Franchisees push back

Amid industry challenges, franchisees get serious about protecting their profits.

These days can’t be great if you’re a franchisee—not in the restaurant business, at least. Same-store sales and traffic have been weak for two years. Competition is intensifying. Labor costs are rising. Rent costs keep escalating. And some customers just won’t come in without a coupon or a discount. Oh, and then there are the remodels, the new technologies and the fees that third-party delivery services charge. 

“It’s the franchisee who is getting squeezed,” says Keith Miller, former head of the Coalition of Franchisee Associations and a longtime Subway operator. “Nothing has gotten cheaper. 

These challenges are testing franchise relationships that have, in fact, improved post-recession. The results are some high-profile disputes between franchisors and the individual operators they rely on to run restaurants.

Miller’s own Subway system is one such example: As operators complained vociferously about the profit challenges of the chain’s $4.99 Footlong offer in January. Tim Hortons, too, has faced operator complaints, both in its home market of Canada and in the U.S.

Branching out

The percentage of franchised locations appears to be slowly increasing, according to Technomic’s Top 500 Chain Restaurant Report.

“We’re coming out of an era of pretty good feelings,” says Ron Gardner, managing partner with the Minneapolis law firm Dady & Gardner. “Business was pretty good for most people, at least relative to the real tough years after the crash.” But things have tightened up, he says. “With QSR lagging, there’s pressure. And when financial pressure increases, tensions increase.”

At the same time operators are grappling with these industrywide challenges, structural shifts continue to occur. Restaurant systems, particularly large ones, have refranchised thousands of units of late, focusing more on franchising. Franchisees, in fact, operated 76.5% of all locations of the Top 500 chains by sales in 2016, up from 75.4% in 2011, according to Technomic. And it’s a percentage that continues to grow each year. As franchisees continue to run more restaurants, good relationships between operators and the home office are crucial. 

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Profits and revenues

One potential source of contention: Franchisors aren’t dependent solely on profits from restaurants. In selling the right to operate their brands—focusing on marketing, brand maintenance and support—franchisors turn running of the restaurants over to franchisees, who are in turn more dependent on profits from individual locations. While the franchisor generates some revenue from the top line, taking a percentage of the franchisees’ revenue, it’s also generating licensing fees and fees from operators opening new stores. 

As driving sales continues to be difficult, and some franchisors push discounts to generate traffic and revenue—sometimes at the expense of operator profits—tension between the groups can escalate. But things changed during the recession; relations eased as both sides took a more cooperative approach. 

“I think the lesson of the crash in 2009-10 is that we’re better off working the hard times together,” Gardner says. “The crash forced franchisors to be more reasonable in things like development and price setting. Out of that has grown, ‘Let’s see if we can figure out how to work together without fighting.’”

As a result, he says, systems have found ways to work together even in times of stress.

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“Franchisors and franchisees, they don’t agree on everything, they are stressed on things, but they are talking and working together more than they did a decade ago,” Gardner says.

Still, the tension over discounts has repeatedly come to the forefront. Subway—for which traffic has fallen 25% since 2012 and operators’ unit volumes are just over $400,000—is dealing with a franchisee revolt over the $4.99 Footlong. Similarly, franchisors of multiple brands are offering discounts to generate traffic, especially amid intense competition in the limited-service restaurant space. But franchisees continue to complain about these discounts being too prevalent, especially at a time of rising costs for labor.

“If I discount this week, and you beat my discount next week, then it’s a vicious cycle we’re in in QSR,” Miller says. “We’re overdiscounting. And it’s the franchisee who is getting squeezed.” This discounting, along with some other ways franchisors are trying to drive profits, is what Miller calls “short-term thinking.” Publicly traded systems are answering to investors, who frequently focus on a chain’s success from quarter to quarter. 

Not all companies are looking for that short-term fix, though. Many private-equity groups that own franchisors are looking a few years down the line. Still, more systems are focusing on franchisee profitability and cash flow. Companies such as Burger King say they have made it a point to ensure that new offers can be done profitably. And a new generation of private-equity firms, such as Panera Bread owner JAB Holding, are focused on keeping their investments for a long time, instead of immediately planning for an exit.  

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Partnering up

In the years after the recession, you would have been hard-pressed to find a system with as difficult a relationship with its operators as KFC. The chain’s same-store sales persistently struggled. It had bad locations. And restaurants were closing by the hundreds as the franchisor terminated operators who wouldn’t remodel—even if they couldn’t.

In 2015, KFC changed course. It started working with its franchisees, reaching a deal to invest $185 million in the brand in exchange for control over advertising. The deal helped usher in the chain’s ongoing ad campaign featuring a revolving door of actors playing the chain’s famous founder, Colonel Sanders. KFC saw positive same-store sales growth for 13 consecutive quarters after introducing the campaign.

“They built an extremely cooperative system,” says Gardner, who worked with KFC franchisees in that agreement. “It’s serving them extremely well as times get harder.”

Cooperative franchise arrangements have generated sales improvements for a number of chains. KFC’s rival, Popeyes, generated strong sales increases annually under former CEO Cheryl Bachelder—leading to its $1.8 billion sale to Burger King owner Restaurant Brands International. The chicken chain notably had a good relationship with its operator community prior to the sale.

Wisconsin-based quick-service chain Culver’s has also quietly generated strong sales in recent years, leading to an investment last year from the private-equity firm Roark Capital. Its average unit volumes are near $2.3 million, while global sales increased 9% in 2016.

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Getting buy-in

Many of the operators inside 600-unit Culver’s came up through the system.The chain has a mentorship program in which an operator who wants to open a second unit taps a leader from his or her existing location. That employee goes through a 16-week franchise program and becomes an operating partner. “They’ve already established a strong working relationship with Culver’s Franchising, which is cool,” says George Kelsey, vice president of training and operations for Culver’s.

The company holds regional meetings with its executives and also runs
ButterBurger University, which is largely voluntary and trains about 2,000 franchisees a year. The communication, Kelsey says, “has been a very valuable part of our success formula.”

Kelsey also says that the chain gives its operators an opportunity to talk about initiatives during tests, long before they are employed throughout the system. The company’s franchise advisory council gives input and voices its opinion on these efforts.

“We pretty much resolve issues prior to a decision being made,” Kelsey says. “Most reasonable people, if [given] the opportunity to have input in a decision, will feel pretty good about the decision. That’s a good management practice, and it’s done well for Culver’s.” By addressing concerns right away, the approach prevents them from boiling to the surface post-rollout, and it ensures franchisee buy-in upfront. “Franchisees don’t want to run the system,” Gardner says. “They want people to listen to them as people who have on-the-ground experience.”

Miller says franchise systems should not look at their operators as employees, but as investors who have put their money and hard work into the brand. In many systems, he says, franchisees have personal guarantees attached to their restaurant: If they default, they lose not only their business but potentially also their home and savings. 

And franchises that are profitable get more investment from a franchisee, who will develop new units, remodel restaurants, add technology and carry out other initiatives to help a system grow. “I’ve always looked at franchisees as investors,” Miller says, “and they should be treated as such.”

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