The Australian Small Business Blog

Wednesday, February 05, 2014

Do penalty rates kill profitability?

by Dr Greg Chapman

There was recently some controversy when a restaurant posted on their menu board that they couldn’t open on public holidays because of the mandatory 2.75 times penalty rates in South Australia, claiming that they would have to increase their menu prices by the same amount. Another article a few days later revealed the same situation in Canberra, and now it is being raised in the Australian Industrial Relations Commission by the Government. There has been a lot of ill-informed and abusive commentary by some patrons in social media (how unusual!), so what is the reality?

First let’s deal with the claim that their prices would have to increase by 2.75 times to cover their costs. As many rightly pointed out, labour is not their only cost.

Typically, most restaurants operate with the simple formula that labour costs are a third of their prices, food makes up another third, with the remaining third being their Gross Profit, which then must cover their overheads and deliver, hopefully, a net profit, after the owners wages, which can be as little as a few percent of the turnover.

If we assume that this is the case, the establishment would have to increase their prices by 25%, just to break even, with zero gross profit and no overhead contribution on a public holiday. To achieve the same level of Gross Profit contribution as was achieved on normal days, they would have to increase prices by about 88%. They may be prepared to forgo some of that profit contribution as any Gross Profit at all helps with the overheads, but the owner may just prefer a day off!

So ok, the 2.75 price increase claim was way out, but the point remains that without any price increase, every meal would cost the owner money from their own pocket. Some made the point that the restaurant would be busier on the holiday. True. So the owner has a choice, do they increase staff, or just reduce customer service to contain costs. Ever been in a crowded restaurant on a public holiday and found it impossible to attract the waiter’s attention?

Another alternative adopted by many restaurants is to have a holiday menu to avoid the problem of a holiday surcharge. The dishes are different, so prices can’t be directly compared with the normal menu, but an effective price increase can be achieved in this way.

While such strategies are possible, a 2.75 penalty rate is very hard to cover, which is why many restaurants close in South Australia and Canberra on public holidays.

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Dr Greg Chapman is the Director of Empower Business Solutions and is Australia's Leading Advisor on Emerging Businesses and provides Coaching and Consulting advice to Australian Small Business Owners in Marketing & Business Strategies Planning & Systems. He is also the author of The Five Pillars of Guaranteed Business Success and Price: How You Can Charge More Without Losing Sales.

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