A lot of struggling restaurant brands seem to believe that franchising will be their saving grace. Last month, for instance, my colleague Lisa Jennings wrote about &pizza, the fast-casual chain that is selling most of its corporate stores and will start franchising. The chain’s sales declined 15%, according to Technomic Top 500 data.
Another colleague, Joe Guszkowski, wrote about California Pizza Kitchen, which also launched franchising in the U.S. Its sales fell 10% last year.
MOD Pizza, meanwhile, flirted with bankruptcy last year. It has always franchised but owned a healthy dose of corporate stores. Now it plans to sell them.
Franchising as a business can be great, particularly if it’s done the right way. Refranchising a struggling brand is a tried-and-true method in the industry. If you can’t make money running restaurants, sell them to someone else and hope they can do a better job and are willing to tolerate weaker profit margins while the corporate parent enjoys the capital-light, high-profit franchising business.
But in doing so, these brands are putting themselves at a distinct disadvantage, particularly in a market like this one.
Specifically, franchised brands will have a tougher time navigating a high-cost environment in which the consumer is especially price sensitive.
By franchising a brand, companies do several things that make it tougher for operators to profit. First, they put restrictions that make it difficult for operators to cut simple costs in the name of consistency. Operators must use specific equipment and specific signage and use specific types of technology. This is generally good because brands do need to be consistent from one store to the next. But it can eliminate an important source of profit-finding for restaurant owners.
Second, royalty and ad fund payments also mean those operators must make a profit from less revenue. That $3 cheeseburger, for instance, might in fact bring in just $2.60. That can encourage franchisees to raise prices to generate the profits they need, which can be problematic in a price-sensitive environment. And when brands want to offer discounts to satisfy price-conscious consumers, then franchisees may have to raise prices on other products to make up for tighter margins. In the worst situations, franchisees push back hard on discounts or simply opt not to do them, as in the case of Subway.
Third, franchising makes it tough to get things done. When Chipotle wants to remodel units, it just reaches into its vault and funds a remodel. When rival Qdoba wants to remodel, it must work with franchisees to get that done. Those franchisees, if they’ve planned well and have financing, may have prepared and budgeted for it. But if Qdoba were struggling (it’s not—its sales grew 10% last year), those franchisees may not have the ability to fund those remodels, which will deprive that restaurant—and the franchisor—of any sales lift or efficiency benefit that may come with the new design. This gives Chipotle a distinct advantage in the burrito business.
The latest bankruptcy of a Burger King franchisee, Consolidated Burger Holdings, followed the company’s apparent inability to fund remodels for many of its locations. The franchisee’s financial problems—and weak sales of the brand itself—made it that much harder for the operator to pay for those capital costs. So the market was stuck with old Burger King restaurants.
All this can play a role at a time when consumers are cutting back on dining, as they are now. When people do not eat out as much as they would like, for whatever reason, they will visit brands that give them what they want and will not visit brands that fail for one reason or another.
A customer that walks into a restaurant that’s dirty, or that has slow service because there are not enough people behind the counter, may be far less likely to come back. If the prices for the items they want are too high for what that customer thinks they’re worth, they won’t come back. If the local stores don’t spend enough on local marketing, those local customers may forget those brands exist when it comes time to order.
Restaurant chains that look to turn themselves around with a company-store model ultimately benefit when they succeed. When they opt for franchising, in other words, they are eschewing that benefit, either to pay off debt or to cut costs or as part of a financial engineering strategy. Either way, they are making it even tougher on their brands to succeed in a market like this.