No Free Lunch For Minimum Wage And McDonald's

Jan.13.14 | About: McDonald's Corporation (MCD)

It's easy to let emotions cloud your judgment in a topic as heated as the minimum wage. Instead of falling victim to this, let's present the facts and try to observe them objectively. Instead of quickly coming to a conclusion, I'll just present some facts that I believe to be obvious and relevant towards the discussion. Mainly, how would the minimum wage increase affect a company like McDonald's (NYSE:MCD), from a realistic and financial viewpoint?

I hope that we can all agree that there would be no free lunch from a minimum wage increase. The added liabilities would have to be added somewhere- from higher prices, more unemployment, lower CEO wages, or other creative measures. I do not want to argue where these increased costs should come from. I don't want to assume that I know better than the people who are paid to figure this out. I'll leave that decision and conclusion to them. However, we can look at some basic facts and get an idea of which possibilities are more likely.

Instead of starting with assumptions, let's start with facts. The most reliable facts I can think of would be the SEC Annual Reports - which McDonald's is required to file by law. Other facts pulled from random articles online can be easily manipulated to prove an argument. Trying to keep this piece as unbiased as possible, let's ignore those numbers. Numbers can be easily manipulated, and to keep this argument consistent I want to only use one source of data. The most obvious and accurate source of data would be from the SEC Annual Report.

The most recent annual report states that McDonald's has 440,000 employees. How many of those are on minimum wage? We can't know for sure, it isn't reported. Instead of making vast assumptions that can't be properly proven, let's do analysis that is often implemented in the engineering field. We will do some worst case analysis, so we can know how much McDonald's could be affected from the minimum wage increase. It makes for a good starting point and puts a limit to the discussion. By starting from the worst case and avoiding bad assumptions, we decrease the chance of making an inaccurate conclusion. Engineers use this kind of analysis to prevent fatal mistakes from ruining their design.

Ok, so the worst case analysis of a McDonald's minimum wage increase would assume that all 440,000 had a wage increase. Of course we know that this isn't likely or possible, since we know that some employees are paid more than minimum wage. But for the sake of the worst case analysis, this is what we have to assume.

The current federal minimum wage is $7.25 per hour (source). President Obama and Democrats are pushing for a proposed minimum wage increase to $10.10 per hour. How would this affect McDonald's in a worst case scenario? Again, in a worst case scenario all 440,000 employees would be full time and receiving the minimum wage. We know this isn't accurate because McDonald's does hire many part time workers, but the SEC Annual Report doesn't state how many, so we can't know. Instead of making an incorrect assumption, the worst case scenario is calculated.

A full time worker works 2,080 hours a year. Worst case scenario would have McDonald's paying 915,200,000 hours a year (440,000 employees x 2,080 hours). Again, using a worst case scenario, McDonald's would see an increase in costs of $2.85 per hour, which is the proposed minimum wage minus the current federal minimum wage. Final worst case analysis would show that McDonald's increased costs for the year would be $2,608,320,000. ($2.85 x 915,200,000)

How does this compare to current financials?

We can know these facts by looking at the annual report. McDonald's reported profits of $5,464,800,000 in 2012. It turns out that it's not enough to "simply take some profit off the top" to pay for the minimum wage increase. The costs incurred would be a significant hit to earnings, a 47% decrease. We can all agree that just taking from the earnings would case a sharp fall in the stock price, jeopardizing retirees and pension plans that are heavily weighted in U.S. Blue Chip Stocks like McDonald's. It doesn't make sense to take almost 50% away- which could amount to 10s of thousands of dollars- from our teachers and firefighters, just to increase the minimum wage.

So that argument is out. No matter how greedy a company like McDonald's seems, it turns out that they don't have unlimited profits to pay out. Where else can the costs come from?

I think that the next logical place to look would be increased food prices, like many suggest. Unfortunately, the full menu isn't broken down in the annual report. In fact it is almost impossible to calculate with 100% accuracy, as prices fluctuate based on location and variable costs such as rental real estate prices. I think we can safely assume that current management is doing their best to optimize food prices for maximum revenue and profits. After all, they are capitalists and looking out most for their shareholders (it's what they are paid to do for a living).

Knowing that these prices are already optimized for profit is an important consideration. Basic economics 101 tells us that price is determined by 2 things, supply and demand. These factors are fluid and causal, meaning they affect the other. An increase in supply leads to a decrease in demand, if price holds constant.

Clearly, forcing McDonald's to increase their prices because of the minimum wage would negatively affect their demand curve, thus decreasing profits and revenue. This obviously can't be avoided as there's no such thing as a free lunch. But how much would it affect demand? Again, using only the most trustworthy sources of information won't give us this answer. That's not the point of this article. We should consider this elasticity of demand curve as a starting point.

Source: here.

This is taken from a simple economics class. Again, the values and steepness of the curve is open to interpretation for the readers. But we can draw some simple conclusions. Mainly, that an increase in price will lead to a decrease in demand, which will hurt revenue and the bottom line. Maybe the increase in prices will offset the decrease in demand, but this is rarely seen in a situation where the increase in price was forced.

One last possible situation would be to take the money from the CEO, because he makes too much money. Many people feel that it is unfair how much the top executives make, and so it should be redistributed to the workers. Let's see if this is a viable solution. According to Forbes, the McDonald's CEO made $13,180,000 in 2012. If we took his salary and gave it to the minimum wage, the company would still be short $2,595,140,000. In other words, taking from the rich and giving to the poor would solve 0.5% of your problem.

In total, we've examined 3 possibilities of where the increased costs of a higher minimum wage could come from. It could be a mix of lower earnings and higher prices, both of which would hurt the shareholders. Unfortunately, that means taking from some to give to others, no matter how you structure it.

You can choose to believe that the shareholders are greedy anyways and deserve less than the workers, and if that's your opinion, fine. But I beg you to think deeper of who the shareholders really are. Yes, many of them are very wealthy. But many of them are average people like you and me, depending on companies like McDonald's to retire.

All in all, the issue is not as simple as some make it out to be. If I've opened your eyes to that fact, then this article has served its purpose.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.