Will Danny Meyer tip move change restaurant landscape?

Michael Halen, Jennifer Bartashus, Jeffrey Langbaum Bloomberg Intelligence analysts

Restaurants may face tall order as Danny Meyer nixes tipping

Union Square Hospitality Group’s decision to eliminate tipping at its 13 full-service restaurants and instead raise prices may have significant implications for full-service restaurants across the U.S.

CEO Danny Meyer said the company aims to boost pay for staffers who don’t normally share in tips to waitstaff, such as cooks, dishwashers and reservationists.

Labor, rent, credit card and tax expenses will likely jump significantly, however, and the chain risks alienating customers and its best waitstaff.

Eliminating tips could lower restaurant tax, legislative risk

Eliminating tipping could be a way for full-service restaurants to mitigate tax and legislative risks. The boost in hourly wages to adjust for having no tips and keeping employees’ pay whole could create breathing room against a barrage of municipal, state and federal actions to adjust the minimum wage.

The move could also simplify record keeping and reduce the risk of restaurants being audited and having to pay back FICA (Federal Insurance Contributions Act) taxes on underreported or unreported tips by employees.

Restaurant labor expenses could rise if tipped wages disappear

A shift away from tipped wages in full-service restaurants could translate into increased labor expenses, because higher hourly rates would be needed to offset the loss of tips. The average hourly wage for waiters in the U.S. was $10.40 in 2014, $8.27 more than the tipped minimum wage of $2.13.

This wage jump may be more than casual-dining chains could offset with price increases. Operators will likely watch for how employees and customers respond to Union Hospitality Group’s decision to eliminate tipped wages.

Franchisees shield DineEquity, Denny’s from higher labor costs

Margins of heavily franchised full-service restaurant chains DineEquity (99% franchised) and Denny’s (91%) are shielded from the higher costs associated with a European-style restaurant model that eliminates tipping and raises prices.

Franchisees would pay the higher labor, rent, credit card and tax expenses that would likely result if the U.S. restaurant industry adopts this system. Ruth’s Hospitality Group (55%), Buffalo Wild Wings (53%) and Brinker (45%) also have a significant number of franchised stores.

Higher menu prices from no tipping may boost restaurant rents

Restaurant rents may rise if full-service U.S. chains eliminate tipping. Restaurants would raise menu prices, which would boost revenue and drive up rents because of rental agreements that often require restaurants to pay landlords a percentage of sales.

Rents may be renegotiated prior to the end of the lease (often 10-20 years) depending on location. Chains in larger cities may face concessions such as higher maintenance or longer terms.

An inability to renegotiate may mean some chains delay eliminating tipping.

Restaurants likely to tap technology to combat rising labor cost

Restauranteurs are likely to take a wait-and-see approach to Union Square Hospitality Group’s adoption of the European-style restaurant model. If eliminating tipping and raising prices spreads in the U.S., chains would likely invest in technology to reduce labor.

Server handhelds, tabletop tablets and mobile payment can enable workers to cover more tables, allowing restaurants to have fewer front-of-the-house employees. This would offset higher labor and employee taxes. Remaining waitstaff would cover more tables. v

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