Economics, Falsifiable, Politics

Franchise Economics: Why Tim Hortons Has Become A Flashpoint In The Minimum Wage Fight

Since the minimum wage increase took effect on January 1st, Tim Hortons has been in the news. Many local franchisees have been clawing back benefits, removing paid breaks, or otherwise taking measures to reduce the costs associated with an increased minimum wage.

TVO just put out a piece about this ongoing saga by the Christian socialist Michael Coren. It loudly declares that “Tim Hortons doesn’t deserve your sympathy“. Unfortunately, Mr. Coren is incorrect. Everyone involved here (Tim Hortons the corporation, Tim Hortons franchisees, and Tim Hortons workers) is caught between a rock and a hard place. They all deserve your sympathy.

This Tim Hortons could be literally anywhere in suburban or rural Canada. Image Credit: Marek Ślusarczyk via Wikipedia Commons

It is a truism that a minimum wage increase must result in either declining profits, cuts to other costs, or rising prices. While supporters of the minimum wage increase would love to see it all come out of profits, that isn’t reasonable.

Basic economics tell us that as we approach a perfect market, profits should fall to zero. The key assumptions underpinning this are global perfect information (so no one can have any innovations that allow them to do better than anyone else) and zero start-up costs (so anyone can enter any market at any time). Obviously, these assumptions aren’t true in reality, but when it comes to fast food, they’re fairly close to true.

It is relatively cheap to start a fast-food restaurant (compared to say opening a factory). The start-up costs for a McDonalds, KFC, or Wendy’s are $1,000,000 to $2.3 million, while a Subway costs about $100,000 to $250,000 to start. This means that whenever someone sees fast-food restaurants making large profits in an area, they can open their own and take a fraction of the business, driving everyone’s profits down.

They’re probably driven down much lower than you think. If you had to guess, what would you say the profit margins for a fast-food restaurant are? If you’re anything like people in this study, you probably think something like 35%. The actual answer is 6% [1].

In addition to telling me that the average fast food restaurant has a 6% profit margin, that link helpfully told me that 29% of operating expenses in a fast-food restaurant come from labour costs. Raising those labour costs by 20% by increasing wages 20% increases total costs by 6% [2]. The minimum wage isn’t making fast-food restaurant owners make do with a little less in the way of profits. It’s entirely wiping out profits.

Now maybe your response to that is “well my heart doesn’t really bleed for that big multinational losing its profits”. But that’s not how Tim Hortons works. Tim Hortons, like almost all fast-food restaurants is a franchise. Tim Hortons the corporation makes money by collecting fees and providing services to Tim Hortons the restaurants, which are owned by the mythical small business owners™ that everyone (even the proponents of the minimum wage increase) claim to care so much about.

Most of these owners aren’t scions of wealthy families, but are instead ordinary members of their communities who saw opening a Tim Hortons as an investment, a vocation, or as a way to give back. They need to eat as much as their workers.

Faced with rising labour costs and no real profit buffer to absorb them, these owners can only cut costs or raise prices.

Except they can’t raise prices.

That’s the rub of a franchise system. The corporate office wants everything to be the exact same at every store. They set prices and every store must follow them. But there’s divergent incentives here. Tim Hortons the corporation makes a profit by selling supplies to its franchises; critically, they make a profit on supplies whether those franchisees turn a profit or not. They really don’t want to raise prices, because raising prices will hurt their bottom line.

It’s well known that (in general) the more expensive something is, the less people want it. Raising prices will hurt the sales volume of Tim Hortons franchises, which will decrease the profits at corporate Tim Hortons. The minimum wage hike affects Tim Hortons the corporation very little. They might see slightly increased shipping costs, but their costs are far less dependent on Canadian minimum wage labour. Honestly, the minimum wage increase probably is a net good for Tim Hortons the corporation. More money in people’s pockets means more money spent on fast-food.

Tim Hortons the corporation probably won’t say it, because they don’t want to antagonize their franchisees, but this minimum wage hike is great for them.

So, Tim Hortons franchisees have to cut costs or run charities. Given that they are running restaurants and not charities, we can probably assume that they’re going to cut costs. Why does it have to be labour costs that get cut? Can’t they just get their supplies for cheaper?

Here the franchise system bites them again. If they were independent restaurateurs, they might be able to source cheaper ingredients, reduce the ply of the toilet paper in their bathrooms, etc. and get their profits back this way.

But they’re franchisees. Tim Hortons the corporation has a big list of everything you need to run a Tim Hortons and you are only allowed to buy it from them. They get to set the prices however they want. And what they want is to keep them steady.

The only cost that Tim Hortons the corporation doesn’t control is labour costs. So, this is what franchisees have to cut.

There are two ways to decrease your labour costs. You can “increase productivity”, or you can cut wages and benefits. “Increase productivity” is the clinical and uninformative way of saying “fire 20% of your workers and verbally abuse the others until they work faster” or “fire 20% of your workers and replace them with machines”. While increased productivity is generally desirable from an economics point of view, it is often more ambiguous from a moral point of view.

Given that the minimum wage was just raised and it is illegal to pay any less than it, Tim Hortons franchisees cannot cut wages. So, if they’re against firing their employees and want to keep making literally any money, they have to cut benefits.

This might make it seem like corporate Tim Hortons is the bad guy here. They aren’t. The executives at Tim Hortons labour under what is called a fiduciary duty. They have a legal obligation to protect shareholder interests from harm and to act for the good of the corporation, not their own private good or for their private moral beliefs. They are responding to the minimum wage hike the way the government has told them to respond [3].

Minimum wage jobs suck. For all that economists claim there is no moral judgement implied in a wage, that it merely shows the intersection of the amount of supply of a certain type of labour and the demand for that labour, it can be hard to believe that there is no moral dimension to this when people making one wage struggle to make ends meet, while those earning another can buy fancy cars they don’t even need.

It is popular to blame business owners and capitalists for the wages their workers make and to say that it shows how little they value their workers. I don’t think that’s merited here. Corporate Tim Hortons has crunched the numbers and decided that if they raise prices, fewer people will buy coffee, their profits will decrease, and they might be personally liable for breach of fiduciary duty. In the face of rising prices, franchisees try and do whatever they can to stay afloat. We can say that caring about profits more than the wages their workers make shows immense selfishness on the part of these franchisees, but it’s little different than the banal selfishness anyone shows when they care more about making money for themselves than making money and giving it away – or the selfishness we show when we want our coffee to be cheaper than it can be when made by someone earning a wage that can comfortably support a family.

Footnotes

[1] As long as there are other available investments approximately as risky as opening a fast-food restaurant that return at least 6%, profits shouldn’t drop any lower than that. In this way, inefficiencies in other sectors could stop fast food restaurants from behaving like they were in a perfectly free market even if they were. ^

[2] This calculation is flawed, in that there are probably other costs making up total labour costs (like benefits) beyond simple wage income. On the other hand, it isn’t just wages that are going up. Other increased costs probably balance out any inaccuracies, making the conclusions essentially correct. This is to say nothing for corporate taxes, which further reduce profits. ^

[3] We can’t blame fiduciary duty, because fiduciary duty is how investing at all can happen. You might not like investing, but without investing, saving for retirement or having a national pension plan is impossible. If your response to this is to say “well let’s just tear down capitalism and start over”, I’d like to remind you that people tried that and it led to a) famine, b) gulags, c) death squads, d) more famine, and e) persistent shortages of every consumer good imaginable, including food ^

One thought on “Franchise Economics: Why Tim Hortons Has Become A Flashpoint In The Minimum Wage Fight

  1. This is one of the most balanced perspectives on the Tim Horton’s minimum wage debacle. Thank you, Zach.
    I just wish the Media can give us the back story and an objective report, instead of prodding the masses to scream blue murder with their half-truths.
    There was a time when our society treated half-truths as lies but now, almost everything in the news is swallowed hook line and sinker. It is really sad.

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