Understanding and managing restaurant labor costs plays a significant role in profitability and is crucial for your management team to understand. Labor costs include wages, benefits, payroll taxes, and other mandatory contributions, making them a critical factor in determining a restaurant’s profitability. Successfully managing labor costs can be the difference between a thriving restaurant and one that struggles to stay open.
Labor Costs
Labor costs refer to all expenses related to the compensation of employees working in a restaurant. These costs go beyond just hourly wages or salaries; they also include overtime pay, employee benefits, payroll taxes, and compliance-related expenses like workers’ compensation. Specifics can vary from state to state on some compliance-related labor costs, so make sure you are not only following the letter of the law but also budgeting for it.
Maintaining a full team of quality employees is especially challenging, but restaurant labor costs are controllable expenses that directly impact your bottom line. Efficient labor cost management ensures profitability and allows you to price your menu competitively without compromising on quality of service.
Components of Labor Costs
Labor costs can be broken down into several key components, each contributing to the overall expense. Make sure your team is aware of each element as you work strategically to control overall labor costs.
Wages and Overtime Pay
Wages paid to employees are at the core of labor costs. These expenses include hourly wages and salaries for full-time and part-time staff. While wages are the baseline, overtime pay can significantly increase labor costs if not managed effectively. Time-and-a-half pay will quickly escalate your labor costs, so manage schedules to prevent overtime unless it genuinely makes sense.
Employee Benefits
Employee benefits include health insurance, paid time off (PTO), retirement plans such as 401(k)s, and other perks that restaurants may offer to attract and retain staff. While benefits are essential for maintaining a motivated and loyal team, they can substantially add to your overall labor expenses. For example, offering health insurance may increase your labor costs by several percentage points, depending on the plan and number of employees. Use payroll data to ensure you can afford those incentives.
Payroll Taxes and Mandatory Contributions
Employers are required to pay various payroll taxes and mandatory contributions, including Social Security, Medicare, and Unemployment Insurance. These taxes are non-negotiable and represent a fixed percentage of your payroll. In the U.S., Social Security and Medicare contributions are collectively known as FICA taxes, and they amount to 7.65% of an employee’s gross wages, with an additional 0.9% Medicare surtax for higher-income employees.
Workers’ Compensation and Compliance Costs
Workers’ compensation insurance is mandatory in 49 states and covers medical expenses and lost wages for employees who get injured on the job. Restaurants must also comply with various federal and state regulations, such as the Family and Medical Leave Act (FMLA) and the Affordable Care Act (ACA). Compliance with these regulations comes with additional costs, such as insurance premiums, legal fees, or administrative expenses. Do your homework to avoid surprises. Working with a restaurant-specific payroll company enables operators to leverage technology that adapts to local, federal, and state legislation, helping reduce the risk of penalties and fines.
Payroll Processing Fees
Managing payroll involves paying employees, maintaining accurate records, calculating taxes, and ensuring compliance with labor laws. Many restaurants outsource payroll processing to specialized firms or use payroll software. These options involve fees, and while necessary for ensuring compliance and accuracy, these extra expenses contribute to the overall labor cost structure. Finding a great solution that integrates with your POS system is a smart move.
The Impact of Restaurant Labor Cost on Profitability
Labor costs directly impact a restaurant’s profitability and are a major expense that you must carefully manage.
Profit Margins
High labor costs will chip away at desirable profit margins. For example, if your restaurant’s labor costs are too high, the profit margins on every cover decrease, leaving less room for other expenses like food costs, rent, and utilities.
Operational Efficiency
Labor costs are tied to operational efficiency. Being overstaffed during slow periods means paying for non-revenue-generating labor, decreasing your profitability. Conversely, being understaffed during peak times can lead to poor customer service, longer wait times, and, ultimately, lost sales. Striking the right balance between staffing and demand is key to operational efficiency, employee productivity, and customer satisfaction.
Competitive Pricing
To remain competitive, restaurants must price their menu items strategically. However, if labor costs are too high, it may be challenging to offer competitive prices without sacrificing quality or profitability. Controlling labor costs allows you to maintain reasonable prices while still ensuring high-quality service and food.
Calculating Labor Costs
Labor cost percentage is the most common metric used to evaluate labor costs. It shows how much of your revenue is spent on labor and is calculated using the following formula:
(Total Labor Cost / Total Sales) x 100
For example, if your total labor cost for a month is $5,000 and your total sales are $20,000, your labor cost percentage would be:
($5,000 / $20,000) x 100 = 25%
When calculating labor costs, include all related expenses, not just wages. This means factoring in overtime pay, employee benefits, payroll taxes, workers’ compensation, and payroll processing fees. Failing to include these costs will cause you to underestimate your labor cost percentage, potentially resulting in budget shortfalls or inaccurate pricing decisions.
Ideal Labor Cost Percentage
Quick-service restaurants typically aim for a labor cost percentage between 25% and 30%.
Full-service restaurants often fall in the 30% to 35% range, with fine dining reaching up to 40% depending on the type of guest experience and menu pricing.
Monitor Labor Costs Regularly
Regularly monitoring labor costs is essential to keep them within target ranges. Weekly or even daily tracking of labor costs can help you identify trends and adjust before costs get out of hand. POS systems and labor management software solutions offer real-time labor cost tracking, making it easy to check labor costs in real time and make decisions that will help the bottom line.
Strategies for Managing and Reducing Labor Costs
- Efficient scheduling is one of the most effective ways to manage labor costs. Use forecasting tools to predict customer demand and design your schedule accordingly. You should also watch overtime closely to prevent unnecessary expenses.
- Cross-train employees to perform multiple roles to reduce the need for additional staff during slow periods. This tactic will also solve employee productivity challenges. The same goes for training and adding incentives to increase sales and quality overall.
- Use technology to regularly analyze sales data and identify patterns, adjusting staffing accordingly. Pay attention to productivity metrics like a Sales per Labor Hour report. You can calculate this metric by dividing your total sales by total labor hours. Monitoring this metric helps you identify high-performing employees and shifts, as well as areas where you may need to improve productivity. Watch for trends and analyze historical data to forecast your future needs. Training your management to take a proactive approach to labor costs will only help in the long run.
