LFTL: Alternatives to Cost Plus Service Fees
Service Charge Alternatives for Restaurants
After getting battered by a global pandemic, restaurants barely could talk a breath before being besieged by political opportunists shouting about a “sub-minimum” wage to mislead the public and pass bills eliminating the tip credit. You can hear Matt share our true feelings about these movements here. With the cost structure dramatically shifting, many restaurants instituted service charges to cover increased labor charges.These service charges ran the gamut from replacing tips to a cost plus service charge to recoup increased employee wage expenses.
After the deceptive organizers came the professional plaintiffs – some obscure outfit ran out of a crank’s apartment in Virginia started dining out in DC and suing prominent restaurant groups with cost plus service charges. Given the controversy around service charges, journalists eagerly covered these lawsuits, creating a situation where the restaurants had a strong incentive to settle quickly even though their service charges were largely deemed compliant by regulators.
All this has the effect of unsettling some of our clients and asking about alternatives to cost-plus service charges, and although if you have one and it’s helping you achieve improved profitability we aren’t advising you to get rid of it, we do want to provide some alternatives.
Credit Card Surcharges:
Cedit card surcharges were previously banned by card networks until a settlement from an antitrust lawsuit changed the status over a decade ago. If you’re unfamiliar with these entities, it's advisable to consult our primer on Credit Card Fees for detailed insights. Implementing these surcharges is complex; they must be registered with the card network, clearly displayed, not exceed the processing fee, not applied to debit card transactions, and they’re still banned in several states. Despite these restrictions, they are legal in most states and allow for a 2-4% fee, offering a more legally stable and consumer-acceptable option compared to other surcharges.
A Tip Replacement Service Charge:
In response to changes regarding the tip credit, some restaurants have stopped accepting tips and instead apply an 18%-22% service charge, using the revenue to pay staff either the statutory minimum wage with a share of the service charge income or a higher fixed hourly rate. This approach, more common in fine dining, enjoys broader customer acceptance and reduces confusion. However, opting out of tips can lead to adverse tax consequences, may not suit more casual venues, and to circumvent legal issues it's crucial to transparently communicate that the service charge benefits the employees. We covered some of the nuances of service charges here on the blog last year.
Raise Prices:
Of course you could always just raise prices. Incrementally increasing prices is a viable strategy, though it comes with its own set of challenges, particularly for small restaurants. The demand for dining out is highly sensitive to price changes, meaning that even slight increases can significantly reduce customer visits. This reduction in demand is often underestimated by both policymakers and the general public, who may not recognize the impact of consumers dining out less frequently on the restaurant's overall business – they tend to see a full dining room at 7 pm on Saturday night as a sign that all is well.
Nonetheless, in response to rising costs, most of our clients typically have some flexibility to adjust prices without severely affecting demand. A balanced strategy that involves both cost management and careful price adjustments can be effective. Many establishments, particularly those facing labor challenges, may opt for straightforward price increases as a simpler solution over making more complex and emotional labor-related decisions.
Doing more than the standard cost-plus pricing and understanding the psychology behind pricing strategies, such as implementing tiered, dynamic, fractional, charm or à la carte pricing, can also play a crucial role. These strategies allow for more nuanced pricing adjustments that can meet both your financial needs and customers' expectations. Engaging in a discussion about the most effective pricing strategy for your restaurant can provide tailored solutions that align with your specific circumstances and market dynamics and we’re happy to help.
Manage Labor:
Notice we didn’t say cut labor to not be reductive but if you decide to remove a cost-plus service charge you need to understand that you’re losing a revenue stream that was off-setting a large labor increase. Managing labor costs needs to become a weekly focus – with FOH wages getting reset to full minimum wage it demands constant evaluation to a KPI benchmark that allows good profitability. We’ve talked about labor management strategies here and here but don’t hesitate to book a labor consultation if you want to learn strategies around effective labor management.
Getting rid of the tip credit is certainly a large change and like all large changes, it can be an opportunity for positive growth and we are here at Harmony to help with that reality.