Ivar’s wage increase strategy bears watching

  • By James McCusker
  • Thursday, April 2, 2015 12:07pm
  • Business

There’s a lot to like in the Ivar’s Restaurants’ new, $15 minimum wage strategy for its Seattle sit-down restaurants. The first is that it is simple. Workers, customers, government meddlers … everyone can understand it. And there are no exceptions — the new wage extends to the “back room” staff, the mostly unseen workers who prepare the food, maintain the kitchen, and clean up afterward. The new strategy will even simplify the company’s payroll and income tax returns — no small feat in today’s world.

The second thing to like is that its simplicity was extended to the wage schedule itself. It is $15 an hour effective April 1st. That’s it. It is a single pay increase; not incremental raises dribbled out on a calendar like spilled coffee.

The strategy is this: On April 1st, the minimum wage for Ivar’s staff in its sit-down restaurants in Seattle was raised to $15 per hour. There will be no tipping at these restaurants; it comes with the meal. Instead, there will be a 21-percent charge added to the menu price, 17 percent for tipping and 4 percent to defray the increase in wages mandated by the city.

Minimum wage rates at Ivar’s quick-service and stadium restaurants were reset to $11 per hour on April 1st in compliance with the new law, and prices there were raised 3 percent to offset the increased cost.

There is even something for economists to love in the Ivar’s plan: a look at what economists call the “price elasticity” of demand.

Elasticity is a measure of how responsive demand is to price changes. How Ivar’s customers react to the price increase will be measured in the number of meals sold and the total revenue obtained. The demand for a product or service is called “elastic” when the quantity sold goes up or down substantially when the price is reduced or increased. The actual measurement is done by dividing the percentage change in quantity by the percentage change in price.

For the business manager, the price elasticity of demand is of crucial importance to the bottom line — the survival line for businesses in competitive markets like restaurants. The “sweet spot,” of course, is at what economists call “unitary elasticity”—the point where total revenue is highest and would be lower if the price were either lowered or raised.

In the real world, customer demand is affected by many variables, and price is just one of them. Customers’ reaction to price changes will vary widely with location and service levels. Additionally, though, customers’ sensitivity to price changes will be affected by a variety of causes, including the overall economic situation and their own position in it.

Successful restaurateurs seem to have an instinct for the pricing “sweet spot,” which is a good thing because as a practical matter it is difficult to calculate the actual demand curve without extensive testing of higher and lower prices. Restaurants are usually very cautious about price changes, for they raise the risk of a collision with customers’ expectations and preference for stability. That is why prices changes, especially increases, tend to be gradual in a competitive market.

Seattle’s new minimum wage law presents a situation that is different because most employers of entry-level workers face the same change at the same time. Restaurants are the most visible businesses within this group, and they operate in a brutally competitive environment. That means that the eyes of politicians, public, and economic policy analysts will be on them and how they respond to the new mandate.

The Ivar’s’ pricing strategy is of particular interest because it raises questions about customer perceptions as well price elasticity. The nominal price increase — the price on the check that the customer is staring at — is not 4 percent but 21 percent.

The question, then, is whether the knowledge that it includes the tip will be stronger than the sticker shock. That is a different question from a straightforward demand elasticity test, which relates to the 4 percent increase only.

We really don’t know the answer to either question, although some people claim to. It is safe to say that the industries that employ substantial numbers of entry-level workers will see a restructuring. Managers will be searching for their new “sweet spot” as they adjust to a new cost structure. Businesses closest to the margin, breaking even or barely making a profit, will probably disappear.

The public, and the analysts, will have to rely on reflected results — businesses closing, moving, or prospering — to estimate the effects of the cost increase. Given the intensity of interest in this mandated minimum wage it is very likely that any changes will be over-interpreted. But that “comes with” any economic policy decision.

James McCusker is a Bothell economist, educator and consultant. He also writes a column for the monthly Herald Business Journal.

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