Fast-food chains such as McDonald's, Chipotle, and Starbucks are preparing for potential labor disputes in 2024.

• In April, an estimated 500,000 fast food workers in California will receive a $20 minimum wage, as agreed upon by fast-food companies, the Service Employees International Union, and Governor Gavin Newsom's administration.
• Fast-food chains such as McDonald's, Chipotle Mexican Grill, Starbucks, Taco Bell, Shake Shack, El Pollo Loco, and In-N-Out Burger, which have nearly 30,000 franchised and company-owned restaurants in California, viewed the deal as the "least bad option or worst good option" in a fight over a new California law.
• Restaurants are closely monitoring the impact of labor cost offsetting strategies on menu prices and franchisee profits, while keeping an eye on the potential spread of unionization efforts to other states.

In California, fast-food workers will receive a minimum wage increase to $20 an hour starting April 1, only in that sector.

The pay raise for a specific workforce, estimated at over 500,000, is the main focus of Assembly Bill 1228, a compromise law reached last summer by fast-food companies, the Service Employees International Union, and Governor Gavin Newsom's administration. All parties involved praised the agreement, although the industry acknowledges that an alternative outcome could have been disastrous.

The recently passed AB 1228 overturned a previously enacted bill, AB 257, which aimed to increase the hourly minimum wage to $22, establish a Fast Food Council with the power to enforce working conditions, and impose a joint-employer rule on franchisors for their franchisees' violations. As a result, both the industry and the SEIU saved millions of dollars intended for voter lobbying on a November ballot initiative.

According to Matt Haller, president and CEO of the International Franchise Association, the removal of emotion from the negotiation process has led industry experts to view the current situation as the least bad option or worst good option, depending on one's perspective. Despite the uncertainty surrounding the referendum, Haller stated that the concessions made in exchange for a predictable business environment for his members moving forward.

Despite avoiding some significant challenges, El Pollo Loco, In-N-Out Burger, and other fast-food chains in California are still planning to address the inevitable increase in their labor costs.

The industry is aware of the possibility that an active SEIU may increase its efforts to unionize fast-food workers, something the industry has mostly avoided, while also monitoring similar minimum wage legislation and union organizing initiatives in other states.

Franchisors plan to raise menu prices as a strategy to cope with inflation, higher interest rates, supply-chain costs, and previous wage increases resulting from the Fight for $15 movement. While the exact amount of the price increase is still being determined, it is certain that everyone will increase their prices. According to Brian Harbour, an industry analyst at Morgan Stanley, franchisees have the discretion to set their own prices.

During McDonald's third-quarter earnings call in October, CEO Chris Kempczinski stated that there would be a wage impact for California franchisees due to the minimum wage increase. He did not provide an exact amount, but acknowledged that it would need to be worked through with higher pricing. McDonald's has 9% of its nearly 13,500 U.S. locations in California, most of which are franchises.

Chipotle, which operates approximately 460 company-owned locations in California, has not yet decided to raise prices in the state to offset the anticipated labor increase in California next year. However, a company spokesperson stated in an email to CNBC that the CFO, Jack Hartung, mentioned on the Q3 earnings call that they are studying the possibility of increasing prices mid-to-high single digits (4-5-6% to 7-8-9%) to offset the labor costs. This means that prices will be that much higher as a percentage.

Darin Harris, CEO of Jack in the Box, stated that the company will depend on pricing increases of 6% to 8% to boost its menu prices. He noted that the response of consumers to this latest round of price hikes is uncertain and may affect the chain's sales projections for the upcoming year.

The new mandate applies to all businesses operating in California, and they will likely raise prices by a consensus of 10%, according to Haller. However, he questioned how much price increase can be implemented before it negatively impacts customer value.

Order kiosks, drive-thru chatbots and automation

In response to the wage hike, California's fast-food restaurant operators are considering automating certain tasks to increase workers' efficiency and productivity, which may result in eliminating some jobs. For instance, automated drink dispensers and robotic burger flippers are being tested across the country. Chipotle, Starbucks, and Sweetgreen are experimenting with automated food and beverage preparation systems.

Wendy's has started using generative AI chatbots to take drive-thru orders and is now offering the technology to all its franchisees, including almost 300 in California. Similarly, other fast-food chains such as Carl's Jr., Hardee's, Del Taco, McDonald's, and Sonic Drive-In have also adopted chatbots for drive-thru ordering.

Self-order kiosks are becoming increasingly popular in fast-food restaurants, with Yum Brands, the owner of several fast-food chains, aggressively installing them. According to Yum CEO David Gibbs, kiosk sales see an average of 10% higher checks compared with front counter sales and have excellent profit flow-through.

Maria Hollandsworth, the interim president and CEO of El Pollo Loco, reported positive test results with kiosks during the company's November earnings call. This led to reduced restaurant-level labor hours per day. In addition to rolling out the kiosks across the chain, the company is also driving labor efficiency with new salsa processing equipment and testing additional initiatives, such as automated dishwashers.

The SEIU hopes that the implementation of AB 1228 won't significantly reduce human input in California's fast-food industry, as automation minimizes human input. Joseph Bryant, international vice president of the SEIU, stated, "We're hopeful the companies genuinely appreciate the value and contributions of their workforce as part of the customer experience. It's on all of our minds what will be the impact of this next wave of technology, driven by AI, and at the end of the day, I don't think anybody thinks it's a better experience to deal with pads versus people."

The new minimum wage law is already affecting some workers in California, with Pizza Hut announcing that it will lay off 1,200 delivery drivers. This move could benefit delivery companies such as Uber and Lyft.

Fast-food workers and unionization

The time is ripe to accelerate union organizing among fast-food workers in California and possibly beyond, Bryant said, citing not only the passage of 1228 but also growing support for unions across the country. In general, there is a different kind of perception or appreciation into what the labor movement means, what labor unions do, particularly as the wealth gap in this country continues to grow, according to Bryant.

While only about 10% of U.S. workers are unionized, and less than 1% of fast-food workers, Starbucks has a significant number of unionized employees. Specifically, employees at nearly 370 of its company-owned stores have elected for unionization. However, there are still more than 16,000 Starbucks nonunionized workers. Despite this, Starbucks has recently stated that it wants to resume talks with union representatives early next year.

Bryant stated that the gap between union support and actual membership is a hindrance to organizing fast-food workers in California and other states. Although he is optimistic about AB 1228, he also acknowledged that companies will not make it easy. "Even looking at 1228, they spent millions to defeat those efforts," he said.

Haller stated that he has no doubt that the SEIU will utilize the 1228 outcome to advance their political goals of organizing workers and increasing market share. He added that the union's failed attempts to unionize fast-food workers in California and other states are a confirmation of the franchising model. Haller believes that this is a positive development for the franchising industry.

The bill AB 1228 presents an opportunity for some fast-food companies to increase their market share in California. Longer term, McDonald's Kempczinski stated to analysts that this is an opportunity for them to gain share, as they believe they are in a better position than their competitors to weather this.

Harbour stated that other major fast-fooders share his optimism. "The belief is that we can increase wages and invest in tools or equipment to maintain productivity," he said.

Haller agreed with the notion that both large corporations and big franchisees are better equipped to capture market share through the acquisition of underperforming locations or franchisees who were considering leaving the business in the near future.

Haller stated that some brands may choose not to establish in California because it is challenging to locate first-time owners who can successfully monetize a business centered on value due to the high costs.

Although fast-food companies will initially have to invest more in labor and technology, their commitment to increasing pricing to offset some of that impact has probably assuaged investors' concern. Moreover, the earnings of the major chains are at or close to all-time highs, so AB 1228 doesn't seem to be worrying people too much.