the 80s, goes to college, lands a good job and creates a successful life for a family of four.
So when I told my dad that when I wanted to start a restaurant, I was a little surprised at his immediate reaction of, “Why in the HELL would you want to do THAT?!?” in his unique Chinese-Southern accented drawl of someone that learned English while attending the University of Louisville. Having graduated with a masters in electrical engineering, supported by evening shifts at the local Chinese eatery, my dad instilled in me from an early age that that white-collar work should be the pinnacle of one’s ambition. Restaurant work, as he often said in Chinese, was for those who enjoy misery. It would turn out that my dad’s advice turned out to be truer than I would have ever expected.
Seattle made national news in 2014 when voters passed the $15 minimum wage initiative. As per the norm, the internet echo machine blew up with talking heads on each side spewing rhetoric about what this would mean to the Seattle economy. The narrative from the perspective of business owners was all but lost, other than a poignant letter by famed Seattle restaurateur, Tom Douglas, who provided a rationale look from the trenches of a food service operator. The fact that Tom’s letter can no longer be found on his own website, should speak volumes on the divisiveness of the issue.
As Seattle a small business restaurant owner, I’m going to publicly share what we made last year, because it’s important to hear the voice of businesses like ours.
Total profit for 2015: $8,856.57
This purpose of this post is not be political, but to show actual economic effects of what happens when a rapid series of expenses are added into a business with low margins. Lastly, I would hope to show that there isn’t simply an evil villain pulling the strings behind each business, but real people trying to make a livelihood.
A Little Background
To understand my story, I’m going to take a step back and explain how I even decided to get into the service industry.
For starters, I’m in my thirties and in the tech field. In my short lifetime, I’ve seen two serious market crashes that created great doubt in my mind on the wisdom of “buy and hold”. I understand compound interest and 7% annualized returns quite well, given that I know how to program quantitative statistical experiments.
That said, I also happen to be a fan of Nassim Nicolas Taleb, who wrote the book The Black Swan, a book on the theory of the dangers of unpredictable events. While not an economist, Taleb also happens to be an options trader who wrote a book on derivatives while also making 8-figures along the way. I made it to about page 20 before my brain tried to divide by zero and blew up.
What Taleb and I have in common, is a healthy respect of volatility. As such, my view is that if I’m going to take the standard investment route of a young earner by taking on more risk, I figured I would hedge my bets on a risk that at least was based on my own merit as opposed to the whims of the market.
Naturally, I picked the riskiest, most dangerous start-up with the highest risk of failure: the
misery restaurant business. Restaurants fail, but my belief was that a fundamental grasp (or lack thereof) of restaurant business math was likely far more correlated to success than one’s own ability to cook. As it happens, I’m also a skilled cook, but I digress.
A few years ago, myself and a few partners found a small restaurant that fit our profile. The restaurant had existed at the same location for over 10 years with a modest, but steady revenue stream in a stable location. It was a little tired and needed some TLC however, which factored into us purchasing the business for below market price. This was necessary, as we had no financing and had to make a 100% cash purchase.
For those thinking that financing a restaurant purchase is easy, the reality is that banks are risk adverse and won’t loan to anyone without a history of successfully operating a restaurant. Getting a loan for young entrepreneurs like us was essentially a catch-22; we can’t get loans because we don’t own a restaurant, we can’t own a restaurant because we can’t get a loan. As such, we pooled our cobbled savings, retirement funds and used family loans to finance the purchase.
We went with a fast-casual franchise for the stability of a brand, training, existing procedures and generally higher margins. Without a food service background, we didn’t want to jump in over our heads and overplay our hand. None of us were terribly excited at the idea of paying a royalty, but we viewed it as a price premium for reduced volatility until we could venture out on our own concept down the road.
Our franchise, as most, required us to take a two-week, on-site training course at the franchise headquarters. I was one of the few (other than an insurance salesman) that had no food service background. Truth be told, I felt that the training was almost unnecessary, as it covered basic business concepts and how to adhere to the cookbook. To me, restaurant business was very much common sense: hire and train good people, control costs, upsell, follow the recipe book and most importantly, don’t do anything to jeopardize our new investment.
A Crash Course in Restaurant Economics
In our first year, our small restaurant made a modest operating profit. As owners, we put in 30 to 35 hours a week into the business, especially in the first few months, but it tapered to about 20 hours a week after that. Averaged out as owners, we were probably paid close to $15/hr for our sweat equity. However, after one-off expenses such as franchise fees, legal fees, training, repairs and tenant improvement, we actually ended up actually losing money, which wasn’t that unexpected, as we knew this going in.
Our hope was to get the restaurant to become less hands on, by training and building up a manager from within the ranks, so that we could eventually recoup our investment, then turn a profit. Based on historical sales, we had expectations that it would be 3 years to recoup our costs, then the next 3 years could double our investment, for an annualized return of about 33%, not including our own time we put in.
Many people think that restaurants are some type of hugely profitable enterprise, especially if I say a number like 33% return. The reality is that small restaurants are “profitable” on paper, but are usually only profitable because of the sweat equity that an owner puts in.
One franchise operator (we’ll call him Mr. Kim) earns about $120,000 per year, which sounds great, until you realize that Mr. Kim and his wife work 7 days a week, 14 hours a day. No holiday, no vacation, no sick time. They employ exactly one employee.
All said and done, Mr. Kim’s true wage is $11.78 per hour. If Mr. Kim does well, it’s because Mr. Kim works harder than 99% of the population. I have no qualms admitting that Mr. Kim puts even my own work ethic to shame, as I “only” work about 80 to 90 hours a week.
The reality is that after owner salaries are paid, most restaurants are profitable to the tune of 3% to 5% per year. This takes people by surprise, but there are very real expenses when operating a restaurant. The breakdown is as follows:
- 25-40% food cost
- 30-35% labor
- 15-25% rent plus utilities
If you add up the low side, it equals 70% expenses, leaving 30% profit. If you add the high side all up, it actually equals 100%, leaving little profit. If you’ve ever wondered why the steak or lobster costs so much at the fancy restaurant in downtown, it’s because the margins are thin and expenses are high. Tom Douglas stated that his profit margins were 5% and he has some of the most popular restaurants in Seattle.
Starting a restaurant is a form of gambling. You put a large amount of money up front and hope to make your initial investment back in the next few years. As it stands, most restaurants fail during the first or second year, because they can’t get enough traction or repeat customers during this incubation period or they simply run out of cash. It’s a risky business, because you have to generate immediate cash flow, otherwise your business is burning through cash keeping your rent paid, lights on and staff to stand around waiting for customers.
The Effect of a 60% Wage Increase
On January 2016, Seattle minimum wage is $13/hr, which represents a 40% increase in our labor cost from the prior wage of $9.32. Come 2017, it will be a 61% increase.
When we started our business, our labor cost was right around 25% and our store profit without owner salary was about 33%. When minimum wage increased to $13/hr, our labor bumped up to 35% and cut our bottom line by 10% down to 23%. Next year, our labor cost will bump up to 40% (increase of 15% from 25%) and our bottom line will be 5%.
To put things into perspective, the average American household in 2013 spent $3,000 or 6% of their budget on gasoline at $3.50 per gallon. If the gas budget increased to 21% (increase of 15% from 6%), but the exact same amount of fuel was purchased, that would be the equivalent of $12.25 per gallon gasoline prices. This is the type of shock that restaurant owners are facing, yet the public would have a meltdown if politicians suddenly imposed a 350% gas tax. For Seattle, this is somehow perfectly acceptable to push this type of sticker shock on us restaurants in 3 years.
In previous years, we paid over the minimum wage by a 10% margin to attract and retain talent. We have to reduce this margin to make ends meet. However, mopping floors at $13/hr suddenly becomes a lot more attractive than washing dishes at $13/hr if there is limited upward mobility (i.e., fewer and smaller raises for a job well done). The only true way we can rely on our employees not leaving for greener pastures is making our workplace more enjoyable (something we try to do already) or by hoping that the job situation deteriorates so that they feel lucky to have a job. It’s a bad thing for business owners to hope for.
The hardest part is wage inflation. We are lucky that our shift leads, assistant managers and managers are fully understanding of the predicament. That said, when we have to hire new faces, it will be almost impossible to ask someone to perform the same functions as “normal” worker for the same pay. Our only recourse, as we’ve seen many other businesses do, is that senior employees outside of the city limits seem to be very willing to commute for the higher pay and be appreciative of the wage bump. As such, I can only imagine that employment within the city limits will drop dramatically for minimum wage workers by the time the $15/hr minimum floor is implemented.
Speaking of city limits, the difficulty in increasing prices is that 5 minutes away, the Seattle city boundary ends. This means that we are competing with restaurants that will have 60% lower labor costs who aren’t forced to raise prices to make ends meet. Every time I have an inkling of feeling sorry for ourselves, I think about the restaurant owner one street away from the city limits, where he/she is forced to complete with untouchable lower price points.
As such, most Seattle restaurant owners are gingerly raising prices hoping not to lose customers and are digging into profits to make it work. Those with sit down service can at least go from a tip system to service charge system, at the risk of alienating their best servers, however. Among small business owners, there’s already blood in the streets, as a flood of mom and pop restaurants are going up for sale trying to avoid the oncoming train.
Come next year, when minimum wage of $15 an hr goes into effect, that is when the real economic experiment begins. That’s when restaurants can no longer cut hours and have to raise prices by another 10-20%. Will customers balk at this price or will the general lift in wages throughout the city enable people to afford to pay more while eating out?
I really don’t know, but we’re all going to find out soon enough.
Who is Really Hurt by the $15 Minimum Wage?
I wrote that a restaurateur will try to recoup their initial investment and then sunset into profitability. Unfortunately, we have come to terms that we won’t even recoup our investment. Our savings and retirement funds going into the restaurant will be gone. Two of us just became proud fathers last year and another is about to have his first this year. I thank my stars that we still have day jobs and I still have my ecommerce businesses.
The final kick is that since the 2008-2009 crash, commercial leases almost always require a personal guarantee. In the event that we, the tenant, cannot pay our lease, our personal assets (read: our homes) are on the hook. Even with a failing restaurant, we would be better served continuing to bleed money instead of letting the landlord come after us, short of negotiating a buy-out or other arrangement.
If and most likely when we eventually close the restaurant, we’re going to be laying off a team of top-shelf employees. They are hard workers and I simply wish I could continue paying them while making a living myself. As it stands, we’re more or less operating a private charity now.
Onlookers will tell us that we’re fools for getting into the restaurant industry, but I have no regrets. We had a handful of unexpected repairs and expenses that made things worse, but if not for the minimum wage hike, we would probably be succeeding. We are succeeding with our second restaurant, which coincidentally, is not located in Seattle.
The thing that gets me about the minimum wage increase is that it’s often framed in terms of racial bias. Having been an entrepreneur for over a decade, I’ve met plenty of Caucasian business owners, but the food service sector (or at least my single observation) seemed over weighed toward minorities. A quick Google search revealed that a survey by The National Restaurant Association shows minority and women restaurant ownership expanding by over 50% from 2007 to 2012.
I mention this observation because the boogeyman of the minimum wage debate is Wal-Mart and McDonalds, corporations that conjure images of rich, white men in board meetings. While affluent white males have become common targets of classicism, the actual truth is that many minorities and women are far more represented as restaurant owners that employ minimum wage workers. Many operators are new immigrants, with no other job opportunities and many of whom happen to own a franchise.
For that reason, there is one quote from the minimum wage debate that stood out:
“.. franchises are treated as large businesses because they receive the benefits of being associated with the larger franchisor network of many more than 500 employees… As a result, franchises have distinct advantages over the typical independent small business—training, product development, and marketing support—to name just a few.” -Office of Seattle Mayor Ed Murray
At best, this statement from the mayor’s office indicates that it does not comprehend the situation. It also invalidates the personal effort that each franchise owner puts into his or her business, plus the reasons someone would chose a franchise over starting an completely new business. I guarantee the mayor that Mr. Kim has no “distinct advantage” other than he works his ass off.
Franchises are one of the few businesses categories that can still qualify for SBA loans, as the franchises are proven models. It also paints the cross-hairs on a disadvantaged portion of the population that utilizes the franchise model because the barriers to entry are low.
Collateral damage will take place by discriminating against franchises. By taking aim at the McDonalds and Burger Kings, we also target random bystanders like Menchies, Baskin Robbins or local chains like Dick’s hamburgers. Last I checked, no one I know has anything bad to say about frozen yogurt or the terrible working conditions of scooping ice cream. Yet these are the businesses that have 3 years to adapt or die.
At the end of the day, I don’t have answers to the minimum wage question. I can say that I believe inequality is a major issue facing our country. I do believe that anyone putting in an honest day of work shouldn’t be figuring out how to feed themselves or put a shelter over their head. At the same time, why are business owners not included in that very same logic when we put more work and more money in than the employees we hire?
I have resigned myself to the fact that sometimes there are no answers, only events that we could not have predicted. It frustrates me not because of that fact that I have invested time and money in a failed business, but that the sole reason I did was so that I could avoid Black Swan events – only to be hit square in the face with one.
It turns out that I really should have given Wall Street my money instead of putting it into the local economy, because it would have been a heck of a lot less heartache.
*Grant’s opinion are his own and do not represent the opinion of anyone else, including his business partners, employees, franchise or Mike. If you are a small business or restaurant owner, I invite you to comment below as to your thoughts and to share this post as well.