Small restaurant chains worry about ACA costs

Some restaurant operators are scaling back expansion plans because of uncertainty about the expense of insuring employees under the new federal health-care law.

The concerns are especially acute among smaller operators who are more likely to be on the cusp of the Affordable Care Act's requirements for increased coverage of workers. The doubt is adding to anxiety over other rising costs for items like ingredients at a time when diners are cutting back on eating out.

Sam Ballas, chief executive of ECW Enterprises Inc., owner of East Coast Wings & Grill, a 26-unit chain in North Carolina and Texas, in March imposed a three- to five-unit limit, for the time being, on the number of restaurants that franchisees can own, because of worries about health-care costs.

The law requires employers with more than 50 full-time equivalent employees—those who work 30 hours or more a week—to start offering health insurance to full-time employees in 2014, or to pay a penalty.

Mr. Ballas said several East Coast Wings franchisees are up against that limit now and that one is considering selling a restaurant to remain below the threshold.

Mr. Ballas's company studied the past two years of financial data from its restaurants, and modeled how many units a franchisee could own and remain profitable after covering full-time workers. The model showed that franchisees who operate three or fewer stores are likely to remain under the mandatory insurance threshold, while an owner who manages five restaurants efficiently would have just enough scale to offset the cost of paying for insurance or the penalty. Beyond that number, Mr. Ballas said, his company isn't sure how many restaurants a franchisee could profitably operate under the new law.

"There is no question that the Affordable Care Act has thrown a wet blanket on franchise development," said Stephen Caldeira, CEO of the International Franchise Association. In a recent survey of its members, the trade group found that 64% of franchisers and almost 72% of franchisees said the health law creates some uncertainty or significant uncertainty in long-term planning.

"Small-business people are telling us they're afraid to take on any more debt until they know the full cost of the Affordable Care Act," said Richard Hunt, CEO of the Consumer Bankers Association.

The restaurant business has been a focus of debate about the health-care law's impact, in part because of its heavy reliance on part-time workers who don't currently have coverage. Some executives have warned that it could hobble the industry, although some companies, including Wendy's Co.have scaled back initial estimates of how much the law will cost their restaurants, and others, such as Dunkin' Brands Group Inc.have played down the impact the health-care overhaul will have on the industry.

The Obama administration says the health-care law will benefit small businesses like franchises, in part by creating insurance marketplaces where they can pool their buying power. "The Affordable Care Act will save money for businesses while giving workers and employers access to quality, affordable health care," said a Treasury Department spokeswoman.

The law hasn't crimped expansion plans for some big restaurant companies. Large chains tend to have sophisticated procurement departments that can hedge against volatile commodity costs as well as the scale to negotiate prices of other items, such as paper goods, which can better help franchisees absorb other cost increases. McDonald's Corp., MCD which estimates the law will cost $10,000 to $30,000 per restaurant, is opening more new restaurants in the U.S. this year than it has in each of the past three years. A spokeswoman said she hasn't heard of franchisees scaling back expansion plans.

For others, though, the law adds to other reasons for caution. White Castle Management Co., a closely held chain that doesn't franchise any of its 406 restaurants, says it is significantly slowing its growth plans in light of rising health-care and other costs. The burger chain plans to open two or three new restaurants this year, down from about a dozen three years ago, and five in both 2011 and 2012, company spokesman Jamie Richardson said.

White Castle currently offers health insurance to employees who work 35 hours or more per week, and 80% of eligible employees accept. Under the law, the offer will have to extend to those who work 30 hours weekly, and employees who refuse will have to pay a penalty. "What we don't know is what percentage who decline insurance now will sign up for it" when the law takes effect in January, Mr. Richardson said. "This has caused us to re-examine our strategy."

Franchisees say some of the law's details, such as how employers will count workers' hours, have yet to be finalized, limiting their ability to plan. Joe Drury, who owns 22 Wendy's restaurants in Tennessee and Virginia that employ 600 people, said he wants to open three more restaurants next year. But "if the Affordable Care Act costs me too much money, I'm not going to. It's as simple as that," he said.Wendy's spokesman Denny Lynch said health-care costs are among many concerns franchisees have expressed, along with high chicken and beef costs. Like other restaurant chains, Wendy's is pushing franchisees to remodel their restaurants in order to remain competitive with the likes of McDonald's, which has upgraded thousands of restaurants. Wendy's is presenting franchisees with different remodeling options ranging from $350,000 to $750,000 per store.

Wendy's originally estimated the cost of complying with the law to be $25,000 a year per restaurant, but more recently its chief financial officer revised it to $5,000 because the company expects many employees to decline the insurance.

"I sure hope he's right," said Mr. Drury, who said he hasn't yet done his own calculations for his operations.

Mr. Drury said he is committed to remodeling his existing stores because "I have to do it to protect my market share." But, he said, "I'm not committing to how fast I'll move until I know what the costs of the health-care act will be."