Tuesday, July 30, 2013

Bad Economics Doesn't Help Anyone

UPDATE July 30, 2013, 11:05 pm: Since the article I discuss here originally ran, HuffPo has added a correction at the bottom that the "researcher" in question is actually registered as an undergraduate at the University of Kansas. As yet, no substantive changes to the general thesis of the story, though.

Forbes.com has also updated their story, tacking on 3 paragraphs at the end in which a UK economics professor splashes a little cold water on the undergraduate's "leap of faith."

I would like to start this off by stating that I fully support raising the minimum wage and that I am not comfortable with the notion that the median hourly pay for a fast food worker is less than $9.00 an hour (which translates to around $18,000 a year for a full-time employee).

And it's for this very reason that ledes like this one from the Huffington Post raise my hackles: "McDonald's can afford to pay its workers a living wage without sacrificing any of its low menu prices." Their source for this sweeping statement is "a new study" provided to them by "a University of Kansas researcher." 

That "researcher," it turns out, is a research assistant at the University of Kansas School of Business. One assumes that he is still in training and has not yet learned how to read an annual report much less how corporate finance operates. The mistakes of a student are understandable. What isn't so understandable is why paid journalists (even poorly paid online journalists) don't bother to do a basic fact check on it.

If you take the six seconds required to pull up McDonald's 2012 Annual Report, you can see exactly where the "researcher" got his numbers. They're on page 28, the consolidated statement of income. McDonalds' total revenues for 2012 were $27.567 million. Later in the same chart, the line item for "Payroll & employee benefits" is $4.71 million. Divide payroll expense by total revenues and you get 17%, which is the number the "researcher" used for the argument that you could double wages and only have to increase menu prices by 17%.

Here's problem #1 with that thesis: he used the wrong revenue number. McDonalds doesn't own all its restaurants. Most are franchised. The salary expense figures used in the "study" are for company-operated restaurants, while the revenue number is for the whole company, which includes fees from franchisees. If you do the same math exercise with just the revenue figure for the company-owned restaurants (which is $18.6 million and is available right there on the same income statement), you see that payroll and benefits makes up 25% of the revenue from company-owned restaurants.

So, the whole "study" starts with an elementary mistake, but it's a supremely flawed premise in the first place, as if a corporation is machine which you can steer just by pushing a couple of levers. It assumes that the price of food is inelastic and that you can just blindly raise prices 17% and not see a fall off in demand, because it's "just 68 cents per Big Mac" (or, $1.01 per Big Mac if you use the 25% figure.)

And yet other outlets like Forbes.com (who one would think understood corporate financials better) have started picking up the same report and publishing it without a bit of scrutiny. In fact, their description of what the "researcher" did sounds pretty impressive: "he did some financial modeling based on McDonald’s annual reports and data sets submitted to investors." This "modeling" involves, basically, dividing two numbers, one of them the wrong one.

Ultimately, "analysis" like this is so simplistic and reductive as to be meaningless. It makes a great splashy headline, but it implies that the problems of wage inequality and affordable food is black-and-white simple: if these damn corporations just stopped being so greedy all the problems would go away.

But it's not that simple. Since the 1950s, the fast food industry has been defined by a low-margin, cost cutting model with cut-throat price pressure from the market. And consumers, literally, have been eating it up. The notion that there's so much headroom lying around in the financials that companies could simply double their labor costs is laughably naive.

I think it galls me so much because I'm on the side of the people who want fast food workers to make more money (and for fast food quality to be much better, too.) And, there are some very interesting and dedicated people out there trying to make that happen. I've written about a few of these folks in the past, like Nick Pihakis of Jim 'n Nick's BBQ, and I've got a lot more stories in the works.

It's not as simple as us all just paying 68 cents more for a Big Mac, but for me, at least, it's a lot more promising because it's a future that might actually happen. I'll take a look at some of the practical things that could happen in a couple of future posts.

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