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Why refranchising is good for the restaurant business

Despite some issues, franchisees are better at running restaurants than franchisors.

The Bottom Line

My colleague Peter Romeo isn’t necessarily wrong when he recites some of the problems that arise when franchisors don't operate more locations.

If I had a nickel for the number of activist investors who have blindly suggested that restaurant companies refranchise without actually understanding the process that much, I’d be wealthy enough to be an activist myself.

But that doesn’t mean Wall Street is all wrong, or that Peter is all right. In fact, despite some of the challenges I’ve been writing about recently, refranchising is still a net good thing for the restaurant business.

Here’s why:

Franchisees are better at running restaurants.

When franchisors operate company stores to have some “skin in the game,” too often that skin is dry, cracked and neglected.

In 2012, for instance, large-scale Burger King operator Carrols Restaurant Group bought 278 restaurants from its franchisor. The restaurants were in poor shape and had weak sales and bad profits, which improved considerably under the franchisee. In 2015, restaurant-level earnings more than doubled at those locations.

There’s nothing wrong with franchises operating restaurants. But when running restaurants is done simply as a franchising strategy, then operations become secondary.

Franchisees, meanwhile, are determined to run good restaurants and earn profits so they can make their money. That ultimately helps sales and improves the health of the system. Back in 2015, average weekly sales at those refranchised Carrols Burger King restaurants increased more than 10%.

Franchisors can concentrate on brand management.

Selling franchises and marketing a system require different skills than operations. Freed from the responsibility of maintaining and operating restaurants, systems can devote their attention to running the system.

For this, we go back to Burger King, which quickly unloaded its restaurants and then proceeded to focus on its brand. After some hiccups, the chain has been on a roll—same-store sales rose 5.1% in the fourth quarter, for instance.

The chain has discounted plenty but has concentrated those discounts on less popular items such as its chicken nuggets, pancakes and ice cream. Its 2-for-$6 Whopper deal has been so successful that other systems are mimicking the idea.

The biggest problems in franchising tend to come from bad management, and not franchising itself. Bad management is not unique to franchised brands.

Investors aren’t the only ones making money.

Franchisees have done as much as franchisors to fuel the refranchising trend by eagerly purchasing stores being sold. If they felt franchisors needed more skin in the game, why are they buying the locations?

Restaurants generate a lot of cash. So franchisees have been able to buy the stores cheap, improve operations and generate even more cash—making many of these operators quite wealthy.

Private-equity groups, which once avoided franchisees like the plague, have been investing in these franchisees. And now other investors are getting into the act.

For instance, Greg Flynn was a good franchisee of Applebee's in 2008. As Applebee's refranchised, Flynn bought up large swaths of those locations at low prices. He then bought into Taco Bell, and then acquired Panera Bread locations when that system, pushed by an activist, refranchised some restaurants.

Flynn Restaurant Group is now the largest franchisee in the U.S. And Flynn himself was named our 2016 Restaurant Leader of the Year. 

One of his investors is the Ontario Teachers Pension Plan. In other words, teachers are making money for their retirement from refranchising.

You don’t have a problem with teachers making money for their retirement, do you Peter?

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