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