Nation’s Restaurant News – 2018 Top 200: Deal-making alters company rankings

Merger-acquisition landscape remains attractive into 2018

Ron Ruggless | Aug 22, 2018

This is part of the Nation’s Restaurant News annual Top 200 report, a proprietary ranking of the foodservice industry’s largest restaurant chains and parent companies.

Mergers and acquisitions again changed the complexion and makeup of this year’s Nation’s Restaurant News top foodservice company rankings, and the deals continued into this year as well.

Merger and acquisition activity in the census, which included 2017 deals, crossed segments and size, ranging from JAB Holding Co.’s $7.5 billion buyout of fast-casual bakery-cafe brand Panera Bread Co. to Darden Restaurants Inc.’s $780 million purchase of Cheddar’s Scratch Kitchen from private-equity owners.

And the activity has continued into 2018, with Roark Capital Group closing in February on the $2.9 billion acquisition of casual-dining Buffalo Wild Wings Inc. by Roark-affiliated Arby’s Restaurant Group Inc.

“In my view, the Panera buyout by JAB in April 2017 and the Buffalo Wild Wings purchase by Roark, via its Arby’s entity, in November 2017 were highly significant and stand out among the large amount of merger and acquisition activity of late,” said John Gordon, principal in the San Diego, Calif.-based Pacific Management Consulting Group.

Scott Olson/iStock/Getty Images Plus

JAB Holding Co.’s acquisition of Panera Bread was the largest deal among many in 2017 tracked by Nation’s Restaurant News.

And Gordon said still favorable, though increasing, interest rates and a hunger for growth on a global scale are helping fuel the merger and acquisition activity.

“The general driving forces behind restaurant M&A remain robust, principally because larger strategic buyers look to acquire brands that have been established and can grow more quickly than building them from square one,” Gordon explained.

“In addition, the cost of debt, while a bit higher in 2017 and 2018 than the very-low cost years prior to 2016, is still favorable,” he said.

Courtesy of Cheddar’s Scratch Kitchen

The acquisition of Cheddar’s contributed to Darden’s double-digit growth in estimated Latest-Year revenue.

Private investment firms are also adding money to the M&A fire.

“Many private-equity funds have available funds from investors seeking a return,” Gordon said. “Also there has been the growth of the global restaurant-brand integrators — like JAB and Restaurant Brands Inc. [backed by the 3G firm] — following in the pathway of Yum! Brands, to gain worldwide scale and scope.” JAB is based in Luxembourg and RBI in Oakville, Ontario, near Toronto.

The biggest M&A deal of 2017 was the JAB acquisition of St. Louis, Mo.-based Panera Bread, which took the longtime publicly traded company into private hands.

Gordon said that deal “was significant because it displayed further development of the JAB Group as a huge privately held restaurant and coffee/consumer products player, as well as recognized the goal of [Panera] CEO Ron Shaich to avoid the rigors and ‘shortsighted nature and demands’ of stock activists.”

Gordon said Panera and Buffalo Wild Wings were at different positions in their businesses at the time of the deals.

“Panera was very strong and growing at time of acquisition,” he said.

Whereas “Buffalo Wild Wings was in a downturn and was in the immediate aftermath of a painful board proxy battle. The long-time CEO had opted to retire and faced a leadership and market momentum void. It was the just in time solution, in my opinion.”

Merger and acquisition impact on company foodservice revenue in the Latest Year was considerable. Orlando, Fla.-based Darden Restaurants, for example, in its Latest-Year saw estimated U.S. revenue increase by 12.7 percent, with much of that gain from a projected $664.1 million in sales from earlier purchase Cheddar’s.

Among other notable foodservice mergers and acquisitions that have or will have an impact on company revenue:

  • Paris-based Sodexo, after the close of its Latest Year in December 2017 acquired the Centerplate contract-management firm from Olympus Partners for $675 million. Centerplate, with estimated Latest-Year U.S. foodservice revenue of about $790 million, could significantly bolster Sodexo’s balance sheet going forward.
  • JAB, in addition to its Panera acquisition, acquired through an affiliate in October 2017 the 270-unit Bruegger’s Bagels bakery-cafe chain from Groupe Le Duff S.A.-affiliate Le Duff America Inc. The company also acquired, through its Panera LLC affiliate, the 304-unit Au Bon Pain bakery-cafe chain held by LNK Partners LLC. And in May of this year, it agreed to acquire Pret A Manger, a London-based bakery-cafe chain, with about 530 locations worldwide, including about 90 in the United States.
  • Houston-based Fertitta Entertainment Inc. in August acquired for $57 million the Joe’s Crab Shack and Brick House Tavern & Tap chains out of bankruptcy from J.H. Whitney affiliate Ignite Restaurant Group Inc.
  • Private-equity firm Olympus Partners in January sold Overland Park, Kan.-based NPC Restaurant Holdings Inc., a franchisor of Pizza Hut and Wendy’s restaurants in the United States with reported Latest-Year revenue of $1.36 billion, to a privately owned joint-venture group that included Los Angeles-based Eldridge Industries.
  • Jack in the Box in March completed its sale of Qdoba to Apollo Global Management in a $305 million cash deal. Affiliates of New York-based Apollo, which also owns the parent companies of the Chuck E. Cheese’s and Peter Piper Pizza dining-and-entertainment brands, gained more than 700 owned and franchised Qdoba restaurants in the U.S. and Canada. In fiscal 2017, the Qdoba brand generated systemwide sales of more than $820 million.
  • Restaurant Brands International, parent to the Burger King and Tim Hortons brands, completed its $1.8 billion acquisition of publicly traded Popeyes Louisiana Kitchen Inc. in March 2017, adding more than 2,600 quick-service restaurants to it portfolio. RBI’s Latest-Year revenue includes an estimated $184.1 million in post-acquisition U.S. sales and franchising income from Popeyes.
  • Irving, Texas-based Del Frisco’s Restaurant Group Inc., parent to the Double Eagle, Del Frisco’s Grille and Sullivan’s Steakhouse concepts, in June acquired for $325 million the Norwalk, Conn.-based Barteca Restaurant Group and its 15 Barcelona Wine Bar and 16 Bartaco full-service restaurants. Barteca, as a freestanding company, had reported Latest-Year U.S. foodservice revenue of $128.2 million.
  • Private-equity deals continued to alter the parent-company landscape, including several over the past year by New York-based Sentinel Capital Partners LLC. In December, Sentinel   acquired from Centre Partners Management LLC the 531-unit Captain D’s and 49-unit Grandy’s limited-service chains. The Sentinel acquisition was offset by the February sale of the 350-unit Huddle House family-dining chain to Elysium Management and the April 2017 sale of Checkers and Rally’s Hamburgers chains, with a combined 850 units, to Oak Hill Capital Partners for $525 million.
  • Cerberus Capital Management L.P. in January 2017 acquired out of bankruptcy the Garden Fresh Restaurant Corp., parent of the Sweet Tomatoes and Souplantation buffet chains, previously controlled by Sun Capital Partners. Those chains previously were controlled by Sun Capital Partners. In a quick flip, Cerberus, in August 2017, sold Garden Fresh to investor groups led by Perpetual Capital Partners, which now owns controlling interest.

Restaurant Business – A good summer for restaurants, but not for chains

July sales spiked 9.7%, but large brands are still seeing traffic problems, thanks perhaps to “chain fatigue.”

This has been a good summer for the restaurant industry. According to federal retail sales data, U.S. restaurant sales jumped 9.7% year over year on a seasonally adjusted basis.

That continued a recent surge. Sales rose just 3.8% in April and have accelerated every month since then—potentially signaling that consumers are opening their pocketbooks as their taxes decrease and their finances improve.

But there’s one problem: Restaurant chain sales, at least for now, don’t appear to be keeping pace.

Same-store sales in July, according to the monthly Black Box Intelligence Index, rose just 0.5%. And same-store traffic has been down all year long, including a 1.8% decline in July. And the monthly Technomic Chain Restaurant Index was also weak in May and June even as total industry sales seemed to jump.

Blame what John Gordon, a restaurant consultant out of San Diego, calls “chain fatigue.” “Guests have always had the desire to try something new, to enjoy a quality experience, and to be entertained,” Gordon said. “We have chain restaurant unit overload that leads to chain restaurant fatigue.”

“The overall experience doesn’t seem to be good enough right now,” he added. “But it can be fixed.”

Chain fatigue?

The annual growth in restaurant sales has spiked the past three months.

Restaurant Sales Monthly Annual Change

Source: U.S. Census Retail Sales, Food Services & Drinking Places, Seasonally Adjusted

Some do question the data itself. Technomic, a sister company of Restaurant Business, does not pay much attention to the federal data over concerns about the limited number of sources for its calculation.

And a 9.7%, annual increase in sales should be reflected more in chain performance.

Yet, for the most part, same-store sales in the second quarter were modest and chains such as McDonald’s, Starbucks, Chipotle, Shake Shack, Dunkin’ Donuts and others reported lower traffic.

Quick service and fast casual chains’ same-store sales averaged under 1.5% in the second quarter. That wasn’t enough to match the 2.8% annual increase in menu prices so far this year—meaning that these chains’ traffic fell.

If consumers were rushing out to their local restaurants the past three months, more of those publicly traded companies would have reported stronger same-store sales.

Still, the discrepancy backs a growing contention among many industry observers that consumers are shifting more of their spending toward small chains and independents that are not typically captured by major indexes.

And there are more chains now than there was even five years ago. Consider that chains such as Shake Shack, Mod Pizza and Blaze Pizza, among others, were barely registered if they existed at all five years ago.

“When you think of how many new players are out there, especially in segments like fast-casual that we didn’t even have a few years ago, there are so many players in there, and some of them are becoming the favorite restaurant of a lot of people,” said Victor Fernandez, vice president of insights and knowledge at Black Box parent company TDn2K.

“If you have six favorite chains and now you have seven, now you lose that much traffic.”

Fernandez noted, for instance, that more chains are doing better this year. He said that half of restaurant chains his company surveys have better same-store sales than a year ago. The year before, that number was just 36%.

And consumers do have a lot of choices in their restaurants. The number of locations in the U.S. has jumped 16% over the past decade, according to federal statistics.

With so many choices, in addition to convenience stores and grocery store prepared food, consumers might be spreading their dollars.

“The number of options are so big that the overall sector is growing at a rapid pace, but chains are not capturing that same spike,” Fernandez said. “The dollar is getting diluted among more locations.”

The Union Tribune – Jack in the Box franchisees press company board to replace CEO

Jack In The Box franchise holders that own 2,000 restaurants are calling for the replacement of the company's executive management.

A group of Jack in the Box’s franchisees is calling for the ouster of Chief Executive Leonard Comma, claiming the San Diego quick service restaurant brand is not spending enough to support them.

The National Jack in the Box Franchisee Association – comprised of 95 owners of roughly 2,000 of the Jack in the Box’s 2,240 locations – published a letter Tuesday calling for its board of directors to replace Comma and the current leadership team.

Michael Norwich, chairman of the association and owner of 14 Jack in the Box franchise restaurants, cited a lack of corporate resources for marketing and other support services – which is causing “unsustainable losses in sales.”

“Management is thinking so quarter to quarter right now,” said Norwich in a phone interview. “That is what is really hurting us.”

“There are two ways to get the value in the business – driving profitable top line sales or cutting expenses, and they have really focused on the latter,” he said. “We don’t even have a chief marketing officer at the moment. There have been key positions in the marketing department that have gone unfilled.”

This summer, Chief Marketing Officer Iwona Alter left the fast-food chain after 13 years with the company. One of its advertising agencies also is no longer working with the firm.

“There has been a lot of turnover,” said John Gordon, head of San Diego-based restaurant industry advisory firm Pacific Management Consulting Group. “When you have the CMO go and do not have a replacement, and the ad agency goes before the CMO, that pattern tells me there is some stress.”

In a statement, Jack in the Box said it has worked closely with the National Franchisee Association leadership over the past year.

“We have always been open to their constructive feedback and have worked to address any legitimate concerns,” said the company. “Importantly, we believe the viewpoints expressed today by the NFA leadership are not reflective of the entire franchise community.”

The franchisee group cast a “no confidence” vote in Jack in the Box’s executive team at its annual meeting in July, according to the letter. It has hired Robert Zarco, a Miami-based trial lawyer with experience in franchisee rights, to represent restaurant owners in the dispute.

The public letter calling for replacement of the CEO is a surprising step for Jack in the Box franchisees, many of whom have operated franchises for a long time, said Gordon, the restaurant industry consultant.

“This is nuclear in the franchise world,” he said. “Jack in the Box, we love it here in San Diego. It is our home brand. But it has always had trouble growing outside of the West Coast.”

Under pressure from activist shareholders, Jack in the Box sold off its Qdoba Mexican restaurants recently. It also has been transforming company-owned restaurants into franchise locations.

Although Jack in the Box posted better-than-expected earnings per share and revenue in its most recent quarter, the gain was driven by a lower tax rate and share repurchases. Same store sales growth — a key metric in the restaurant business — was only 0.5 percent.

Quick service franchise restaurant companies typically spend about 4 percent of revenues providing services and support to their franchisees, said Zarco. With Jack in the Box, the target for this type of spending this year is 1.8 percent, he said. “That is a dramatic reduction.”

Zarco claims he has been trying to engage in direct discussions with Jack in the Box’s board of directors, but at this point has been unable to do so.

New York-based activist investor Jana Partners, which owns 7.5 percent of Jack in the Box’s stock, told Bloomberg News in an email that it shares the franchisees’ concerns about Jack in the Box’s performance and the lack of urgency in addressing it. “We appreciate their input and will incorporate it into our ongoing dialogue with the company.”

Shares of the company closed trading Tuesday up 16 cents at $84.22 on the Nasdaq exchange.

John A. Gordon – Why Is Restaurant CapEx Spending Assistance To Franchisees On The Upswing?

Some interesting developments in restaurant franchising are becoming a reality even in the “asset light” restaurant space. It turns out that it does take money to make money in the future.

The requirement for franchisee capital spending (CAPEX)—the big-ticket construction, equipment and information technology outlays—is often underestimated and almost always under reported. These outlays traditionally have been the franchisee’s responsibility. A few chains, like McDonald’s (MCD) and Tim Horton’s (THI) Canada, kept real estate and construction in house and initially corporately funded it, with franchisor cost recovery occurring over time by the franchisee paying at or above market rents. Later, the McDonald’s franchisee must pay for remodels, as well as the more costly total rebuilds or relocated units. Typically the franchisee remains responsible to pay for all future remodel and maintenance CAPEX outlays. But this is relatively rare, mostly the franchisee funded the capital spending via friends and family, bank debt, partners and injected cash. That was doable by some, especially after the Great Recession as interest rates remained very low.

This “franchisee sole responsibility to fund” reality has begun to change in some brands over the last few years out of necessity.

First, as the utility and success of technology backed loyalty, delivery and digital interfaces have been pioneered by Panera (PNRA) , Starbucks (SBUX) and Dominos (DPZ), the digital level of complexity has been raised. Restaurant franchisors have come to understand that an IT backbone would have to be built and maintained centrally by brand headquarters.[1] It would have been unworkable for there to be thousands of servers among a brand’s franchisee units all maintained separately—the cost to implement would have been impossibly expensive and many of the systems would be built differently and likely couldn’t talk to one another.

Another issue: the level of capital expenditures necessary to remodel restaurants and add new brand mandated systems and equipment has become big numbers. Our calculations show that depreciation expense—the typical proxy for capital spending that is a tax deduction and a non cash expense—isn’t enough to provide a fund. The actual outlay of cash required is greater than that. Even if restricted cash is available to pay for future remodels and upgrades, the effect of inflation on construction and equipment would require even more funds than were originally earmarked to get the same purchasing power. Keep in mind that most franchisees have a store development agreement in place, whereby building new stores or purchasing new stores competes for funding with remodels. Bank debt can partially suffice unless lending covenants are already stretched.

Finally, franchisees are typically in ‘wait and see’ mode on remodels and new sales platforms until the franchisor executes it themselves and proves that it works. That builds in delays–time of implementation lags. If the franchisor has company stores (some do not, such as Dunkin Brands (DNKN) and Subway, for example), it takes time for brands to get proof to market and get the franchisees on board. This has happened with all of the leading franchisors—McDonald’s, Wendy’s (WEN), Burger King (QSR), Sonic (SONC) and many others.

As a result, some franchisors have taken the lead in making co-capital investments with franchisees to jump start future progress. A partial list follows:

  • Since McDonald’s (MCD) owns most of its real estate, it can justify partially funding franchisee costs. This occurred in 2008/2009, with the McCafe co-investments (about $150K per store), and then in 2016/2017 with its Experience of the Future Investment (about $6 billion in total franchisor/franchisee investment over 2018-2020, with the franchisor funding about 55% of that.[2]
  • Via its parent YUM Brands (YUM), Pizza Hut made a basket of investments in 2017 ($130M)[3]and 2018 ($200M)[4] to enhance restaurant operations, marketing and remodeling. This was done to ease the burden on franchisees and to ensure improvements were implemented more quickly.
  • Dunkin Brands (DNKN) recently set aside about $65M for CAPEX and equipment to help fund test store’s expansion to its Next Generation store types.[5]

There are several actions required of both franchisors and franchisees to make these business issues work for all.

First, the franchisor must take the lead to timely source and test lower cost remodels and new store footprints. They are the brand steward and are responsible contractually to define brand standards. Many franchisors are slow to prioritize this, often prioritizing central national marketing expense, share buybacks and debt service requirements. The size, look and location of the remodeled restaurant is critical. A capital investment such as building and locating a new store is costly. If the wrong site is picked, it is almost impossible to reverse the effect of that missed opportunity”

Additionally, better scorekeeping is necessary. Much greater visibility to fully loaded (i.e., with capital spending and debt costs fully allocated) franchise store economics is required. Some franchisees don’t report their capital spending and capital spending data; some franchisors are afraid to know and pretend they don’t have that data. Tracking EBITDAR or EBITDA is of only so much use if the CAPEX and debt service costs can’t be seen.

Finally, franchisees need to ask and document their needs and wants in an organized way. Through either franchisee associations or via brand advisory councils, organized requests and backup needs to be presented. There is strength in numbers—some franchisors prefer to deal with individual franchisees head to head to avoid group pressure.

[1]Some franchise brands have implemented a small fee on loyalty and digital transactions sales to fund this outlay. Dominos and Subway are examples.

[2]Investor’s Business Daily, Q4 MCD Earnings call discussion, January 30 2018

[3]Nation’s Restaurant News, May 3 2017. In 2015, YUM noted it invested $180M for KFC requirements.

[4]https://investors.grubhub.com, February 8 2018.

[5]Restaurant Business Online, July 28 2018

USA Today – Subway $5 Footlong is going away, but paninis may be coming

, USA TODAY Published 5:58 a.m. ET Sept. 10, 2018 | Updated 8:00 a.m. ET Sept. 14, 2018

Subway Restaurants’ $5 Footlong jingle is the kind of ear worm that’s hard to get out of your head, but now you might have to.

The iconic sandwich may no longer be at your local restaurant. Trevor Haynes, current CEO of the Milford, Connecticut, company, told USA TODAY in an exclusive interview that starting this month, each franchisee will be allowed to decide whether to sell the sub that is so famous.

Or infamous.

When the chain brought back the $5 Footlong last winter after a years-long absence, many franchisees were irate. They complained loudly of the slim margins they earned off of the discounted ‘wich, and according to Haynes, the company – whose restaurants are 100 percent franchised – listened to the gripes.

“How do we help our franchises with more of a regional value message, so they’re able to (have) a value proposition that fits with their economic model,” Haynes said. “If you look at California, there’s a very different cost of business than in Arkansas.”

The 53-year-old privately-held company, originally called Pete’s Super Submarines, had $16.8 billion in global sales in 2017, thanks to some 44,000 restaurants worldwide, including 25,000 in the U.S. Subway, which has put about 1,300 stateside locations on the chopping block in two years, declined to share growth percentages or customer traffic numbers.

Haynes, 47, became CEO this summer after Suzanne Greco, sister of Subway co-founder Fred DeLuca, retired. The Australian has worked for the company for 12 years on three continents and inherited a brand still smarting from the sex and child-pornography scandal of former company spokesman Jared Fogle.

The demise of the $5 Footlong is just one of the differences customers will notice at Subway. Here are four other changes Haynes shared with USA TODAY.

Other cheap eats are available

Remember that some franchisees may choose to retain the $5 Footlong, but Subway is encouraging different markets to try their own value options. For examples, customers in San Francisco can now buy a $3.99 6-inch sub.

“Affordable food is what we’ve always stood for,” Haynes said. “It’s not just about one price point.”

Restaurant consultant John Gordon of Pacific Management Consulting Group questions how low Subway can drop its prices, due to its main meats – ham, roast beef and chicken.

“Those are generally more costly on a per-pound basis than the ground beef that the burger guys use, so Subway has a hard time discounting,” he said. “There’s a tremendous amount of franchisee disruption and negativity regarding this discounting … They take it in the shorts. Their average check goes down.”

So what about wacky stunt foods, so beloved by other fast-food brands such as Starbucks and Taco Bell?

“Maybe off-the-menu-type products or Unicorn-type drinks at some time, but it needs to be profitable and successful for our franchisees,” Haynes said.

The chain is testing some more exotic tastes. Haynes said they’re working on what’s been dubbed Firebird chicken, a spicier rotisserie-type poultry, and guajillo steak.

Plus, 200 San Diego locations are testing a quartet of new sandwiches, which the chain refers to as “regional flavors” – a Steakhouse Melt (shaved steak, American cheese, onions, green peppers, spinach and Sub Spice), a California Club (oven-roasted turkey, fresh avocado and Mustard Seed Spread), a Provencal Tuna Melt (tuna, cheese, tomatoes, spinach and Provencal herbs) and an Italian Grinder (pepperoni, Genoa salami, Black Forest ham, onions, Signature Herb Garlic Oil and cracked black pepper).

New beverages include Watermelon Agua Fresca and Passion Fruit Agua Fresca.

And while the large, long rolls are a key part of Subway sandwiches, the company is now experimenting with paninis in California.

They’re not the brand’s first foray into alternative breads. In March, Subway launched a line of wraps, which Haynes called “extremely successful for our brand.” Subway had tried this carb form in in 2004, followed by a tortilla option in select markets three years later.

Gordon doesn’t expect much from Subway’s move to new tastes, though, explaining, “Bold flavors and spices have been a big deal in restaurants for at least five years. They totally missed that. They were asleep at the switch.”

He said the $5 Footlong was a hit in 2007-2008 due to the recession and the healthy image the veggie-heavy subs had at a time when Americans began to care more about what they ate. Then, crickets.

“That was 10 years ago. Nothing has happened at Subway essentially in 10 years,” he said.

Gordon gives Subway a thumbs-up for its new wraps but advises moving away from bread and starting to serve meats shaved and stacked deli-style, if the chain wants to avoid fellow sub chain Quiznos’s downward spiral.

You want how many pickles?!?

They key to Subway’s continued success is underscoring customers’ ability to pick precisely what they do and don’t want on their sandwiches, according to Haynes.

“With other brands, it’s very much packaged formats. We customize. You can add as many tomatoes or olives as you want,” he said. “We have millions and millions of combinations and flavors.”

Aaron Allen, founder of the Orlando, Florida-based eponymous global restaurant consulting firm, is unimpressed by Subway’s continued emphasis on customization.

“It’s certainly in the playbook of many more (fast-food) restaurants than it was previously,” he said, explaining that with an increasing number of chains focusing on self-ordering – both at in-store kiosks and online – the approach becomes even less unique to Subway.

Subway also is bumping up against increased competition from sandwich upstarts and their step-sibling, the hamburger joint.

“We need to stick to what we know and do it very, very well. We can’t be distracted,” Haynes said. “Burger chains are big competitors. We need to make sure we’re playing in that arena as well.”

The company records more than 7 million transactions globally every day, he added.

Don’t just Instagram the food

Subway restaurants are being redesigned. The bright, fresh, green palette is vegetable-inspired, and the decor overhaul for everything from freestanding drive-thru locations to the kiosks will “start in earnest” next year, Haynes said.

The cost is about $40,000 for a typical 1,200-square-foot store.

But Allen wonders how many franchisees, more accustomed to makeovers every five to seven years, will be happy about spending money to spiff up their stores.

“It’s one of the lowest price-point franchises to get into,” he said. “But it also makes it hard to refresh and modernize. It’s difficult to get the franchisees to buy into that.”

Even though the U.S. is famous for its burgers and fries, you won’t have the same fast food experience in every state.

Follow USA TODAY reporter Zlati Meyer on Twitter: @ZlatiMeyer

Wray Executive Search – Restaurants and Weather: Deeper Thinking is Required

john-a-gordon

by John A. Gordon, Principal and Founder of Pacific Management Consulting Group

We heard it quite frequently mentioned last quarter in restaurant earnings calls: the effect of weather. Any restaurant veteran knows it matters, but how much and over what period of time? Weather does matter, but it impacts unequally and sometimes in short bursts.

Research says that retail spending is positively influenced by sunlight, lower humidity, higher barometric pressure and higher temperatures. [1] 2.3% of retail sales levels are said to be influenced by weather. [2] One alternative now present is online sales, which jumps during bad weather, which can be both good and bad for restaurants.

Bad weather can shut down virtually outside all human activity. Other than running out of food at home, we know there is no biological survival imperative to eat at restaurants; it is typically both impulse and planned occasion driven in nature, with both kitchen replacement and social/entertainment as prime motivations. But it represents superior convenience and positive for socialization. Over the last several decades, the ratio of food spent away from home has surpassed food spending at home. That is great for us; the problem is that spending is spread over more and more establishments in the US.

Consider the following recent restaurant weather examples:

  1. An international QSR operator with a mix of both hot and cold beverage sales mix has noted in the past that it the US has been too hot in the winter and too rainy or cooler in the spring or summer months. One winter there was a stretch of 60-degree highs in the northeast that was considered “too hot”. This was said that despite the mix of beverages; now the menu mix is so balanced that a drink for any kind of weather is obtainable, and that virtually all of their sales came from the pre-lunch period, when temperatures were cooler in the day. Business can’t be both ritualistic and impulsive at the same time.
  2. From my own review of store sales numbers, restaurant concepts with primarily a cold drink base (think, Jamba Juice (JMBA) and the ice cream and yogurt players) have a legitimate weather gripe. For example, the Jamba unit at Boston Logan Airport will be busy even early in the day but a walkup Jamba Juice unit in Honolulu will struggle to get traffic on a windy, cooler winter day. Their menus are so limited that there is no weather alternative.
  3. Casual dining operators with outdoor patios can be affected by either too hot or too cold weather as both conditions have noted in the past. Other casual diners might be positively impacted from bad weather in that poor weather cuts down on other options and it becomes a great use of time to go to an eatertainment venue such as Dave and Buster’s (DAVE), as an example.
  4. During one of the frequent snow and cold snaps in the northeast this year, CNBC interviewed a steakhouse operator within walking district of the Financial District in Manhattan. His weather analysis was that when the daytime high was around 20 degrees or less, or if there was snowfall, that was the “kill business” zone.
  5. Dominos ‘s has noted they vastly prefer rain and snow and national distractions where people might cluster at home. Casual diners might prefer a summer rain but not a winter rain.
  6. Sonic (SONC) may also have legitimate weather gripes, with a portion of their sales mix drive in based. They detailed their projected Q1 2018 impact by time zone, as the following shows:

JGordon1

There are several good weather analytics firms, such as Planalytics, The Weather Channel and more. I’d suggest that restaurant prediction models be more calibrated over time to account for the presence of drive-thrus, delivery, dense urban/CBD walk-in store mix (that is more impacted by the potential to walk in) and menu diversity as explanative factors.

Restaurant executives on the spot to explain what has happened in and why should be wary to overuse the weather factor. After all, almost all of the comparisons are versus prior year, and weather happens and is embedded in early month’s results. Unlike the retail demand for a winter coat, restaurant desire is more evenly spaced. Too much mention of weather blends in with empty earnings call words such as “it performed up to our expectations” and “we’ll make our projection via second half of year excessive performance”.

[1]  The Effect of Weather on Consumer Spending, Journal of Retailing, 2010, No. 17, 512-520.

[2]  Weathernomics, The Weather Channel, 2015.

Restaurant Business – Franchisors need to say more about franchisee finances

The bankruptcy filing of large Applebee’s franchisee shows that franchisors don’t reveal enough of their operators’ financial health, says RB’s The Bottom Line.

The Bottom Line

By Jonathan Maze on May 10, 2018
Earlier this week, my colleague Peter Romeo wrote about the bankruptcy filing of RMH Franchise, the 163-unit Applebee’s operator, the chain’s second-largest.Such a filing was not quite unexpected. Applebee’s same-store sales plunged in the past two years before its recent, modest recovery, following a significant operator investment in kitchen processes in 2016.Indeed, RMH pretty clearly blames those moves for many of its problems.“The franchisor has had four presidents since the beginning of 2014,” RMH CFO Mitchell Blocher said in one bankruptcy court filing this week. “Throughout this period, different franchisor-mandated initiatives led franchisees … to incur significant capital expenditures, further straining liquidity. These initiatives included converting existing grills to new wood-fired grill platforms in all restaurants and a new ad campaign, neither of which were received favorably by customers …”Still, the bankruptcy filing illustrates a big problem when it comes to the financial reporting of restaurant franchises: the vast majority of them do not include any information about the financial health of their franchises in securities filings.

For the most part, franchises will report royalty or ad fund income, but little that provides an indication of overall operator health.

Given that many publicly traded restaurant companies are relying more and more on franchisees to operate their restaurants, it would be good to know how healthy that franchisee base is, would it not?

And more than just provide information to analysts, more franchisors should provide some general data in their securities filings that give a good indication of their operators’ overall financial health.

“So many franchisors are so intensely franchised and so intensely asset light, sometimes 95%, sometimes 100%, that the investor is just not informed quickly enough, or at all able to discern what the underlying business fundamentals are,” said John Gordon, a restaurant consultant who has long advocated for more reporting of franchise financial data.

A few brands have reported information on franchise finances over the years. Domino’s, for instance, has long provide operator cash flow, even when that cash flow wasn’t so good. Popeyes, before it was sold to Restaurant Brands International last year, would report franchisee EBITDAR, or earnings before interest, taxes, depreciation, amortization and rent.

McDonald’s and some others will also provide regular updates on the earnings of operators, though not formally.

To be sure, many systems work hard to ensure the financial health of their operators. And even the healthiest system is going to have some franchisees that struggle and close restaurants. Individual market challenges, operator decisions and other factors all play a role in a franchisee’s fiscal health.

But as the Applebee’s situation illustrates, a brand’s overall actions can have a big impact on the health of the entire system. When that system’s same-store sales plunge the rate that its sales did in 2016 and into 2017, that can have a broad impact on operator health.

Dine Brands executives have been talking about their operators’ finances in recent earnings calls, as analysts have pressured them about those issues. As Peter noted in his story, the company said last week that three franchisees are behind on royalty and ad fund contributions—a potential indication of financial problems.

To be sure, all franchises have to publish and make available their franchise disclosure document, or FDD. But the federal government does not require the FDD include relevant information on operator finances—though a large number of systems do report average unit volumes and more progressive systems will provide franchisee earnings data.

But for the most part, FDDs can be big and complex and intimidating, even for sophisticated researchers.

The issue of franchisee health could become a bigger issue in the coming years. Industry same-store sales have been generally weak, especially for casual dining chains. And many systems have refranchised many of their locations, at the request of Wall Street.

To buy these locations, these operators, like RMH, undertook massive amounts of debt. RMH filed for bankruptcy protection with $68.5 million in secured loans, plus another $30 million in unsecured loans. The company used the funds to acquire a number of franchisees and grow larger.

That’s been a common practice since the end of the recession. But, as some of these systems have problems, many of these operators could find themselves behind the financial 8-ball. They could ultimately file for bankruptcy protection or close units or both.

That makes it more important than ever for franchisors to publicly disclose more about the health of their franchisees.

BNN – Freshii’s reach out to Subway is creative, but don’t expect action: Analyst

John Gordon, principal at Pacific Management Consulting Group, joins BNN’s Michael Hainsworth for a look at Freshii’s latest outreach to disenfranchised Subway franchisees and why he believes the move is shrewd but likely won’t be able to see the light of day.

https://www.bnn.ca/company-news/video/freshii-s-reach-out-to-subway-is-creative-but-don-t-expect-action-analyst~1305924

Franchise Today – How to be a Winner Restaurant Franchisor

This week on Franchise Today, host, Paul Segreto, welcomes as his guest, John Gordon, Principal of Pacific Management Consulting Group. Gordon is a finance and economics expert who provides research and niche earnings analysis, management consulting and advisory expertise to those who need to know about franchise and chain restaurants, hospitality and multi-unit retail sector companies. Paul and John will be joined by Franchise Today co-producer, Joe Caruso. The topic of discussion is QSR Franchise Unit Economics and Profitability and what this show title states, How to be a Winner Restaurant Franchisor.

 

Restaurant Business – Subway could close more locations, and move others

After a tough few years, the sandwich giant is taking a deep look at its locations and ownership.

For most of its 50-year history, Subway enjoyed nearly uninterrupted unit growth on its way toward becoming the most prevalent restaurant chain in the world. But, after five years of customer count declines in its vital U.S. market, the Milford, Conn.-based sandwich giant is trying a different tack: shrinking.

Company executives said in an interview with Restaurant Business they expect more closures in the near future as the chain employs data to determine the viability of each of its nearly 26,000 U.S. locations. The company also predicts a number of its restaurants will be moved to new, better locations—Subway expects to relocate 1,000 of its global restaurants this year, half of them in the U.S.

In addition, the chain foresees as many as 15% of its franchisees selling restaurants to multiunit operators who want to expand—potentially shifting ownership of thousands of locations.

The effort could have a major impact on the sandwich giant’s size and franchisee ownership. But executives believe it’s an important element to help the chain improve unit volumes and profitability.

“It’s a really big shift,” CEO Suzanne Greco says. “We have an opportunity now to really, if nothing else, stabilize where we are. This is just the beginning. More will be coming out. But we’re at a period where people are very optimistic that we’re at a turning point.”

Traffic erosion

Subway is coming off a difficult stretch in which it lost two key players: its founder, Greco’s brother Fred DeLuca, to cancer, and its longtime spokesman Jared Fogle to prison. But its broader problem has been what Greco calls “a slow erosion of customers.”

Subway’s traffic has fallen 25% since 2012, a decline that put a brake on that uninterrupted growth.

Last year, according to Technomic’s Top 500 Chain Restaurant Advance Report, Subway’s system sales in the U.S. declined 4.4% to $10.8 billion—its lowest level since 2010. Its unit count declined by 3.1%, to 25,908. It was the second straight unit count decline after more than 20 years of increases. The chain has closed 1,200 locations over the past two years.

The sales challenges came to the fore late last year when franchisees protested the chain’s $4.99 Footlong offer.

“With anything new, like a brand transformation, that means change,” Greco says of the chain’s relations with franchisees. “When you change things, people get concerned and there’s debate. Our key strategy is to open up our lines of communication and listen to them.

“We’re trying to make the best business decisions. Sometimes things get emotional. But our job is to make the best decision we can.”

Subway sales by year per Technomic

Management change

Greco took over as CEO of Subway in 2015. She had been involved with the chain since 1973, when she started as a sandwich maker, and had held various roles with the company. But after DeLuca’s 2013 leukemia diagnosis she was given more and more responsibility, ultimately becoming only the second CEO in the chain’s history.

“When I came on board, we had a huge challenge, with the passing of Fred,” Greco says.

Already hurting from the loss of customers, the company was ready for some change. Subway performed an evaluation of its business, and looked at how to turn it around, she said, knowing that the down traffic meant starting from a tough spot.

“We were already losing customers when we started our transformation,” Greco says. “That makes it even more difficult to turn around.” She said that if the work had started before the “slippage,” the company might be in a better position today.

“We are where we are,” she says. “But we’re doing some exciting things.”

The persistent declines in traffic and sales have left the chain with unit volumes that are low—at just over $400,000—for such a large company. While Subway has been built to be profitable even with low volumes, the sales have put pressure on the chain while leaving many of its franchisees in danger of going out of business.

Meanwhile, smaller rivals such as Jimmy John’s and Jersey Mike’s kept growing. Jimmy John’s U.S. system sales grew by 6.2% last year, according to Technomic. Jersey Mike’s, meanwhile, has been one of the industry’s fastest-growing chains in recent years. Its system sales grew by 18.2%.

A chain that once helped destroy Quiznos by simply adding toasters is now at the mercy of its smaller rivals.

Development shift

Subway largely stopped adding new units after Greco’s arrival in 2015. That alone was a major shift. Operators have said that in the past they were given little choice but to build new units near their existing restaurants because if they didn’t, others would.

The company’s focus now is on “same-shop profitability, rather than location growth,” says Don Fertman, Subway’s chief development officer. Under Greco, the company developed its own modeling software, using a mapping program to assess individual locations. It is analyzing stores to determine which would be best to relocate, sell to other franchisees or close.

Subway “is working closely with franchisees on relocation,” Chief Business Development Officer Trevor Haynes says. “It could be 25 feet away. It could be across the street or down the street or put into a freestanding location with a drive-thru.”

Operators who relocate into new facilities with a better footprint “are seeing phenomenal results from that action,” he says.

Subway did about 500 such relocations in 2017. Fertman says the chain expects to double that in 2018, with about half of the moves in the U.S.

Subway unit count by per Technomic

Closures and sales

Executives also believe the chain needs to close underperforming locations. “We think there will be additional closures,” Fertman says. How many is uncertain. But the company believes that a smaller system will ultimately be stronger.

“Over the next five to 10 years, we might see fewer restaurants but a stronger, more robust franchisee base and a stronger, more profitable system,” Fertman says.

John Gordon, a restaurant consultant out of San Diego, believes that culling locations is an important step for Subway to improve unit volumes.

He says the company’s willingness to accept a unit count decline is somewhat surprising. “Typically, this is something the franchisor will fight until the cows come home,” he says.

While some units may close, many others could change hands. The company surveyed its operators and asked whether they would prefer to expand or stay where they are—or downsize or exit. Of those operators, 15% said they wanted to downsize or exit—that would represent at least 4,000 stores, if that were true systemwide and every operator had one location.

“Now we’re going through the process of matching them up with multiunit operators who want to expand and have an opportunity to acquire additional locations over time,” Fertman says, expecting there to be “more consolidation over time.”

Executives emphasized the system will still feature small, one-unit operators. “Some of those people are some of the hardest-working operators we have,” Greco says.

The company also expects new franchisees in the system who “come into the Subway system and get excited and bring new energy,” Fertman says.

But larger operators get more sophisticated over time, building organizations that can be more efficient. And larger operators might also be able to pay for remodels.

Fresh Forward

Subway is banking on remodels, which could be an extensive program, given the sandwich chain’s immense scope. But it could also be challenging, given the restaurants’ low volumes.

There are about 170 Subway locations with the chain’s Fresh Forward design, which highlights Subway’s freshly made ingredients, with displays of the chain’s vegetables and its breads. “We bring the vegetables forward,” Greco says. “Look at the sandwich. Look at the bread. Look at the technology.”

The company has tested kiosks in many of these locations, which would join Subway with chains like McDonald’s and Panera Bread in adding self-order stations. But executives don’t appear to be big on the kiosks, given consumer reaction so far. “They’ll play with the kiosk and then just go talk to staff members and order their sandwich, anyway,” Haynes says. “We have customers come in, play with their order and then don’t complete it and go order it at the counter. It’s like a little gaming.”

He adds, “The mobile phone or portable device is going to be your kiosk.”

The company said it has financing options and has worked with operators to offset the costs of the remodel. Subway also says that the design is available in different tiers and price points, so smaller-volume stores can more easily afford the remodel.

Sales boost

Matt Starr is undertaking a number of the store transformations that Subway believes can help the chain thrive in the future.

Starr has been a Subway franchisee since 1988, and his company owns about 70 locations around the country, about half of which are in the Portland, Ore., area.

Two years ago, Starr took over a Subway in a poor location with an owner who was “tired and disengaged.” With better operations, he says, the store’s sales increased 20% in the first year. And in the meantime, the company found a better location for that restaurant that was “about a 9-iron” away. “Seriously, it’s about a half a block,” Starr says.

That location was opened with Subway’s new Fresh Forward design, and the sales took off. Starr says they are up another 70% over the past nine months. “That store is up 98% over two years ago,” Starr says. “Sales are still building. In January that store was over double the sales in January of two years previous.”

Starr is repeating the process in other locations. One of his business partners took over a high-volume shop in Portland, remodeled that location and has seen sales increase more than 50%.

Starr believes that the remodel is a “major component” of the increase, in part because customers want to stay longer and they are amazed at seeing the company slice its fresh vegetables. “People come in and ask, ‘Do you really slice your veggies?’ That happens at every single Fresh Forward shop,” he says.

Revitalization

Subway’s revitalization strategy includes a number of different elements beyond the remodels, including more marketing earlier this year to promote the chain’s healthfulness. The chain’s primary shareholders, including Peter Buck and DeLuca’s family, invested $25 million into the chain to support that marketing.

Late last year, Subway named Dentsu Aegis Network, a customized team of ad agencies, to handle its creative and media accounts. The company has a new campaign that focuses on the chain’s customization platform and its fresh ingredients.

The chain has also been focused on its digital efforts, including its mobile app and a new loyalty program.

“The brand proposition is just as valid today as when it first opened,” Greco says. “We’re very relevant when we offer fresh, nutritious, affordable sandwiches that are customizable. We just need to get relevant with today’s consumer.”

The $4.99 offer was part of that strategy, part of a way to combat intense discounting in the quick-service sector. But concerns about profitability roiled franchisees and they fought back, petitioning the company to stop the offer.

According to Technomic Transaction Insights data, Subway lost market share in January, suggesting the deal didn’t click with consumers.

But the company believes the deal fulfills an important value element. “We still have $4.99,” Haynes says. “It’s another one of the pillars we’re focused on: value, health and indulgence.”

Subway is quietly launching a set of wrap sandwiches, with double the meat, for $6.99, that executives hope can serve a more premium customer looking for something a little different.

And they say the chain still has the health halo, even if Fogle and his Subway diet are no longer part of the brand. “Customers still regard us as a healthier alternative to what other QSRs offer,” Greco says, noting that the chain uses full-grain breads, serves chicken without antibiotics and has removed artificial colors. The chain also has plenty of fresh vegetables. “We’re able to talk about something compelling the other QSRs can’t talk about.”

Subway vegetables Fresh Forward

Turning point?

Greco suggests that the company still has a way to go. Subway is still the biggest chain in the world by unit count, and a fix of its sales takes time.

“When you think of the size we’re dealing with, we have the makings of a brand transformation plan,” she says. But Greco believes the company could be at a turning point on its turnaround.

“All of this stuff coming together at once gives us a platform,” she says. “We’re excited about what we have in the future at Subway. We’re a big brand. It took us 50 years to get here.

“Every big brand has to go through rough times. This is not the first time we’ve hit rough times. But things are changing quickly, and we’re doing a lot to get ahead of that.”

Honolulu Star Advertiser – Fast food chains aim for sweethearts on Valentine’s Day

Associated Press

ASSOCIATED PRESS

Valentine’s Day scratch-and-sniff cards, which give off a fried chicken aroma, are seen at a KFC today in Santa Clara, Calif. In an attempt to capture a bit of the $3.7 billion that the National Retail Federation expects Americans to spend on a night out for the holiday, KFC is handing out the cards to diners who buy its $10 Chicken Share meals or a bucket full of Popcorn Nuggets.

NEW YORK >> Is that love in the air or french fries? White Castle, KFC and other fast-food restaurants are trying to lure sweethearts for Valentine’s Day.

It’s an attempt to capture a bit of the $3.7 billion that the National Retail Federation expects Americans to spend on a night out for the holiday. Restaurant analyst John Gordon at Pacific Management Consulting Group says it appeals to people who don’t want to splurge on a pricier restaurant. And some customers enjoy it ironically.

White Castle, which has been offering Valentine’s Day reservations for nearly 30 years, expects to surpass the 28,000 people it served last year. Diners at the chain known for its sliders get tableside service and can sip on its limited chocolate and strawberry smoothie. KFC is handing out scratch-and-sniff Valentine’s Day cards that give off a fried chicken aroma to diners who buy its $10 Chicken Share meals or a bucket full of Popcorn Nuggets.

Panera Bread wants couples to get engaged at its cafes; those who do can win food for their weddings from the soup and bread chain. And Wingstop sold out of its $25 Valentine’s Day kit, which came with a gift card and a heart-shaped box to fill with chicken wings. The company says 1,000 of the kits were gone in 72 hours.

The Columbus Dispatch – Wendy’s vaults Burger King, Taco Bell as sales grow

Wendy’s passed a few milestones at the end of 2017.

The Dublin-based hamburger chain crossed the $10 billion mark in system-wide sales for the first time, reached an all-time high average of $1.6 million in sales per store, and inched past rivals Burger King and Taco Bell into the No. 4 spot on QSR Magazine’s list of the largest restaurant chains.

Though Wendy’s didn’t post eye-popping same-store sales gains, a key industry metric, its 1.3 percent rise capped five straight years of positive same-store sales, an industry-best streak.

“2017 was a strong year for Wendy’s,” Wendy’s CEO, Todd Penegor, told analysts on an earnings call.

Penegor went on to outline some near-term goals for the company, including $12 billion in system-wide sales by 2020. System-wide sales includes the combination of sales from company-owned stores and those controlled by franchisees.

If the $12 billion mark is realized, it could bump Subway out of third place on the QSR Magazine list. Helping Wendy’s move up the list is Subway’s free fall, with about 1,000 stores closing in the past year. Chipotle’s struggles have also helped.

It’s still a predominately hamburger market in the U.S., with McDonald’s, at No. 1, Wendy’s and Burger King all in the top five largest chains. Starbucks is the second-largest restaurant chain.

“Fundamentally, the three burger majors are in one pack,” said John Gordon, principal of Pacific management Consulting Group, a restaurant industry analyst, “then you have everyone else.”

Analysts on the quarterly earnings call focused on technology rollouts, delivery, store development and the company’s stake in Arby’s, which just bought Buffalo Wild Wings. Wendy’s restated its Arby’s investment at just more than 12 percent of the new, combined company, worth about $325 million.

Will Slabaugh, an analyst at Stephens, said Wendy’s has gotten aggressive with its advertising again, going after rivals with its ads on TV and online touting fresh beef instead of frozen. The push differentiates the brand, Gordon said.

“Fresh beef tastes better,” he said, “and they have rung that bell for 40 years.”

Another area Wendy’s has led is in the rejuvenation of the value menu. Its “4 for $4 deal” launched two years ago has created a wave of copycats, even a few five items for $4 offers, and sparked efforts at competitors like McDonald’s to restart their own value menus.

Slabaugh asked Penegor about delivery, a new service for most fast-food chains, and whether it was receiving any pushback, or lower satisfaction ratings, from consumers.

“None,” Penegor said, “we aren’t seeing any pushback at all.”

Wendy’s has joined with DoorDash to offer delivery at about 20 percent of its stores. Penegor said the company is seeking other partners to expand the service.

There’s another milestone the company hopes to surpass by 2020: more than 7,000 stores, up from about 6,600. That’s one hurdle that Gordon sees as pretty high given the crowded restaurant market.

“It is hard as heck to get a Cadillac store site,” he said.

jmalone@dispatch.com

@j_d_malone

 

Restaurant Business – Value Takes Center Stage, Again, At Quick-Service Chains

McDonald’s, Subway, others introduce new offers this week as industry competitiveness continues.

Earlier this week, Subway officially announced its controversial $4.99 Footlong offer. On Thursday, McDonald’s will introduce the latest iteration of its dollar menu, an offering that will give customers a selection of items for $1, $2 or $3.

Those are the two largest restaurant chains in the U.S. by unit count—operating 50,000 locations, combined.

And, like clockwork, their efforts have helped usher in a new era of value-making in the restaurant business.

“50,000 units in the U.S. will be banging on value this week,” said John Gordon, a restaurant consultant out of San Diego. “That’s going to make it very tough” for everybody else.

On Wednesday alone, Wendy’s announced an expanded 4 for $4 value menu, adding eight new entree options to its meal deal. The Charlotte, N.C.-based chicken chain Bojangles’ announced value offers at $4 and $5.

And Taco Bell, which has long had a $1 menu, announced new Nacho Fries that will be priced at $1 when it debuts Jan. 25.

To be sure, restaurants frequently push value in January, largely because it’s the slowest month of the year. Consumers are adjusting their budgets after the holidays, and weather frequently keeps people home.

“The first quarter is always the lowest volume quarter of the year,” said Richard Adams, a former McDonald’s franchisee turned consultant. “And you’re coming out of the fourth quarter, which is the highest volume quarter, and suddenly you’re confronted with doing half the volume you did in December. So, it’s a good time for you to goose sales.”

The value wars are taking on new importance these days because the restaurant business is increasingly competitive. Industry same-store sales have been weak for the past two years, and the chains are hoping the offers will put them front and center in front of consumers who have more choices than they’ve ever had.

But they also come as the industry relies more heavily on franchisees to run the restaurants, and generate profit. McDonald’s and Wendy’s, for instance, have refranchised most of their company-operated restaurants in recent years. Subway has no company locations.

The discounts can highlight a tension between franchisors that rely on royalties, paid as a percent of sales, versus franchisees, which rely on the profits they earn off those sales. The value offers come amid a difficult operating environment in which labor costs and rent costs are skyrocketing.

This tension exploded to the surface in recent weeks as media outlets, including Restaurant Business, reported on complaints from Subway operators over the planned $4.99 Footlong offer.

On Monday, the Milford, Conn.-based sandwich giant started selling a selection of five Footlong subs for $4.99. Operators petitioned the company to stop the offer, complaining about the offer’s profitability after years of sales declines.

“Rents have doubled in almost every store,” Stuart Frankel, a Subway operator who invented the $5 Footlong but has been a critic of the $4.99 deal, said last month. “There’s nothing that goes backwards. And food costs are significantly higher” than when Subway first introduced the $5 sandwich.

Still, Subway’s offer is limited only to a few of the chain’s sandwiches, including Black Forest Ham, Meatball Marinara, Spicy Italian, Cold Cut Combo and Veggie Delight.

McDonald’s $1 $2 $3 Dollar Menu is a new generation of the Dollar Menu that the chain had for years and largely ended in 2012. Four items on the new menu are priced at $1: any size drink, Cheeseburger, McChicken and the Sausage Burrito. Sausage McGriddles, small McCafe beverages, two-piece Buttermilk Crispy Tenders and a Bacon McDouble are all at $2.

The Sausage McMuffin with Egg, a new Classic Chicken Sandwich, Triple Cheeseburger and a Happy Meal are priced at $3. It’s the first time McDonald’s has put its iconic kids meals on a value menu.

“We know that customers motivated primarily by value and deals come more often and spend more,” McDonald’s CEO Steve Easterbrook said on the company’s third quarter earnings call in October.

In past years, McDonald’s operators complained about the Dollar Menu, especially as costs increased. But Adams said the new offer is better from a profit standpoint because of the higher prices. “That makes a big difference,” he said.

McDonald’s new Dollar Menu is clearly moving other competitors to join in. Wendy’s, which arguably ushered in the new value era with the introduction of its 4 for $4 offer back in 2015, expanded that offer with new entrees this week.

The entrees available in that offer include the Jr. Bacon Cheeseburger, Crispy Chicken BLT, Spicy Go-Wrap, Double Stack, Crispy Chicken Sandwich, Grilled Go-Wrap Jr., Jr. Cheeseburger or the Jr. Cheeseburger Deluxe. Customers also get nuggets, fries and a drink.

Taco Bell, meanwhile, will introduce its Nacho Fries later this month. Taco Bell said it would introduce 20 $1 items on menus and in test markets this year on top of its existing, 20-item $1 menu.

The quick-service Mexican chain had been testing the product in West Virginia and Bakersfield, Calif., this spring.

The fries are seasoned with a Mexican seasoning and served with warm Nacho Cheese. Customers can get them “Supreme” for $2.49 or “Bel Grande” for $3.49.

Gordon said that quick-service chains should not rely on these discounts for too long, and that any discounts should come alongside more profitable, higher-priced items for bigger-spending customers.

“I don’t see it as a tactical failure to discount in January,” he said. “The greater question is how it’s done, and what’s done after it.”

The Street – Starbucks Shows Other Companies That Worker Benefits Don’t Have to Hurt Margins

Retailers and restaurants now have more incentives than ever to
consider generous family leave policies, thanks to the corporate tax
cuts.

BY CATHALEEN CHEN
Jan 24, 2018 3:31 PM EST

Starbucks Corporation (SBUX) is sharing the tax-cut pie with its employees.

The coffee giant announced Wednesday, Jan. 24, it will spend $250 million to raise employee wages and offer family and sick leave benefits, following Wal-Mart Stores Inc.’s (WMT) similar announcement a week ago. The decision to offer an extended benefits package was “accelerated by recent changes in U.S. tax law,” the company said in its announcement Wednesday. That includes $120 million allocated to wage increases, based on regional costs of living and local laws.

Starbucks and Walmart employees, however, won’t be the only ones reaping the benefits, experts say, as the retail and restaurant industries at large will get a cash boost from the federal tax cuts signed into law in December. Even if the costs of these worker benefits strain profit margins, chains like Starbucks likely will realize business growth by improving employee retention and brand marketing.

This could be the start of an entire industry shift, according to Brianna Cayo Cotter, the chief of staff for PL+US, an advocacy organization for paid family leave. “The [Starbucks] news today, so close on the heels of Walmart’s announcement about extending paid leave to the hourly workforce, reflects the beginning of a tectonic shift in corporate America,” she said.

Cotter also predicted that, to stay competitive, companies like CVS Health Corp. (CVS) may quickly follow the two companies’ lead.
Starbucks may be spending more cash on the benefits package, but they’ll likely save money by retaining more employees, according to John Gordon, principal at Pacific Management Consulting Group. “What’s nice is that as these companies are increasing benefits, they’re moving from a tax rate in the mid-30s to the high-20s,” he told TheStreet. “And it’s so hard to get employees to stay right now for restaurant operators.”

Employee retention, for instance, has long plagued the restaurant industry. In 2016, the hospitality sector, which encompasses restaurants, had a turnover rate of 70%, according to the National Retail Federation.

In spite of the federal tax cut, Starbucks suffer too much from losing some cash in the first place, Gordon added, pointing to the Seattle-based chain’s increasing EBITDA margins in the past three years. “Starbucks is already doing better than a lot of others in the space,” he said. “Last year, they had a company-operated EBITDA margin of 22.6%, compared to 21.4% three years ago.”

Starbucks’ new family leave policy will allow full-time and part-time “partners” — that’s what the coffee company calls its employees — to accrue one hour of sick leave for every 30 hours worked. An extended parental leave policy will now allow all non-birth parents up to six weeks of paid leave. Since the end of 2016, Starbucks has granted six weeks of paid leave for birth parents.

Companies like Chipotle Mexican Grill (CMG – Get Report) and Panera Bread Company, owned by the German JAB Holdings, according to Gordon, could be pressured into enacting similar benefits packages because like Starbucks, because they also have high margin rates. According to Glassdoor, Panera, for instance, does not offer paid maternity leave.

Walmart’s new family leave changes, announced on Jan. 11, is more comprehensive, but is extended only to its full-time employees. Under its new policy, full-time hourly workers get 10 weeks of paid maternity leave and six weeks for parental leave.
Before, only eight weeks of maternity leave and two weeks of parental leave were available to full-time workers.

Ninety-four percent of low-wage working people — such as retail workers — have no access to paid family leave, according to PL+US. The U.S. is the only industrialized country without a federally mandated paid parental leave policy.

San Diego Business Journal – Rubio’s Caters to Florida’s Tastes

DINING: Marketing Sells the Food Rather Than the Eatery’s Story

By Jared Whitlock

Call it a tale of two coasts.

In California, the marketing for Rubio’s Coastal Grill has long leaned on the story of co-founder Ralph Rubio getting hooked on fish tacos while on a Baja camping trip in 1974, and later giving the U.S. its first taste of the fare in a walk-up stand in Mission Bay. Read more

Associated Press – Papa John’s founder exiting as CEO weeks after NFL comments

NEW YORK (AP) — Papa John’s founder John Schnatter will step down as CEO next month, about two months after he criticized the NFL leadership over national anthem protests by players — comments for which the company later apologized.

Schnatter will be replaced as chief executive by Chief Operating Officer Steve Ritchie on Jan. 1, the company announced Thursday. Schnatter, who appears in the chain’s commercials and on its pizza boxes, remains chairman of the board. He is also the company’s biggest shareholder.

Earlier this year, Schnatter blamed slowing sales growth at Papa John’s — an NFL sponsor and advertiser — on the outcry surrounding football players kneeling during the national anthem. Former San Francisco 49ers quarterback Colin Kaepernick had kneeled during the anthem to protest what he said was police mistreatment of black men, and other players started kneeling as well.

“The controversy is polarizing the customer, polarizing the country,” Schnatter said during a conference call about the company’s earnings on Nov. 1.

Papa John’s apologized two weeks later, after white supremacists praised Schnatter’s comments. The Louisville, Kentucky-based company distanced itself from the group, saying that it did not want them to buy their pizza.

Ritchie declined to say Thursday if the NFL comments played a role in Schnatter stepping down, saying only that it’s “the right time to make this change.”

Shares of Papa John’s are down about 13 percent since the day before the NFL comments were made, reducing the value of Schnatter’s stake in the company by nearly $84 million. Schnatter owns about 9.5 million shares of Papa John’s International Inc., and his total stake was valued at more than $560 million on Thursday, according to FactSet. The company’s stock is down 30 percent since the beginning of the year.

“I think it’s possible that this was a conscious decision to get him out of the line of fire,” said restaurant analyst John Gordon, who is the founder and CEO of Pacific Management Consulting Group. “The focus of the brand needs to be the pizza.”

Schnatter, 56, founded Papa John’s more than three decades ago, when he turned a broom closet at his father’s bar into a pizza spot. Since then, it has grown to more than 5,000 locations. Schnatter has also become the face of the company, showing up in TV ads with former football player Peyton Manning. Schnatter stepped away from the CEO role before, in 2005, but returned about three years later.

Ritchie said new ads would come out next year. The company said later Thursday that it had “no plans to remove John from our communications,” which it says includes pizza boxes or commercials.

The leadership change comes as pizza makers, which once dominated the fast-food delivery business, face tougher competition from hamburger and fried-chicken chains that are expanding their delivery business. McDonald’s Corp., for example, expects to increase delivery from 5,000 of its nearly 14,000 U.S. locations by the end of the year.

Ritchie said his focus as CEO will be making it easier for customers to order a Papa John’s pizza from anywhere. That’s a strategy that has worked for Domino’s, which takes orders from tweets, text messages and voice-activated devices, such as Amazon’s Echo. Papa John’s customers can order through Facebook and Apple TV, but Ritchie said he wants the chain to be everywhere customers are.

“The world is evolving and changing,” he said.

Ritchie, 43, began working at a Papa John’s restaurant 21 years ago, making pizzas and answering phones, the company said. He became a franchise owner in 2006 and owns nine locations. He was named chief operating officer three years ago. Ritchie said plans for him to succeed Schnatter were made after that.

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Contact Joseph Pisani at http://twitter.com/josephpisani

The Washington Post – The dark side of your $5 Footlong: Business owners say it could bite them


Subway franchisee Keith Miller has signed onto a letter urging corporate leaders not to reinstate a promotion that cuts into his profits. (Marvin Joseph/The Washington Post)
 December 28, 2017
A Subway sandwich is far more than the sum of its fillings, franchisee Keith Miller says.

Those ingredients cost roughly $2. Then he pays labor. Electricity. Gas. Royalties. Credit card transaction fees. Rent.

All told, Miller, who owns three Subway franchises in Northern California, says it costs him well over $4 to produce one of Subway’s foot-long subs. And that is why, when the chain announced plans to drop the price of the sandwich to $4.99 starting in January, he and hundreds of Subway’s other 10,000 U.S. franchisees sent a strongly worded letter warning that the promotion could force some stores to close.

“The numbers don’t work for us,” said Miller, who also chairs an industry group, the Coalition of Franchisee Associations. “Ten years ago, they might have worked. But now they don’t, in my opinion.”

As fast-food chains across the country have slashed menu prices to revive flagging sales, a growing rift has emerged between some name-brand corporations and the local operators who run their outlets.

For years now, the retail industry has been shaken by giant companies that have been able to keep prices low, wooing consumers but squeezing suppliers and smaller competitors. But in the restaurant business, the push to keep prices low has pitted corporate headquarters against individual outlet owners — all operating under the same brand.

Corporations need to grow systemwide revenue to please board members and shareholders. But small-scale franchisees, who face rising costs and increased local competition, are far more concerned with store-level profits.

In addition to Subway’s plans to relaunch the $5 Footlong, McDonald’s will revive a version of its Dollar Menu next month. Taco Bell has promised to expand its selection of discount items, as have Wendy’s and Jack in the Box.

“This is an inherent financial conflict between franchisees and franchisers,” said J. Michael Dady, a lawyer at the Minneapolis firm Dady & Gardner who represents franchisees in conflicts with their corporate parents. “And some have handled it much better than others have.”

To date, the uprising at Subway has been the most visible.

In late November, franchisees began circulating a petition that asked Subway to withdraw the foot-long deal, which they said would hurt their businesses.

Under the franchise system, chain restaurants such as Subway coordinate menus, product sourcing, store design and strategy across all locations. Local operators pay the chain to belong to that system. They also manage the day-to-day business of their stores — rent, labor, ingredients, utilities, maintenance and equipment — and draw their paychecks from whatever is left.

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Discounts can cut dangerously deep into those margins, the petition says.

The document has been signed by nearly 900 people from 39 states who claim to own Subway franchises. Like Miller’s, many are small or family-run entities that operate only a handful of locations.

“Franchisees have repeatedly voiced concerns about frequent and deep discounting,” the petition reads. “Franchisees believe this constant deep discounting has been detrimental to the Brand — as well as restaurant profitability.”

Such a public revolt is highly unusual, said John Gordon, the founder of Pacific Management Consulting Group, a restaurant-oriented firm based in San Diego. The closest precedent is a 2009 lawsuit filed by Burger King franchisees who claimed they were losing money on every sale of the chain’s $1 double cheeseburger.

In a statement, Subway said that the petition does not represent the views of the majority its franchisees and that the promotion is optional. Business owners who opt out, however, may face disgruntled customers.

In a separate presentation to franchisees, Subway said the promotion was intended to help them stanch several years of falling traffic.

“We are in constant communication with our Franchisees and Development Agents,” the company said in its statement. “They are actively involved in many aspects of our decision-making process, and we welcome and encourage their feedback.”

But many franchisees say that corporate attempts to grow sales have added to a growing list of challenges.

Miller said that when he bought his first Subway 28 years ago, his margins could swell as high as 18 percent. But since then, he said, competition has grown far more fierce and costs have risen dramatically for labor, utilities and rent.

Labor costs at fast-food restaurants have increased in each of the past three years, according to the financial-consulting firm BDO, the result of rising minimum wages and increased competition for employees. While the federal minimum wage has not risen since 2009, 29 states and the District of Columbia have instituted higher wages.

In California, where the minimum wage will be $11 per hour starting Jan. 1, Miller’s labor costs are up 50 percent from 10 years ago, he said. The cost of a full-price sub has risen only 20 percent.

“It’s a hard cost per sandwich,” Miller said. “People can only make so many sandwiches per hour. We find it’s about seven.”

Meanwhile, the restaurant market has grown more crowded. Between 2009 and 2014, the United States added nearly 18,000 fast-food restaurants, according to the Agriculture Department — growing at more than twice the rate of the population over the same period and continuing a decades-long trend.

To make matters worse, it’s not just quick-service restaurants competing for consumers’ dining dollars anymore. Fast-casual restaurants such as Panera, delivery services such as GrubHub and meal kits such as Blue Apron have all muscled their way into the market, as have grocery and convenience stores.

As a result, year-over-year sales at fast-food and fast-casual chains have fallen dramatically over the past two years, according to Technomic, a restaurant-analytics firm. And because name-brand chains report those numbers to investors, it has put them under enormous pressure to find ways to pull in more customers — even customers who don’t spend a lot of money per ticket.

Enter a time-honored technique: deep discounts and low-margin “value” items.

“It’s a very classic way to get [sales] up,” Gordon said. “And it’s a very common source of franchisee conflict.”

The idea behind these promotions is that franchisees sacrifice some profit per item in the hope that increased traffic will make up for those losses or that customers will also spring for a side or drink. Ideally, the deals benefit both big-name chains and franchisees.

But operators often see discounts as a gamble, said Dady, the lawyer.

“These are the people who are most invested in the business, as opposed to the big guys,” he said. “They’re not against all discounts. But what our clients want to know is: Will there be a return on the investment?”

In recent months, Dady has heard from a number of clients who are concerned about upcoming promotions. Many cannot speak publicly because of the risk of retaliation from their corporate parent, he added; many franchising contracts include disparagement as a reason for termination, and some firms have subjected complainers to nuisance health and cleanliness inspections.

But analysts say that franchisees for Little Caesar’s, the country’s third-largest pizza chain, also have been vocal behind the scenes — even refusing, in some cases, to carry the $5 pizzas widely advertised on TV.

And at McDonald’s, some franchisees have protested the chain’s cascading promotions, telling analyst Mark Kalinowski in a periodic survey that the deals had cut into their profits.

“We are discounting heavily, against my will,” one franchisee wrote. “So sales should be up and profits down.”

But despite the feedback from some franchisees, analysts say that the discounting push is not likely to end. Chains have no other choice in this ultracompetitive environment, said Malcolm Knapp, the founder and president of an eponymous market-research firm based in New York. Many, he added, have succeeded in devising tiered value menus that also work well for local owners.

“The reality in fast food now is that you need a value menu to survive,” Knapp said. “If you could live without it, would you? Sure. But the business shows you can’t.”

At Subway, the return of the $5 Footlong is also moving forward, nearly 10 years after the chain originally introduced it nationwide. Subway offered the deal periodically between 2008 and 2016, when the company raised the price to $6 — a reflection of rising costs, it said.

Those costs are still rising, Miller points out. And increasingly, he and other fast-food franchisees say that they are getting caught in the middle.

“That’s not just true at Subway, but at all quick-service restaurants,” he said. “You used to be able to make money in this business. Now, well, a lot’s different.”

Restaurant Business – Get to Know the New Breed of Private-Equity Specialists –and Potential Parents

But in the roughly two decades since private-equity firms thundered into the industry, restaurant companies have learned that those capital sources can be valuable partners providing far more than expansion dollars. It’s a matter of finding the right one, as PE firms have followed the natural business law of differentiating in a competitive market.

By all accounts, the PE sector is flush with capital and prowling for deals, but is having a harder time finding good ones, in part because restaurant companies are cagier about selling. Quick-service operators in particular are demanding sky-high valuations and shopping more carefully for ancillary benefits.

The situation is reshaping the PE firm into more of a hunter than a gatherer, tracking particular deals rather than working off a queue. Their focus is on the specific, not the general.

“Now you can divide them into buckets,” says John Gordon, a one-time operator turned PE advisor who runs the firm Pacific Management Consulting Group.

He and others see the firms fitting these broad categories, essentially storefronts for operators shopping for a PE partner.

Incubators

Recent restaurant deals have included equity investments in six-unit Voodoo Doughnut (by Fundamental Capital) and five-unit Velvet Taco (L Catterton). Meanwhile, KarpReilly, a PE firm known for readying infant concepts for expansion, sold Cafe Rio to another PE firm, Freeman Spogli & Co., when it hit 100 stores.

Union Square Hospitality Group, the restaurant operation that spawned Shake Shack and operates such fine-dining landmarks as Union Square Cafe and Gramercy Tavern, has just started a fund to nurture young fast-casual brands. And The Culinary Edge, a menu consultancy, has done the same with The Culinary Edge Ventures, which has already invested in a single-store concept called Starbird.

All are illustrations of private-equity companies shifting down the size spectrum to take chances on younger, smaller ventures that have yet to prove they can travel and scale up. “Everyone is looking for the next big thing, the next Chipotle,” says Jim Balis, managing director of CapitalSpring, a diversified finance company. The company, which just acquired Brass Tap and Beef ‘O’ Brady’s, has holdings ranging from “Tier 1 QSRs down to truly independent concepts that are regional,” he says.

The incubators, as epitomized by KarpReilly, provide far more than funding. The dollars come with assistance in adjusting the menu, forging systems and processes, building an infrastructure and otherwise prepping the brand for growth. Its successes in that regard have included The Habit, Mimi’s Cafe and Miller’s Ale House.

Investor as operating company

The clock doesn’t tick as loudly as it once did for private-equity companies. The whole rationale was to buy, fix and flip the brand at head-turning speed, then distribute the money to the fund contributors and do it all over again.

Now, says Gordon, a PE investor might hold onto a chain for a while because of its cash flow or franchising opportunities. A so-called “asset light” brand, where all stores are franchised, enjoys a low overhead and strong revenues—a formula that can translate into high valuations.

Balis says his firm is a case in point, because it doesn’t follow a rapid-fire buy-and-sell formula. “If we find a good investment and it makes sense to hold onto it, we will,” he says. “We want to be opportunistic. We don’t put specific lives around our investments.”

That tendency has given a number of former restaurant executives a second life as private-equity management advisors. “I’ve been a CEO of a number of restaurant companies,” says Balis, noting he currently holds that title at 17-unit Norms Restaurants. “I know how to do a turnaround. I know how to grow something. I know how to fix operations.”

Edna Morris, the former president of Red Lobster, is now managing partner of Axum Capital Partners, which recently acquired Backyard Burgers.

The king of the investor-operator is Roark Capital, whose Focus Brands subsidiary operates such brands as Moe’s Southwest Grill, McAlister’s Deli, Schlotzsky’s, Cinnabon and Auntie Anne’s. Roark bought Jim ‘N Nick’s Bar-B-Q in July, raising its tally of restaurant concepts to 20, and purchased a minority stake in Culver’s in October. It’s only divested of one to date: Wingstop, which is now public.

Technomic reportFranchisee finders

After chasing franchisors and brand owners for decades, PE firms have steadily broadened their scope to include franchisees, notes Gordon. “They see that consolidation is underway, from smaller franchisees to larger franchisees,” he says.

No longer are these just mom-and-pop prey. And they may sport more affordable valuations than the parent company.

Longtime specialists like Argonne Capital, a franchisee of IHOP, Sonny’s BBQ and Applebee’s, is being joined on the hunt for licensees by the likes of Sun Capital, which acquired a 21-unit HuHot franchise last year. Sun has a larger restaurant portfolio than any other PE firm, but CCW LLC is the only franchisee in the mix.

H.I.G. Capital bought Outback Steakhouse’s franchisee for California, T-Bird Restaurant Group, the year earlier.

Mega dealers

At the high end of the buyer’s market are the multibillion-dollar funds that don’t balk at paying huge multiples for a blue-chip brand. The consummate example is JAB Holding Company, which took Panera Bread Co. private with a bid of $7.5 billion or $315 a share—a 20% premium over the trading price at the time. Analysts say the price equates to a 41- to 46-time multiple of Panera’s  fiscal 2017 earnings.

JAB is used to paying that kind of premium. A year earlier, it bought Krispy Kreme for $1.35 billion, or 19 times the franchisor’s EBITDA. Its portfolio also includes Keurig.

Other deep-pocketed concerns include Golden Gate Capital, which paid an estimated $565 million this spring for Bob Evans Restaurants, and Oak Hill Capital, which spent $525 million for Checkers Drive-In Restaurants.

The Chicago Tribune – 6 Argo Tea locations in Chicago to go cashless starting Monday

Six Argo Tea locations in Chicago will go cashless Monday, a sign of the growing influence of plastic and mobile ordering at restaurants and retail stores.

The Chicago-based chain will stop accepting cash at its cafe in the Loop and those at the University of Illinois at Chicago, the Merchandise Mart and three locations at O’Hare International Airport.

Argo said the introduction of cashless cafes will allow it to speed up service. It has 16 Chicago-area locations, according to its website. It didn’t say why these locations were chosen, but they are in some of the most trafficked places in the city, making speed of service critical. It also didn’t say what percentage of sales are cash transactions.

Argo is encouraging customers to use mobile payment options more often by offering a $5 credit when they download the company’s app.

As an alternative for those customers who don’t want to use their smartphones, credit or debit cards, Argo said it is working to develop an in-store gift card kiosk that will accept cash.

In addition to increasing service speeds, banning cash also allows a retailer to collect more data on its customers’ buying habits. It’s also considered safer, since cash won’t be available in the register, deterring possible thefts.

The trend toward banning cash has been slow so far in Chicago, but some retailers and restaurant chains have tried it. Sweetgreen, a salad chain that opened in Chicago last year, is now cashless at all of its locations. Clothing retailer Kit and Ace, which has a store in the Fulton Market district, has never taken cash, saying it allows stores to be more efficient.

For Argo, especially in the locations it chose, going cashless doesn’t run a significant risk of angering customers, said John Gordon, principal at Pacific Management Consulting Group. Restaurants and coffee shops in city centers tend to see the least cash sales, Gordon said. And brands like Argo and Starbucks tend to see fewer cash sales than brands like Dunkin’ Donuts or McDonald’s because they cater to a more affluent customer.

There’s an added benefit of going cashless, as well: People tend to spend more when they pay with their phones or credit cards.

“Will it turn off some customers? You bet. But I’m guessing there is a significant upside,” Gordon said.

Gordon believes that the cashless trend is still in its very early stages, but he expects big restaurant and retail brands could follow in five to 10 years.

Lauren Zumbach contributed.

sbomkamp@chicagotribune.com

Twitter @SamWillTravel