Cafés and restaurants – at a tipping point?

The Fair Work Ombudsman’s food precincts report[1] – finding that enterprises in three selected foodie streets in Sydney and Melbourne were non-compliant in paying wages to employees, and more, to a significant degree – has confirmed the outcomes of our recent review, based on observations conversations and some reasonable conjecture about the café and restaurant business (CARB).

Tips?!

For one thing, the review offers reasons for the counter-intuitive demands of CARBs for gratuities, when most businesses offer discounts to attract customers; and their premium prices for bulk purchases, when others offer discounts for bulk. The reasons for this seem to be that they need the tips to survive, despite being subsidized by their customers and others to start with.

Although this review could have been offered at any time, it is prompted by FWO’s report, and FWO’s recent successful decision in Fair Work Ombudsman v Skyter Trade Pty Ltd & anor [2018] FCCA 1483, which is illustrative of many of the points made in this review.  Extracts from that decision follow at the end.

Culture

There is a non-compliant culture among many CARBs, the danger being the all-pervasive negative and anticompetitive impact a bad culture can have on industry participants.

Those familiar with the construction industry in Australia will know of the 2015 report into unlawful phoenix activity, that revealed, or confirmed, that contractors were quoting for work without allowance for workers compensation premiums, PAYG, and GST, on the basis that these would not be paid. Such was, and probably remains, the culture in that industry of tax avoidance that those in and entering the industry claim they were ‘forced’ to do that because their competitors were doing the same, and they could not compete on price unless they did so.  (Hardly an excuse, but the point was made).

Among CARBs, anecdotally, the story is similar.

The cash economy

The cash or black economy still exists, being paid cash by customers, and paying staff in cash, in neither case not paying taxes to the ATO.

The old ‘two sets of books’, or more, exist, for tax purposes, and before any sale. CARBs looking to move on are known to start buying excessive volumes of coffee from the supplier and then reselling it to their mates to increase the kilos of coffee purchased in support of inflated revenues.

But the ATO has taken to calculate true assessable income of CARBs based on amounts of coffee purchased; a large tax liability often follows.

The general move away from cash towards credit card payments has resulted in less free cash to pay staff in cash.

A CARB response to this is said to be the particular times of day when a CARB’s EFTPOS machine is, conveniently, “not working – sorry for any inconvenience”, thereby increasing the cash reserves.

STP

The government did have a possible tax solution to this, in single touch payroll (STP), but backed away from payment, to mere reporting, in response to the accountants’ and others’ pleas for business to use their cash flow (emphasis on cash), and, overtly, to continue to use the ATO as their financier. But the more limited implementation of STP is unlikely to impact CARBs, given other free and easy approaches in the tax system.

Below award wages

Then there is the payment of staff at below award wages, assisted by employee ignorance, cultural enclaves, and attitudes,[2] and by restrictive immigration policies.  There are low barriers to entry to work in a café. The staff are transient and often travellers. They often don’t know their rights.

For larger organisations, where there are procedures for fraud control, there is difficulty in having the free cash to pay staff. Other approaches are adopted – paying staff by EFT but below the award, or paying them under an Enterprise Bargaining Agreement (EBA); or paying at the award, but demanding additional hours work without payment. Those CARBs in the large shopping malls are however under more scrutiny and control.

Sophistication?!

The barriers to entry as a CARB owner are low, and the industry attracts unskilled business people as owners, even though skilled, such as it is, in making coffee and sandwiches.  These people are often paying an inflated amount of dollars to buy what they call goodwill, but in many cases, not only is there is no goodwill value, but there is likely to have been an inflated value put on equipment which is often minimal.

There are different structures through which to operate a business – sole trader, partnership, or company being the main ones, with trust arrangements to one side. General business advice is offering by government and more particular ‘setting up a café’ advisers. But knowledge of corporate and tax responsibilities – ACNs and ABNs are easy to get – is limited or non-existent.

CARB owners often seem to judge their success by the amount of money in the bank at any time, without sophistication to allow for tax or staff.  New entrants, and customers, assume that because the café is selling coffee at $3.50 when the cost of the coffee is 20 cents per cup, that the café is making money. That is a misconception. Some boutique coffee shops in high traffic areas enjoy good profits, and high rents, but not many.

IT

Those and others of the better operators use good accounting software and thereby have access to daily management information to track their performance – a café can easily have 50 suppliers, and if they do not use technology to manage those among many other tasks, they will not survive, or do so, just, by operating illegally. But in many cases, the ‘business model’, if there is one, and the small margins (other than on coffee and alcohol) do not allow monies to employ even a bookkeeper.

Restaurants, of the 20th century

Restaurants are said to have a breakeven point measured by seats occupied and average spend expected per seat at different time slots during the day. The staff are programmed to reach the average spend with extras (additional food and drinks) and are often financially rewarded to incentivize them. Restaurants will not serve bread before people order, will take coffee orders before food [so, another coffee when the food eventually arrives], and will portion control the food, so that people can get through an additional course.

Restaurants are subject to the benefits of good customer reviews on social media, but also to negative reviews, which have more of an impact.

For all that reliance on IT, CARBs remain in the last century in offering easy selection and ordering, on-line, and payment, with hapless staff continuing to provide labour intensive unskilled ‘service’.  Impulsive purchasing, long the focus of other retailers, seems lost on CARBs, with menus, for one, handed out and taken back as if they were precious items, and in the brief interlude when one is allowed to have one, they require verbal translation of their more exotic ingredients.

Mark-ups on drinks

From a casual survey around a certain inner suburb of Sydney, CARB owners indicated that they break even or make a loss before liquor sales. While the proliferation of home delivery services has assisted in increased sales of food, customers aren’t sitting down to buy a glass of wine, many restaurants are struggling or going broke. The margin in food is much lower than the drinks.

Caterers – never ask a barber if you need a haircut

There is a view that caterers are a significant contributor to food wastage, and perhaps also to the ‘obesity crisis’, though not yet substantiated. Tell them you have 50 people attending a talk with drinks after, and they tell you that you need 50 three course meal equivalents. It is in their commercial, if not moral, interests to do so.

So, if you have 50 people attending your function, tell the caterer is it for 20, and the food will be more than enough.

The workers

Many overseas employees are sponsored on a work or student visa and must have work to show for it.  Apart from their prior working experience in another country, they are often ignorant or willing in working longer and harder, without access to knowledge or advice, and often in regional areas. Some are so keen to work in Australia, in the hope that they can ultimately become permanent residents, that they are prepared to do whatever they can to achieve this.  And there are those who exploit this.

As to other employees, they sometimes become business owners themselves but with limited perspective on the backroom issues of running a café, and there are cases of early cashflow spent on lifestyle, before, it is said, understanding (really?) that they have tax liabilities to pay.

Competition – a market failure?

Anyone venturing into a café purchase needs to be savvy and to take care and take advice.  Caveat emptor much applies, and sales ethics are low.

Once in, the reality might hit a compliant operator, or at least one who intended to be compliant. And one way out of your poverty it is to do unto another as was done to you. And so it goes on, in a downward spiral of commercial immorality, comparable to the construction industry, and perhaps many others [see our next industry review]. Market competition does not work.

 That is the real danger, the intractable spread of reduced commercial and tax integrity and morality.  History shows it taking over countries, through Australia is more resilient than that, despite the many inequities in our tax and other laws.

 A profitable legitimate business model?

So, is there any business model, paying full wages, super, tax, and proper pricing, that would allow any café to operate profitably?

Some models are available on the internet, often put up with further details available for purchase, but they are unlikely to allow for amounts paid upfront to purchase the business. People are reported to pay $50,000 – $450,000 for goodwill on the basis that a business broker asks for it; and they borrow to do this. There is often no foundation from the perspective of a professional valuer in asking for those sums.

What to do?

Given our expressed views on related issues, that the focus should be on the creation of an environment of disruptors and preventers, rather than on reactive attempts at ex post cures, too much time would be taken in explaining these views again.

Better to hear from those with more politically achievable ideas.  Two eminent academics have offered their four solutions[3] – first, to ‘significantly increase the ombudsman’s resources’; second, to enlist the unions, instead of demonising them, a common populist response in other areas; third, to fix what they say are ‘our flawed immigration policies that explicitly disadvantage temporary migrants and make them a focus for predatory behaviour’, including by ‘removing institutionalised dependency inherent in temporary visas’; and fourth, in having the CARB and related associations ‘be more involved in calling out dodgy practices in their industries’.

All worthy ideas, but an institutionalized environment in society of what are essentially cases of man’s inhumanity to man are hard to overcome.

Ideas are welcome.

 

Post script – Selected paraphrased extracts from Fair Work Ombudsman v Skyter Trade Pty Ltd & anor [2018] FCCA 1483.

The second respondent is a tertiary educated young man with a Bachelor of Business with an Accountancy major and a Diploma in Business. After he purchased the Coomera Pizza Hut he attended training conducted by the franchisor. This included education on the terms and conditions in the relevant Enterprise Agreement and employee entitlements under the Fair Work Act, including statements such as Non-negotiables: not paying penalties, allowances or overtime; … failing to provide pay slips; … Sham Contracting”.

FWO submits that despite attending this training, the second respondent flagrantly disregarded the basic entitlements of the employee. Further, he deliberately attempted to engage the employee as an independent contractor despite clear advice from the franchisor to not engage in such arrangements. His conduct was deliberate. He has not expressed any contrition save for ‘some regret’.

‘The failure to keep proper records and to provide pay slips to employees is an insidious practice that is only aggravated by the creation and provision of false documents designed to conceal the employer’s wrong doing. This frustrates the ability of employees to hold an employer accountable for their minimum entitlements. It frustrates the ability of the FWO and others to investigate, assess and claim employees’ entitlements and can result in significant public funds to be expended on FWO investigations.

By way of mitigation, he was born in China and came to Australia to study. His studies were financed by his father. His father operates his own business in China and wanted him to obtain a good education in Australia so he would have a promising career either in China or in Australia. Whilst he was studying he developed an interest in the fast food industry.

He purchased the business relevant to the present application on the recommendation of a friend in 2013 for $550,000.00 using $320,000 borrowed from a Bank and $250,000 borrowed from his father. The surplus borrowings were used to meet the costs of the purchase and other set-up capital requirements.

He relied upon a Profit & Loss Projection that the franchisor gave him which showed a projected profit range of $100,000.00 per year for the first six years.

The business has suffered a loss each year since. While he has been able to keep up the loan repayments to the Bank, ‘he has no funds to repay his father, something about which “he says he feels very guilty and heartbroken”’. He ‘says that he now knows that it was wrong to pay the employee lower wages and that it was a “serious mistake” to do so. He says that he is still young and “full of drive and really want to pick my life up again and start afresh so as not to let my father down”.

He and his company were ordered to pay over $210,000 by way of penalty.

 

[1] https://www.fairwork.gov.au/reports/food-precincts-activities-report

[2] FWO v Skyter Trade [2018] FCCA 1483 is an example.

[3] Four ways to stop restaurants … ripping off workers, Stephen Clibborn and Chris F Wright, Sun Herald, 15 July 2018.

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