Some franchisors like their restaurants so much, they buy them back from the franchisees and convert to company owned. What’s behind the so-called de-franchising trend? Cash reserves and good unit economics.
Frisch’s Restaurants had a deal in March to sell its 28 Midwestern Golden Corral units to Aziz Hashim, the multiple-concept franchisee. But the chain’s franchisor saw the price tag and took an unusual step—Golden Corral swooped in to buy the restaurants itself.
Golden Corral was armed with a contractual option granting first right of refusal. “It just made sense for us to take this opportunity to add to our portfolio,” said Bob McDevitt, senior vice president of franchising for the 485- unit chain, based in Raleigh, North Carolina. “As we say to our franchisees, we like to eat our own cooking.”
One of the trends in franchising in recent years has been re-franchising, or the sale of company- owned units to franchisees. Numerous concepts, including Yum! Brands, Burger King, Jack in the Box and Jamba Juice, are unloading company-owned units as fast as they can. They believe they’ll do a better job if they concentrate on franchising, and franchisees typically outshine corporate when operating the restaurants.
Now a counter-trend is emerging—some call it de-franchising—in which a number of concepts seek to buy franchise units and grow company operations. Panera Bread, Buffalo Wild Wings, Ruby Tuesday, Texas Roadhouse and Chuck E. Cheese, among others, have been focusing on running more company-owned units.
For franchisees, this might actually be a good thing—a sign that the franchisor is bullish about the system and its future. While each system has different motivations, and some are “de-franchising” more than others, those chains buying franchisee-owned units are more likely to have better unit economics than are those systems selling company stores.
De-franchising can be seen as a “bull signal,” said John Gordon, a restaurant analyst with Pacific Management Consulting Group in San Diego. Refranchising, on the other hand, is more of a bear signal, an indication that the franchisor believes it would be more profitable franchising the system than running its own restaurants.
But there is a downside for franchisees. Franchisors that buy up units often get them at a low price, because they either get involved in the sale early in the process or, more likely, they have the right of first refusal to buy those restaurants. Chains that exercise that right tend to drive off potential buyers, which keeps prices low.
Right markets, right price
Two of the most successful publicly traded franchises in the country, Panera Bread and Buffalo Wild Wings, are both acquiring franchisees, albeit at a pace the chains call “opportunistic,” which means they buy franchisees that are in the right markets, at the right price.
In 2008, Panera Bread had 725 franchise units, 58 percent of its 1,252 total unit count. Today that percentage is down to 52 percent. The number of company-owned Panera Bread operations grew from 527 in 2008 to 740 last year.
“Panera continues to want to be a franchise company,” a Panera spokesman said, but will move to buy when the return is right. “Some of our franchisees are in a different place in life, whether retirement or simply stepping down. When a franchisee does want to sell, we evaluate the opportunity and will move forward on an acquisition if we believe we will earn an acceptable rate of return.”
Similarly, Buffalo Wild Wings saw its percentage of franchisee-owned units fall from 64. 6 percent in 2010 to 60.1 percent last year. On the company’s most recent quarterly conference call, CEO Sally Smith said the company is “open to acquiring attractive franchise restaurants.”
Both chains boast store-level operating profits of 20 percent or more. And that’s the point. When stores are running strong and making good cash, franchisors have a greater incentive to run their own stores. “If you’re really optimistic about your ability to create value and grow profit dollars, you’re less likely to share that,” said Sara Senatore, analyst with Bernstein Research in New York.
She cited healthy store-level profit margins at Chipotle, which does not franchise any units. “A great poster child for somebody that doesn’t want to share with anybody is Chipotle. They like their margins of 25 to 26 percent. They don’t need to franchise.”
Other chains are aggressive about buying out franchisees. Chuck E. Cheese, the Texas based pizza and games chain, is down to 36 domestic franchised units as the company looks to operate all of its units in the United States. The company is franchising in international markets, however. Like the other concepts, its restaurant margins run in excess of 20 percent, thanks to its high-margin video games business. Similarly, the steak chain Texas Roadhouse has stopped franchising and will buy up franchisees as they come for sale.
“If you have a restaurant with a couple million” in average unit volume “and get a margin exceeding 20 percent, that’s a likely candidate with de-franchising,” Gordon said.
Life cycle matters
At least part of the reason is due to life cycle. Chains on a growth trajectory feel no need to franchise because their sales are booming and their profits are strong and they have the cash to add units. As chains age, sales stumble and margins shrink, pressure mounts for them to sell off company stores and focus on franchising. Companies sacrifice the cash restaurant operations can bring in for lower overhead and capital costs. In many cases, franchisees can do a better job operating those stores.
“It’s a function of unit economics, and where they are in the growth cycle,” Senatore said. Mature companies sell a large annuity (profits from restaurants) for a smaller annuity (royalty payments from franchisees) and less risk. Thus, older chains have been more likely to re-franchise, such as Yum! Brands’ chains KFC, Pizza Hut and Taco Bell, and Miami-based Burger King, which is quickly selling company units to franchisees worldwide.
There are certain exceptions. Jamba Juice is a relatively young brand and it has been refranchising, or selling company stores to franchisees. Ruby Tuesday is an older brand with weaker economics and it has been de-franchising, or buying up franchisee-owned stores, largely because it sees itself as an operator.
There’s one company that’s actually doing both. Jack in the Box has been refranchising units in that chain for years in an effort to become 80 percent franchisee-owned. But the company has been more likely to develop units under its high-growth fast-casual brand, Qdoba, which has been moving in the opposite direction—toward more company-owned units in markets where it prefers to run company- owned stores.