In May, a bill to increase minimum wage passed through the Illinois state house and senate- and waits for Governor Bruce Rauner’s signature.
We’ve faced minimum wage increases before but none have been so feverently debated as this: the largest increase the state has ever considered. The $15 minimum wage would be factored over the next five years and, at over double the federal minimum, would make Illinois the highest minimum wage in the country.
The economics of minimum wage make for a complicated conversation. This article lays out the effect this bill will have on our small business, Maeva’s Coffee, and projects a probable path we would take if it were to be signed into law.
Business As Chess
In Thinking Fast and Slow, Daniel Khaneman explains how chess is a rare place true intuition can exist. All of the information regarding both your position and your opponent’s- as well as all possible outcomes- can be known by any observer. Unlike poker or politics, there are no hidden variables.
In chess, there are instances in which a player finds himself in either an unbeatable or an unwinnable position. But, more often than not, chess falls in a spectrum of grey where advantage results from careful attention. Luck has little place in chess.
Perseverance can transform terrible positions into a win.
I play business with the same calculated optimism and perseverance as I do chess.
Look at the entire board.
Choose the best move.
Keep looking until you find the answer.
With every option in plain sight- the solution to any situation is also in plain sight. A game is never over until it is over.
I recently read The Art of Learning by Josh Waitzkin, in which this internationally ranked master focuses on the art of managing the psychological and emotional effects of competitive chess. These aspects of chess are not as pure as managing the information on the board but act as a cautionary tale for us too in business when we are faced with change. During the game, a subjective reaction to a mistake can lead to a compounding series of mistakes that result in defeat. The willingness to address a weak position with determination can lead to a landfall win.
Like chess, for a small business owner, the minimum wage debate also has a duality: the numbers vs. the humanity.
This post is broken into two parts.
The first part is an objective breakdown of how, if passed:
- the $15 minimum wage will be implemented
- how it will affect our shop
- and what we will do to accommodate the change.
It’s the chessboard. Just moves and position.
The second part of this post is a human hypothesis on how the minimum wage increase could play out in the microeconomics of our community.
Our Shop Structure
If you are reading this and have not visited our shop, let me explain our position.
Our shop is located inside an old schoolhouse in a post-industrial town on the Mississippi River, just inside the Illinois border. We own the building in which we operate mortgage-free - a huge advantage to our three year old operation. Our location is surrounded by middle class residential neighborhoods with an average household income of $40k-$75k annually. Not a wealthy neighborhood, but a good one comprised of young families and older retirees who have raised their own families in modest 2-4 bedroom single family homes on small plots of land. Our shop is a few blocks from a well-attended satellite dental school campus for a major state university.
Our location creates limitations on our potential for creating revenue. Our shop is built out inside a classroom of the old schoolhouse and its brick structure renders it impossible to expand our current seating capacity. The structure is also split level and sits up from the elevation of the road about 10 feet. This makes the addition of a direct drive thru addition cost ineffective and unlikely.
We recently celebrated our third year as a bustling community coffee shop. As people have discovered us and come to love this place, we’ve seen an increase of traffic as well as an associated growth in revenue.
By my projections, I believe we will continue to see a slow and steady increase in revenue as we continue to become a foundational part of this community.
I see that growth potential limited by our structure- and don’t project more than a 20% increase over the next five years.
Current Financial Position
Maeva's Coffee employs seven front of house staff, two kitchen staff, and two owner/operators. Three of our ten active staff are full time, with our seven remaining staff working between 15-35 hours per week.
The separation between house and kitchen staff is significant due to how both the federal tip dispersion law and the minimum wage laws are authored.
Regarding tipping: Federal law doesn’t regulate how tips are dispersed if an employee is being paid at least minimum wage and all tips are distributed completely and only to tip eligible employees. An employee eligible for tips is one that works on shift and that is being tipped by our customer.
In short: This means neither our kitchen staff, nor my business partner, who do not work on shift in the shop, are eligible for tips.
- Fiscal Insecurity
No minimum wage law offers wage protection for business owner/operators- a fact that comes at its own cost to entrepreneurs. This, in theory, means we can make as much as we want as entrepreneurs. However, the practice is often reversed. Most small business owners sacrifice a good deal of time, under or unpaid, to start and operate a business.
Quick Look at the Numbers
In 2016, Maeva’s paid out 38% in gross revenue as wages to staff.
$18,900 of this was distributed as Officer Salaries (owner/operator wages). As mentioned, my business partner doesn’t work in the shop but does receive a stipend for ongoing maintenance. In 2016, I averaged 35 hours per week in the shop between both shifts and office management, putting my hourly wage for 2016 at $7.70 pr/hr prior to taxes.
$32,000 of this was distributed to kitchen staff for an average hourly wage of $9.50 per/hr.
The remaining $73,700 was distributed to house staff who made, prior to tips, on average $9.10 per/hr. However, an additional $28,000 in cash tips were dispersed to these staff. This brings our average shop wage to $14.13 per/hr.
Like a game of chess, if SB81 were to become a law, we have several pieces we could move to better position our business for survival. In all likelihood, it is not the use of a single variable that will keep our business running- but a combination of pieces on the board.
Here are some of the possible pieces we can adjust in our small business to accommodate for the $15 hour minimum wage increase.
- Federal Tip Policy
We assume that customer tipping habits at Maeva’s are unlikely to be negatively affected by the minimum wage increase. Assuming tipping remains static to our revenue, we have options available for tip redistribution to alleviate loss.
Federal law regarding tipping practices states that with staff making at least minimum wage, tips must be 100% distributed to tip eligible employees. But it doesn’t mandate how. Business owners in the service industry have the freedom to choose whatever method they wish, whether it be tip pools, weighted tip pools, or even incentivised bonuses. Likewise, we would be allowed to redirect the $27,000 +/- of cash tips into payroll for house staff*.
This would allow us to cover some increase should SB81 become law- but only for house staff. Any increases necessary for kitchen staff, or to owner/operators, would need to be sourced from another aspect of our business.
- Tax Credits
As SB81 is being considered, its supporters are claiming it will not hurt small businesses due to the tax credits offered in the legislation.
Quick Note: If you have never been a business owner, you might not be aware that a tax credit isn’t a check the government hands you- but rather a credit against the taxes you owe.
The particular tax credit offered by SB81 appears to be a general tax credit against the reported profits of a business with fewer than 50 employees when they file their yearly taxes.
Here is the excerpt from the bill regarding tax credits for small businesses:
The amended bill creates a credit against the withholding tax liability of employers with 50 or fewer employees at any time during the applicable payment period, for each qualified employee, in an amount equal to the maximum credit multiplied by the number of hours the employee worked during the reporting period. The credit (or credits) may be taken against payments due for reporting periods that being on or after January 1, 2018 and end on or before either:
1) December 31, 2025 for employers who employ more than 5 employees during the applicable payment period; or
2) December 31, 2027 for employers that employ no more than 5 employees during the applicable payment period.
The amount of the credit is: (1) $0.75 per hour for standard minimum wage workers; (2) $0.45 per hour for tipped workers; and (3) $0.53 per hour for youth workers. The credits can be claimed on employees who make up to $0.25 more than the minimum or reduced minimum wage and have been employed with the employer for at least 90 consecutive days; provided, that those employees could not have had their wages reduced in order for the employer to earn the credit.
This credit does have limitations, as for each reporting period, the employer may not claim a credit or credits for more employees than the number of employees making less than the minimum or reduced wage for the current calendar year during the last reporting period of the preceding calendar year. Additionally, an employer shall not be eligible for credits for a reporting period unless the average wage paid by the employee per employee for all employees making less than $55,000 during the reporting period is greater than the average wage paid by the employer per employee for all employees making less than $55,000 during the same reporting period of the prior calendar year.
Further, the credit cannot reduce the employer’s obligation for any payment due under the Section by any more than the percentages laid out below:
1) For reporting periods that begin during the calendar year 2018, 25%;
2) For 2019, 20%;
3) For 2020, 15%;
4) For 2021, 10%;
5) For 2022, 5%;
For Calendar years 2023 through: (1) December 31, 2025 for those employers that employ more than 5 workers during the applicable period; or (2) December 31, 2027 for employers that employ no more than 5 employees during the applicable payment period, the total amount of credits awarded to a taxpayer in each calendar year shall be equal to the total amount of credits awarded to the taxpayer in calendar year 202
In short, if a business isn't making a profit, a common situation in the first 3-5 years of startup, this credit won’t help to close the gap in the wage increase.
Why I Mention This:
Last year, Maeva’s reported a $16,000 loss due to essential reinvestment needed in equipment for both our upstairs operation and kitchen. Our revenue has seen slight growth in our first quarter but remains on track to see a $16,000-20,000 net income this year. If the minimum wage increases our payroll liability to extend beyond this amount, the tax credit will not apply to our business.
3. Tax Adjustment and Price Increases
Another piece to adjust is pricing.
At the moment, Maeva’s Coffee is incredibly competitive on pricing. We pay a premium on our most essential supplies to provide a product that is noticeably higher in quality than franchise competitors. Yet, our prices are equal to if not lower than your neighborhood Starbucks.
Our menu is currently priced as “tax included”- a decision that allows us to shave time off of our service (it is easier to count in increments of $.25 instead of pennies). However, this means a customer who is paying for a $4.50 16oz mocha is actually only paying less per beverage- the difference is more substantial for retail. There is not another coffee house, franchise or independent, in our surrounding area that uses this method of pricing.
In addition, non-franchise locations often tack on credit card processing fees to displayed menu pricing or have a minimum purchase amount for orders. These credit card processing fees are higher for businesses processing small ticket orders at a smaller annual revenue than franchise locations.
To keep up with the minimum wage increase proposed in SB81, we could keep our menu prices “the same” but reconfigure our point of sales system to add on state/city sales tax and processing fees. If that wasn’t enough, we could raise our base prices.
4. Reinvestment Reduction
As a new business located in a historic building, there is always a need for structural repair or improvement.
In 2016, we reinvested $16,000 of our net income into our kitchen facility. This year we anticipate spending between $3,000-5,000 in adding a second restroom to our main level.
If necessary, we could slow or stop improvements to account for rising labor costs. It is possible that declining margins would begin to outpace depreciation costs with aging equipment over the course of several years.
Less frequent maintenance also creates a risk of service interruption due to failure of essential equipment.
5. Employees Under the Age of 18
SB81 does not offer as substantial of a raise in the minimum wage for employees under the age of 18 who work fewer than 650 hours annually. This law is intended to help seasonal operations- such as summer camps and public pools.
Some year-round operations might try to skirt the intention of the law by hiring employees under the age of 18 and terminating their employment prior to the 650 hour limit.
However, the coffee industry requires a greater level of technical training. The cost of training a new hire for Maeva’s is around $400, and can rise to around $800 when training a new barista who requires product to burn and learn.
The financial aspect of this strategy, coupled with the poor impact it would undoubtedly make on staff morale, doesn’t make it an option I’d consider for my business. However, it may be something we see in franchises operating in Illinois should this change to minimum wage become a reality.
6. Staff Reduction
SB81’s biggest critics cite the inevitable loss of jobs this bill would cause. However, “loss of jobs” associated with this bill could mean several things.
- Some businesses will not be able to support the increased cost of employment. This may be the “straw on the camel’s back” for businesses that are unhealthy for reasons other than the increase burden of labor. They may close, but one could argue this is only expediting their inevitable demise. That being the case, one could argue that currently struggling businesses shouldn’t be factored into numbers regarding job loss when considering the impact of the minimum wage increase.
- As margins grow thinner, older business owners may decide to retire earlier than planned. Closing businesses could create a decrease in the number of jobs available.
Again, one could argue that these businesses were going to close anyway. However, retiring business owners may be counting on the sale of their business, its equipment, or property to sustain them in their twilight years. Without a positive economic market in which to sell their business, a rippling effect may be seen 10-25 years after this increase with heightened strain on our medicare/medicaid system. Is this a measurable effect? Business owners make up a small percentage of the general population.
The financial cost might not be measurable, but the perception of the entrepreneurial experience may be. The more difficult it becomes to survive and thrive on a personal level as an entrepreneur today- the less likely candidates for entrepreneurial ventures will be to start businesses of their own.
- Some job loss will be reduction. Small business owners will have to balance the demands of their current operation, make sacrifices to service, or pare down operational aspects to support fewer staff. Owner/operators entrepreneurs may choose to increase their own workload to alleviate the payroll increase.
Just like a chess game in progress, it is not a single move that will aid a small-town coffee shop in its adaptation to a $15 pr/hr minimum wage but a combination of these variables.
SB81: The $15 Minimum Wage & Its Implementation
SB81 would raise the minimum wage to $15 per/hr over the course of five years. The bill outlines its implementation as follows:
The conversation surrounding small business and minimum wage is complicated. For the sake of simplifying this analysis, the projected experience of our shop and a $15 minimum wage increase below assumes the following:
- That we experience no more than a 20% projected increase of growth over from 2018-2022 and experience no drop in revenue
- No increase to our CoGS for this period
- No increase to State or City Sales Tax for this period
- No equipment repair/purchase exceeding $10,000
While it would be nice to say those things are possible, the reality is one or more of these variables to our business will change before the minimum wage reaches its final increase in 2022. Although calculating every potential possibility would make the hypothesis in this post more mathematically comprehensive, I wanted to create an article that spotlighted the effects of SB81 with as little complication as possible.
Here is the plan of change we would most likely follow if this bill were to be signed into law:
2018: Year One
The first year of this bill’s affect- 2018- we wouldn’t have to “feel” much financially. The bills states that:
From January 1, 2018 to December 31, 2018 every employer shall pay to each of his or her employees who is 18 years of age or older in every occupation wages of not less than $9 per hour.
With the exception of one new hire, all of our staff currently make at or above $9 per hour. The loss of being able to hire in at the current minimum wage, and then giving a wage increase after training, would cost around $270 per year, assuming three new hires annually (.75 increase x 120 hours x 3 hires = $270)
The True Cost of Leveling the Playing Field
The main detriment to our current business would be competitiveness. Since opening for business, we’ve made it a priority to have both a better atmosphere and better wage for employment than franchise competitors. With minimum wage raising to $9 per hour, our current rate no longer gives us a hiring advantage.
Looking forward into 2019, my first move to adjust our small business to this state law would be to start a new redistribution of tips through payroll- raising the wages of staff above the $9 per hour increase so we can continue to offer higher wages than our community standard. We’d increase new hire wages to $10 per hour- with veteran staff wages rising proportionally to compensate for their experience and dedication to our business.
2019: Year Two
In 2019, if made a law, SB81 would increase minimum wage to no less than $10 per hour beginning on January 1st.
This being two years out in operation, I plan to realize a 10% growth in revenue by the end of the second quarter in 2019.
Between 2015 and 2016, we saw a 14% increase of revenue with only a 1% increase in CoGS (our kitchen investment has allowed us to reduce our waste and streamline our supply). CoGS, or cost of goods sold, does not include labor. As sales increase, it is expected that the labor hours required will also increase (ours raised 10% for this 13% overall increase).
Using those values, to keep our current staffing at two people on shift throughout all open operating hours, we can expect a 10% growth in revenue would cause a 7.7% increase in labor.
In 2016, we paid out:
8,113 house labor hours
3,360 kitchen labor hours
11,437 total labor hours
With a 10% increase in revenue, this would cause an increase of:
624 house labor hours
258 kitchen labor hours
As mentioned before, the house hourly increase can be covered by tip distribution. However, kitchen staff are not eligible for tip distribution. With the $10 pr/hour minimum wage in 2019, we would see a rising payroll burden of around $1,800-$2,000 annually.
This burden isn’t too great yet. However, I don’t want to sacrifice service or our brand- so I would likely begin to shift the schedule so there would be one barista on shift for the last hour of the night instead of two.
This change would cover the payroll increase for kitchen staff as well as competitively raise wages for veteran staff.
2020: Year Three
If enacted into law, SB81 would raise minimum wage in 2020 to $11.25 per hour.
At this point, we can no longer rely on current tipping practices to cover our rising labor costs for house staff.
We would need to budget an additional $1.73 pr/hour for kitchen staff and $1.25 pr/hour for house staff, amounting to an additional $15,900 annually for labor. If we wished to stay competitive by continuing to reward trained/veteran staff with proportionally higher wages- and continue the practice of hiring new staff in at more than minimum wage- that cost raises to $29,900.
Had we not reinvested into our kitchen in 2016, Maeva’s Coffee would have shown a net income of just over $12,000. Factoring in a projected 12% increase in revenue over the next three years, we can estimate in about another $1,000 to this number. Without any changes made to pricing, material costs, staff, etc- this net income is the “cushion” we have to accommodate increased labor costs.
Now pieces on the chess board must be developed into a position.
At this point in our hypothetical situation, we’ve been fortunate enough to not really “feel” the impact of rising minimum wage as other community businesses may be experiencing. Year three would be the point wherein the variables mentioned above would have to be changed to cover the rising labor cost and maintain a safe margin for unexpected equipment repair or emergency operating expenses.
First, we would begin charging state and city sales tax, as well as credit card processing fees, in addition to our current menu pricing. With a projected revenue of $370,000, that would bring in:
$300,000 x .0175 = $5,250
$70,000 x .0785 = $5.485 ($10,745 taxes)
$370,000 x .6 = 222,000 (approximate credit sales) x .025 = $5,500
Total Increase of $16,245
These numbers assume no increase in city or state sales tax through the end of the 2020 fiscal year.
By no longer offering our product with prices including tax, and assuming a net income of $13,000, we have working capital of $29,245 with which to cover the minimum wage increase and continue to provide competitive wages for our staff. This would negate any income or “cushion” for any unexpected equipment needs or emergency problems, or our available funds for growth or improvements to the business.
At this point, I believe it's be reasonable to increase pricing. If you are already going to change the way you pricng works (no longer using increments of $.25), one could also add a percentage increase across the board to cover the wage demands of the state. By increasing prices by an addtional 5%, we would cover rising costs and still have an income of approximately $17,000- a pool necessary for emergency expenses and repair. This would be an increase that is surely noticable to the customer.
2021: Year Four
In 2021, if enacted into law, SB0081 would increase the Illinois state minimum wage to $13 pr hour. If labor hours were to stay static to our 2020 calculations, this would increase payroll by $21,600.
At this point- having already exhausted our tip cash flow and freshly “increased” pricing in the minds of customer- it would be time to look at staff reduction.
For our current level of traffic, we don’t need the level of staffing we maintain. I employ additional staff because I feel it does lighten the workload and keep customer service exceptional during our heavy hours- as well as give everyone a morale boost during slower times.
I would evaluate my staff on speed, consistency, and service to find who could carry heavier traffic hours with minimal effects on quality or timeliness. In looking at our current scheduling matrix, I’ve determined our “break even” point for having two staff on shift is $60 in sales per hour. Realistically, if the bar is fully stocked, an experienced veteran can handle around $90-100 in sales per hour. However, multiple hours at this rate can lead to inventory shortage behind the bar, mental fatigue, and order inaccuracy (product waste). With this in mind, I would create a schedule based on our hourly sales trends collected to that point, raising the bar to scheduling two members on staff at the $80 benchmark from the $60.
I realize this would put strain on our staff and could lead to an environment where discontent is more likely. Also, realistically, when I look at my current staff, I believe only a percentage could handle the additional load.
How I Plan to Ensure Quality and Morale
To incentivize my best staff, I would split the difference between the labor savings. Instead of just telling them to work harder for the wages they’ve already been earning- a path Starbucks was recently criticized for taking - I’d offer those who could handle the load a substantial raise. For instance, a staff member who was able to handle $80 solo sales hours well would be saving me at least the $13 per hour I would typically pay a second person to be on. I would offer staff capable of this an hourly rate of $17 pr hour, reducing our labor hours and saving $9 per hour.
Shaving 25 hours per week by scheduling solo shifts, and accounting for the pay raise for our most capable staff, would free up an additional $11,500 per year to put towards the $21,600 gap with the $13 minimum wage.
At any given time, we typically employ 2-3 high school or college students who work 15-20 hours per week around their school schedule. A reduction of 25 hours per week would eliminate two of these part time positions at Maeva’s coffee- bringing our house staff to 6.
This leaves a $10,000 gap to close with the 2021 minimum wage at $13 per hour.
The Truth Behind Being an Owner/Operator
In 2017, on average, I (as an owner/operator) work 2 shifts per week in Maeva’s Coffee averaging 12 hours/wk or 612 hours annually on shift. I spend on average another 13 hours/wk or 663 hours annually on office work, running errands, and behind-the-scenes work. In the prior years of operation, I was clocking in between 45-80 hours per week but, thankfully, our shop has grown from a fledgling startup into a smooth operation.
Having the extra hours available has allowed me to concentrate my other 50 or so work hours per week on our business incubator at The Milton Schoolhouse. Without my attention, our growth had stagnated in 2014-2016. However, this year, we’ve seen the influx of two new startups and the expansion of an existing business in our first quarter alone.
Should Maeva’s Coffee require me to step in to cover additional shifts, we risk seeing a slowing in our growth once again.
Facing a $10,000 gap, I could reasonably work an extra shift per week without jeopardizing our growth completely. If I were to take on an early weekday morning shift- say an opening Monday shift that wouldn’t necessitate a second staff member, I could lighten the payroll load by $26 per/hr. At 7 hours a week, that’s 357 hours annually or a $9,300 payroll reduction.
That 7 hours a week would also eliminate the need for another part time staff member, bringing our house staff to five employees (not including myself). The remaining gap caused by the minimum wage increase for 2021 could be taken from net income without putting Maeva’s at critical risk should unexpected expenses arise.
2022: Year Five
In 2022, if enacted into law, SB81 would raise the minimum wage in Illinois to $15 per hour.
To determine the additional $2 per hour burden on our payroll costs, we are going to assume our business has hit the 20% projected revenue growth by this point.
This would mean:
2022 Revenue = 390,000
Payroll increase of 15.4% or 13,200 labor hours paid out. This is a 7.36% increase from our last revenue increase of 14% in 2020.
Raising minimum wage by $2 from the year prior would mean an additional payroll burden of $26,478 per year.
In 2016, Maeva’s Coffee made 66,500 beverages. Factoring in a 20% projected increase, we can hope that by 2022 that number is around 80,000. If we were to increase all beverage pricing by $.32, we could realize a $25,500 gain that could be used to close the $15 minimum wage gap. If we instituted a similar $.15 increase for food items, we could realize another $1,098. This (on average) 8% increase in beverage prices and (average) 6% increase in food prices would allow us to cover the $15 minimum wage increase.
Five Year Strategy Summary
In analyzing how SB81 would be implemented if signed into law, the five year increase to a $15 minimum wage in Illinois would cause the following changes to our coffee shop’s current business model:
A 43% reduction in house staff, or, the elimination of the equivalent of 3 part time positions, or, a 30% reduction of staff overall
For remaining staff, an average 14% increase in pay prior to taxation over the five year period
A 30% on-shift workload increase for Owner/Operator
An pricing increase of approximately 15.3% on food and beverages over the five year period as compared to 2016 pricing
I believe we would continue to survive and operate at our current level through this period.
However, after five years of increasing labor burden, eliminating available positions, and increasing costs, we wouldn’t realize any increase to our business’ current valuation.
The Psychology of Competitive Chess & Minimum Wage
Anxiety runs high while playing competitive chess.
Familiarity brings comfort. When playing a friendly game with a regular in Maeva’s, I’m relaxed. There is very little at stake. Familiarity brings comfort because it creates an easy environment for experimentation and growth.
Playing tournament chess is a different beast.
Seated across from a strange face, the clock ticking in an unfamiliar environment, I’ve often played games that aren’t my best. Once a game has ended, there is a dizziness from the sheer level of effort and concentration involved.
On the human level of this pending change, I anticipate small business owners will find themselves facing the next five years of implementation with a dizzying anxiety. Those of us who don’t loose position early on will look up in 2023 with elation found only from having survived ourselves.
Not knowing the plays, the traps and tactics each industry would afford during this change, I am sure I will be surprised by those who resign from their business and those who continue on once the law has been fully realized.
For me, as many of my colleagues, our business is our life. We don’t look at change and consider whether we should or should not play. We hope to find ourselves in the best position possible to pursue that dynamic American dream of entrepreneurialism. But if SB0081 became law no longer would we be free to experiment, try new things, and increase value without increasing cost. Instead we would face those tournament conditions and be forced to continue to play for survival in place of growth.