California's fast-food chains weigh options after AB 1228

On April 1, California Assembly Bill 1228 took effect, raising the minimum wage by another 25% for fast-food employees on top of the $16 minimum wage mandate that was enacted at the beginning of the year. The back-to-back increase in labor costs for fast-food restaurants that operate within the state will make California the test ground for automation and “evolving business models” in an effort to trim labor expenses, according to BTIG analysts Peter Saleh and Ben Parente.

The evolution of AB 1228 began with a union-backed bill called the FAST Act, for Fast Food Accountability and Standards Recovery Act, or AB 257. FAST created a Fast Food Council which was given authority to set minimum wages, working hours and health and safety conditions for “limited-service restaurants.” The restaurant industry sued to suspend AB 257, and with a voter referendum pending, the unions and restaurant industry compromised on a deal, subsequently incorporated into AB 1228.

AB 1228 exempts fast-food chains with less than 60 branded restaurants, those located in airports, hotels, theme parks, museums, casinos, corporate campuses and on certain public lands.

But for those impacted by the law, the knee-jerk reaction to raise prices has lacked consistency. Saleh and Parente found that fast-food chains within the state have, so far, responded differently to the law. With customers already recoiling at higher prices and smaller sizes, restaurants are treading very carefully. McDonald’s (NYSE:MCD) has kept prices steady but has discounted some items and re-introduced popular menu items to stimulate traffic. Others have introduced a sliding scale of price hikes. Chipotle (NYSE:CMG) and Starbucks (NASDAQ:SBUX) both raised prices on average by high-single digits. But while Starbucks (SBUX) raised prices universally across the state, Chipotle’s (CMG) increases were higher in the southern part of the state and lower in the north. On the other hand, Shake Shack (NYSE:SHAK) and Jack in the Box (JACK) raised prices by 7.8% on average, but were higher in the northern part of the state, and lower in the south.

Casual dining and third-party delivery aggregators, both exempt from the law, are expected to benefit from AB 1228, according to BTIG’s Saleh and Parente. Because of this, Pizza Hut (NYSE:YUM) let go of 1,200 delivery drivers and now relies solely on rideshare drivers from Uber (UBER), Lyft (LYFT) and DoorDash (DASH). Domino’s (DPZ), however, maintained the more expensive option of keeping delivery in-house.

Higher labor costs will also serve as an accelerant for more widespread adoption of automation developed by companies like Miso Robotics and Hyphen. Although high upfront costs could limit the implementation of full-scale automation, self-ordering kiosks like those from Toast (TOST) will become much more prevalent across the state. With 477 restaurants across the state of California, Chipotle (CMG) is already gearing up to install its first Hyphen automated line at a restaurant in the state.