We were recently asked whether operating a franchise put a company at a disadvantage right now, given some of the industry’s challenges. Costs are rising. Demand for discounts are increasing. More brands are having challenges. That must be tougher on franchises, at least in theory.
The answer? Last year it certainly was.
We looked at U.S. system sales growth by the Technomic Top 500 restaurant chains and calculated the median growth of brands based on whether they franchised or not and then the percentage of their system that is franchisee-owned.
Median sales growth among companies that did not franchise was 4.8% last year, more than double the 2.5% median growth rate among the 500 chains on the ranking.
We use median for such exercises to understand what the typical company was likely to do, and to eliminate the influence of chains on both extremes of the sales growth curve. Total sales growth on the Top 500 was up 3%, so the typical non-franchised brand did great relative to everything.
By comparison, companies that operated at least some franchise locations did poorly, with a median growth rate of 1.4%. In short, if you simply said that a restaurant chain was a franchised brand last year, you could assume they’d be performing worse than average and you’d probably be correct.
Company-run operations did not rely on unit count to get those sales, either. Among the chains without franchises, median unit count growth last year was flat.
By contrast, median unit growth was 1% for companies with at least some franchises and that increases to 1.6% for brands with at least 50% franchised units.
That makes sense. The real strength in franchising is to build a lot of locations quickly.
Company-run operations have to fund new-unit development, which requires financing in most cases, at least until they get big and profitable enough to fund their own growth. But that makes growth slower.
Franchises work by getting other people to get the financing for you. Aggressive sales strategies can fuel tremendous short-term growth. The fastest-growing restaurant chains in the U.S. are almost always heavily franchised. Among those companies that grew sales at least 20% last year, the median percentage of franchised outlets was 77%.
If we adjust the sales results last year to discount unit growth, it becomes clear that company-run businesses had a far better year than did franchises. Organic sales growth at non-franchises grew 4.8% last year. For franchises, that figure grew less than half a percent.
Franchises are great when business is going well. Companies like Dave’s Hot Chicken and 7 Brew can generate insane levels of growth through aggressive unit count expansion, which takes advantage of a market that is hot.
Yet they are at a disadvantage when sales are tougher to come by and pressure is on brands to win over more skeptical consumers. Brands have to work through their franchisee base to get things done, which is not always easy.
Sales challenges in franchises can compound problems by draining stores of profitability, which leads franchisees to cut costs to earn profit margins, which can make matters worse. They may cut spending on maintenance and upkeep or delay remodels. Many turn to questionable forms of financing such as merchant cash advances to keep afloat.
Discount strategies are also more difficult because they potentially hurt franchisee profits.
Over time, franchisees of struggling, unprofitable brands walk away from locations as leases and franchise agreements run out. And the brands end up in a long-term decline. There are many such concepts in the U.S. right now, such as Quiznos, which has declined from $2 billion in system sales and 5,000 locations to $65 million and less than 150 locations.
That decline is now happening at Subway (down by more than 9,000 locations) and Pizza Hut (sales down 8%, put on the market by Yum Brands), among many others.
Company-run businesses, on the other hand, can more quickly adapt to changing realities because they’re making a single decision for the entire system. They are also less prone to over-aggressive growth because they’re the ones writing the checks, which has a tendency to improve decision-making. And company-run operations aren’t charging stores royalties and ad-fund payments, making stores more profitable from the get-go.
So yes, in a market like this, it’s better to be a company-run system.