Edit
OPINIONFinancing

Will franchising fall out of favor?

As pressure grows on franchisees, companies might find it better to keep some locations for themselves, says RB’s The Bottom Line.
Photograph: Shutterstock

the-bottom-line

Last week, Applebee’s bought 69 restaurants in the Carolinas from Apple Gold and, at least for now, has no plans to sell them to another franchisee.

That’s significant, at least for the casual-dining chain, and could be significant for the restaurant business as a whole if Applebee’s ultimately decides to keep those locations—which it plans to operate “for the foreseeable future.”

It’s rare that all-franchised brands buy back restaurants and then keep them. Once you franchise, you stay franchised.

It’s also symbolic. While companies such as Yum Brands have been refranchising for years, it was Applebee’s that seemed to ignite the most recent refranchising trend when IHOP purchased the company in 2007.

Applebee’s sold off company restaurants in droves, sometimes for low prices. Other companies followed suit, and the asset-light business model took off. Companies like Burger King, Wendy’s, McDonald’s, Jack in the Box and others sought to sell their company restaurants to franchisees instead of operate them.

That Applebee’s would buy back restaurants could be a major signal that the franchising tide in the restaurant business has started to turn. That would be a good thing.

Nor would it surprise us to see more deals like this as franchisors realize there is some benefit in demonstrating to franchisees that they know what it’s like running restaurants.

Refranchising company restaurants made sense from a financial standpoint because it’s more profitable to sell the right to operate a brand than it is to sell burgers and fries—after all, they have fewer capital costs and don’t have to hire people and invest in point-of-sale systems. And franchisees frequently run the restaurants better, anyway.

Operators snapped up such deals, seeing an opportunity to grow large. Running restaurants generate a lot of cash, and banks were eager to loan money to franchisees that wanted to get bigger. Flynn Restaurant Group grew rapidly, ultimately becoming the largest franchisee in the U.S., at first by purchasing a bunch of Applebee’s locations in refranchising deals.

By refranchising, companies cede control over their growth and their investment strategies in favor of higher profits. This can slow things down.

Many franchisors, under pressure to increase revenues, have been taking a hard line on their operators, pushing remodels and aggressive development schedules in exchange for the right to buy new locations.

That, coupled with rising profit pressures as sales weaken and labor costs rise, has given rise to a franchisee revolt in systems such as Tim Hortons, McDonald’s and Jack in the Box.

But plenty of systems have proven that you don’t have to unload store operations onto franchisees to do well. In 2011, after its sale to Roark Capital, Arby’s began refranchising. Paul Brown was named CEO in 2013 and put a halt to that. And the company has benefited from improving profits on those company operations in the years since.

Brown took a similar strategy with Buffalo Wild Wings after Arby’s bought that chain earlier this year.

Companies such as Panera Bread did quite well without refranchising all of their locations. Chili’s has also avoided refranchising, and in fact bought out a franchisee last year.

Indeed, a few restaurant chains have actually avoided the temptation to refranchise, opting instead for more company operations.

In addition, brands might find it tougher to find franchisees willing or even able to buy up restaurants in the coming years if interest rates rise or lenders start being more cautious with their loans—a distinct possibility given the financial strain a growing number of these franchisees are under.

But there is clear value in having some store operations. Applebee’s is proof.

Two years ago it pushed a strategy of hand-cut steaks and wood-fired grills that was an abject failure—one of the biggest marketing blunders in recent industry history. Sales plunged, at least one operator filed for bankruptcy, and the company ousted the engineer behind the refranchising strategy, Julia Stewart.

Applebee’s might have avoided that problem if it tested the idea in company restaurants first.

Trending

More from our partners