The business model that made McDonald's a fast-food powerhouse is crumbling
The fast-food business model is under threat.
Chains like McDonald's, Burger King, and Wendy's have long relied on cheap labor to keep menu prices low while still driving a healthy profit.
But the days of cheap labor could soon be over, turning the entire business model on its head, according to Deutsche Bank analyst Brett Levy.
The industry is facing unprecedented pressure to raise wages because of three major factors: a shrinking labor pool, local legislation increasing the minimum wage, and new overtime pay rules, Levy wrote in a recent note.
"With a high level of scarcity across the labor pool (with a current ~5% unemployment rate), it has created an intense headcount battle," Levy wrote. "Second, the ongoing changes to wage-related legislation has created an artificial escalation of costs, which in some cases are greater than companies can handle."
That, along with new overtime pay rules, "could combine to plunge the restaurant industry into a challenging and potentially prolonged phase of escalating wages," he wrote.
While the federal minimum wage, at $7.25 per hour, hasn't been raised in seven years, state and local governments across the country have been enacting legislation to push their minimum wages higher.
About one in three states now has a minimum wage that's higher than $7.25 per hour, and those states have plans in place to raise wages even higher on an annual basis.
As labor costs inflate, restaurants will be forced to raise menu prices and fire some workers as well as reduce labor hours for its remaining employees, according to Levy.
To absorb the cost of a $1 per hour wage increase, a fast-food chain with 18 employees would have to significantly raise prices or cut 180 monthly labor hours, according to his estimates.
Former McDonald's USA CEO Ed Rensi predicted a similar scenario in a recent interview with Business Insider on this topic.
"They are going to raise prices to offset the cost of labor, and then they are going to lose customers," Rensi said. "And guess what happens when they lose customers? They fire employees because they don't need them anymore."
Longer term, many companies would have to invest more in technology and automation to further reduce the need for employees, according to Levy.
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