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 labour to keep menu prices low while still driving a healthy profit.

But the days of cheap labour 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 due to three major factors: a shrinking labour 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 labour 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 the local minimum wage higher.

About one in three states now have 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 labour costs inflate, restaurants will be forced to raise menu prices and fire some workers, as well as reduce labour 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 labour 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 labour, and then they are going to lose customers,” Rensi told Business Insider in an interview. “And guess what happens when they lose customers? They fire employees because they don’t need them anymore.”

Longer term, many companies will have to invest more in technology and automation to further reduce the need for employees, according to Levy.

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