Chick-fil-A model helps it lead – The Atlanta Journal-Constitution

Chick-fil-A model helps it lead

By Russell Grantham

The Atlanta Journal-Constitution

While many of its competitors have hit a wall, Chick-fil-A is on a roll.

The College Park-based chicken sandwich chain rang up the fast-food industry’s highest average sales per store last year — almost $2.7 million per shop — putting it ahead of industry giants such as McDonald’s, which posted $2.4 million.

At the same time, several of Chick-fil-A’s big competitors have stalled. While Chick-filA has been adding stores, rival KFC has been shrinking in terms of total units, as have Pizza Hut, Arby’s, Hardee’s and Dairy Queen, according to QSR, a trade magazine for quick-service restaurants.

So what is Chick-fil-A’s secret ingredient?

There may be several — some better known than others. There’s its well-known, never open-on-Sunday Christian mores, which have lent the company cult status among some customers and employees. Company officials tout the quality of its food and its focus on local communities, which builds repeat business.

But a less known key to Chick-fil-A’s success is its unusual approach to franchising, which is almost unique in the restaurant industry.

Boiled down, Chick-fil-A’s system allows the privately held company to be extremely choosy about who runs its restaurants, and to reward them well if they succeed — or get rid of them if they don’t. Because it owns all its restaurants — seemingly a contradiction in franchising — Chick-fil-A can move quickly into new products and markets. It can shift strong-performing franchisees to bigger stores or give them more responsibility — much like employees — while firing up their entrepreneurial zeal.

“I look at it as a great opportunity,” said Margaret Phillips, who nearly 30 years ago scraped together $5,000 to take over her first Chick-fil-A store in Daytona Beach, Fla. Then 23, she was already a Chick-fil-A veteran, having started at 16 in a shop in North DeKalb Mall. “They have shown us a lot of grace and love over the years,” said Phillips, who now runs a Chick-fil-A restaurant in Commerce.

Normally, companies use franchising to speed up their growth by tapping outside investors’ money to build additional outlets. Would-be entrepreneurs pay an up-front franchise fee and the costs to build and open a new outlet. They also pony up roughly 9 percent of sales to the company for advertising and rights to use its brand and sell its products.

To join a major chain like KFC, franchisees typically need to shell out about $1.9 million before opening their doors, according to Don Sniegowski, editor of Blue MauMau, an online publication that tracks the franchise industry.

But Chick-fil-A CEO and founder S. Truett Cathy turned that model on its head when he decided in 1967 to expand his business into a chain of restaurants.

The company bankrolls the entire cost of its new restaurants and picks the locations. The only cost its so-called “operator” franchisees shoulder up front is $5,000, but they can’t later sell the business or pass it on to their heirs. Chick-fil-A retains ownership of the restaurant, and takes a much bigger cut of each store’s revenues and profits than at most franchises. It gets 15 percent of sales, collects rent on the property, and splits the remaining profit with the operator.

The formula seems to have worked well for both sides.

Based on franchise disclosure documents and interviews with Chick-fil-A officials, the company’s roughly 1,100 operators took home operating profits of about $210 million last year, or an average of $190,000 each. Some make substantially more.

Meanwhile, Chick-fil-A collected about $841 million last year in rent, royalties and its share of operating profits from franchisee-operated restaurants — four times what the franchisees got. The company reported a $175 million profit for 2010 on systemwide revenue of $3.4 billion last year.

Company officials say Chick-fil-A gets 10,000 to 25,000 applications for roughly 60 to 70 new slots that open each year. The result is highly motivated “operator” franchisees like Phillips, Bob Garrett and Melissa Winkfield, whose metro Atlanta restaurants generate annual sales of up to $4 million each — two or three times the average fast food restaurant’s volume — despite being open only six days a week.

Chick-fil-A’s profit-splitting arrangement is a huge motivator for operators, who would not get a share of profits if they were traditional employees, said Russ Umphenour, head of Atlanta-based FOCUS Brands, where he oversees Moe’s and five other fast-food chains.

“If [you’re] thinking about every dollar that walks in the door, [part] of it will be mine, you start to look at the world differently,” said Umphenour, who calls himself “a huge Truett Cathy fan.”

Before joining FOCUS Brands, Umphenour tried a similar plan with many of the managers at his 775 Arby’s restaurants he operated before selling in 2005. In exchange for $5,000, the Arby’s managers got a 10 percent to 20 percent share of their units’ profits. Many of those operators later boosted profits by up to 25 percent, he said.

Still, only a few companies, including the 7-Eleven convenience store chain, Outback Steakhouse and the Shoney’s restaurant chain, have tried similar plans, say industry players.

“I think most companies are scared of it, because they think it will eat into their profits,” said Umphenour.

Chick-fil-A’s 2010 profit margin, which was 5.1 percent of its systemwide sales, was somewhat behind the 6.4 percent profit margin of industry kingpin McDonald’s Corp. last year. But industry experts say Chick-fil-A is beating most rivals in terms of sales and profits per store.

“I’m just amazed that there haven’t been more businesses doing this,” said John Gordon, with Pacific Management Consulting Group, a San Diego restaurant consulting firm.

By not depending on franchisees to build stores and maintain them, Chick-fil-A has grown slower, but has the power to upgrade restaurants, launch new products or change operators whenever it wants, he said. Older franchises such as McDonald’s, Wendy’s and KFC can’t do the same without risking a revolt by franchisees who don’t want or can’t afford to make such changes.

“The flexibility to operate what is essentially a 100-percent company operation is tremendous,” he said.

Chick-fil-A’s unusual approach has helped fuel its steady growth, despite the 2007-2009 recession, with systemwide sales rising from $2.3 billion in 2006 to $3.4 billion last year.

With total sales expected to hit $4 billion this year, it’s poised to displace Oklahoma City-based Sonic as the nation’s 10th largest fast-food chain in terms of revenues. Chickfil-A expects to add 92 outlets next year to its more that 1,500 locations, which includes about 1,000 free-standing restaurants and a smaller number of company-operated stores and units in malls, hospitals, airports and colleges.

Still, Chick-fil-A’s unusual franchising approach and pervasive Christian culture hasn’t been for everyone.

According to press reports, the company has been sued about a dozen times for employment discrimination, sometimes based on religion. According to Forbes, a former restaurant operator who is Muslim sued in 2002, alleging he was fired for not participating in a Christian prayer at a company training program.

Meanwhile, some states have challenged Chick-fil-A’s tight control over franchisees, alleging that they are employees rather than business owners.

Last year, a former franchisee in Delaware sued Chick-fil-A alleging wrongful termination of his restaurant agreement. He also sought unemployment compensation.

The case was settled after the former franchisee received $115,000 in net payments from Chick-fil-A and he “affirmed that … [he was] a franchisee and independent contractor” rather than an employee, according to Chick-fil-A’s franchise disclosure documents.

The company said it has withstood all claims that its franchisees are employees. Otherwise, in its dealings with operators, Chick-fil-A would have been subject to federal employment discrimination restrictions and other occupational rules that don’t apply to independent contractors.

“We work really, really hard to make sure it’s abundantly clear … that we meet all franchise laws,” said Tim Tassopoulos, Chick-fil-A’s senior vice president of operations. “It’s been the same for 40 years. It’s held consistent.”

And while there “have been some lawsuits” alleging discrimination, Tassopoulos said, the company doesn’t ask about operators’ faith or discriminate based on religion, race or other traits. Those lawsuits went through “normal legal resolution,” he said.

This much is clear. By the time new franchise operators walk into their stores for the first time, Chick-fil-A has spent a lot of time getting to know them. And odds are, the operators also enthusiastically embrace founder Truett Cathy’s blending of faith and finances.

When she was 21, Melissa Winkfield was working two jobs, as an assistant manager at a very large burger chain and as a cook at a Chick-fil-A. She ultimately chose to stick with Chick-fil-A because the other company was “all about the numbers,” she said. At Chick-fil-A, “the atmosphere was so different,” she said. The company’s philosophy is “to glorify God by being a good steward.”

Now 39, Winkfield operates a Chick-fil-A restaurant in East Point, one of the company’s highest-volume restaurants in metro Atlanta, with about $4 million in annual sales. She takes home well above the average operators’ income.

“We grew up in a low-income home. My parents are very proud of me,” said Winkfield. “It’s just been an awesome blessing.”

Bob Garrett, 47, likewise counts his blessings.

Before he joined Chick-fil-A, Garrett, of Lawrenceville, was a general manager at a family-owned truck-washing company. But after 18 years at that company, Garrett said he tired of the moves the job required. On the recommendation of a longtime friend working at Chick-fil-A, he decided to become a franchise operator.

A year and a half and 15 interviews later, Garrett took over an existing Chick-fil-A store in Lilburn. The chain later promoted him to open a new store in Hamilton Mill.

Then earlier this month, Garrett became one of roughly 100 operators who Chick-fil-A allows to operate two stores, opening a new store in Dacula.

At the Dacula shop on the eve before its opening, Garrett said he’s “humbled” to get a second store.

Outside in the restaurant’s parking lot, among about 70 tents, a crowd of people threw footballs and tossed flying discs, watched TV, listened to music and got ready to spend the night. The next day, the first 100 customers were to get a year’s worth of weekly meals from Chick-fil-A — now a tradition at new stores.

“This just completely changed my life,” Garrett said of joining Chick-fil-A’s operations. He hopes his two stores, with about 140 employees, will eventually tally $7 million in combined sales, and roughly double his income.

“I get to make more than I’ve ever made in my life, doing what I love to do,” he said.

Top-selling restaurant chains

Chick-fil-A tops the industry in terms of average sales per restaurant. And while industry giant McDonald’s has the second-highest sales per restaurant, the list is generally dominated by fast-growing regional brands or niche chains with a loyal following. Most national brands, such as Burger King, Wendy’s, KFC and Taco Bell (not shown) are slower-growing and generally have average per-unit sales in the $900,000 to $1.4 million range.

Source: QSR magazine

http://pacificmanagementconsultinggroup.com/articles/chickfila.pdf

Dining down, but hopes up – San Diego Union Tribune

Dining down, but hopes up

By Lori Weisberg, UNION-TRIBUNE STAFF WRITER Monday, March 8, 2010 at 8:31 p.m.

To no one’s surprise, traffic volumes at restaurants slumped in 2009, but industry watchers see faint signs of hope that business is picking up as consumers both nationally and in San Diego County start dining out more frequently.

NPD Group, a leading market research company, reported an overall 3 percent decline in restaurant visits in 2009 compared with a year earlier, though declines in the last three months of the year slowed following steep losses in the third quarter. All segments of the industry, from fast food to fine dining, saw fewer customers, but upscale restaurants suffered the steepest losses.

“In 2008, consumers appeared to trade down some full-service visits for fast-food visits. In 2009, they made fewer visits to restaurants overall,” said Bonnie Riggs, NPD’s restaurant industry analyst. “When consumers did visit restaurants, they favored lower-priced options.”

A combination of anemic traffic and only a modest growth in restaurant checks led to a decline in consumer spending at restaurants last year, the first such decrease since NPD began tracking the food-service industry in 1976.

Locally, restaurateurs acknowledge their industry was heavily affected by the prolonged economic downturn but say they are noticing a thawing in consumer spending. Some are even opening new restaurants.

“Last year was probably the worst we’ve felt it,” said Isabel Cruz, owner of five restaurants, three of them in San Diego. “Last year was when sales dropped for us somewhat at Cantina (in Pacific Beach), but this year it feels like it’s stabilizing. I can tell when I go out with my husband that it seems better.”

Cruz is confident enough that she’s opening yet another restaurant, Barrio Star, in the Bankers Hill neighborhood, where she plans to hew to the now-popular price cap of almost nothing over $20.

Although last year was notable for the number of higher-profile restaurants that closed, several restaurateurs are opting to open new dining spots this year, despite cutbacks in consumer spending and high unemployment.

“People still want to go out and socialize and have a good time and have a nice cocktail and feel like they got a good value. I’m talking about someplace that doesn’t feel like a bargain place,” Cruz said. “We really want to keep the price point under $20, and if you do that and it’s good food, it’s not worth cooking for me and my husband at home because it’s what I’d spend grocery shopping.”

NPD, in fact, found that lower food prices, while easing financial pressures for restaurant operators, also made the grocery store more appealing for consumers.

San Diego restaurant consultant John Gordon said that while local trends mirror what is occurring nationally, he sees evidence anecdotally of some modest improvements in the dining business.

“Restaurateurs are modestly encouraged with sales results in January and February 2010,” said Gordon of Pacific Management Consulting Group. “While the average ticket is down because of the need to discount, the traffic component has improved. Without question, there is a group of consumers, higher-income, who have less fear about the economy and are increasing their frequency of going out more, but this is all off a very low base in 2008.”

Tracy Borkum, owner of Kensington Grill and the newer Cucina Urbana in Bankers Hill, said she, too, believes business is picking up, though it may be some time before a return to normalcy. Borkum, who reinvented her former fine-dining restaurant Laurel into a casual, more affordable Italian eatery, has seen instant success, with a full house nearly every evening.

“I think there’s some optimism for the end of this year going into 2011, but I don’t think things will change in 2010 until the unemployment percentages improve,” Borkum said. “I do hear about all these different places that are opening, so obviously there’s some optimism, but people are still very cautious about price point and concept, and I think we exemplify what the community is looking for.”

A recent survey by the National Restaurant Association revealed some renewed confidence, but a return to economic health for the industry will be slow.

“Although the current situation indicators remained soft in January, the Expectations Index rose above 100 for the first time in nine months,” said Hudson Riehle, senior vice president of Research and Knowledge Group for the National Restaurant Association. “Restaurant operators are relatively optimistic about improving sales growth and economic conditions in the months ahead, and their capital spending plans rose to the highest level in five months.”

Daphne’s Greek Cafe files for Chapter 11 – San Diego Union Tribune

Daphne’s Greek Cafe files for Chapter 11

By Lori Weisberg, UNION-TRIBUNE STAFF WRITER Saturday, January 16, 2010 at 12:04 a.m

Daphne’s Greek Cafe filed for Chapter 11 bankruptcy protection this week, but will continue operating all of its 69 restaurants, including the 16 locations in San Diego County.

The filing came after more than a year and a half of talks with the San Diego company’s lender in hopes of restructuring its loan, said George Katakalidis, chief executive of Fili Enterprises, which owns Daphne’s. He was not successful, however, in securing more favorable terms.

The filing, he said, was necessitated by a breach in loan rules, which required Daphne’s to maintain a defined profit level.

“Our covenant was specific, so when sales dropped, profit dropped, and it triggered the covenant breach,” Katakalidis said. “We have a great business, and we didn’t want this to interfere with the business. Chapter 11 will speed up the negotiation.

“We tried to do this humanely over a year and a half. The macro economy for the last year has been a nightmare, and we’re just saying, enough.”

According to the company’s filing in U.S. Bankruptcy Court in San Diego, its creditors number between 1,000 and 5,000. Fili Enerprises estimates both assets and liabilities as between $10 million and $50 million. The company’s largest creditor is U.S. Foodservice in La Mirada with unsecured claims of more than $1.1 million.

Founded in 1991, Daphne’s has locations in California, Arizona, Colorado and Washington.

In an effort to cope with the ailing economy, Fili closed some underperforming cafes and laid off some of its workers over the last year, Katakalidis said. It also has introduced some new, more affordable menu items, one of which includes a pita sandwich, fountain drink and two sides for under $7.

John Gordon, a San Diego-based chain restaurant consultant, said smaller chains are having a difficult time, in part, because they have a tougher challenge obtaining capital.

“Smaller chain restaurants like Daphne’s that are reliant on one bank or line of credit are particularly vulnerable, especially if they negotiated financing deals in the last three or four years,” said Gordon, a principal with Pacific Management Consulting Group.

Companies Should Disclose More About Franchisee Economics

By John Gordon, Pacific Management Consulting Group

A growing number of publicly traded companies are nearly 100-percent franchisee owned. After its sale of 66 units to Apple American Group last month, DineEquity is now almost 100% franchised: 95% at Appiebee’s and nearly 100% at IHOP. Other chain restaurants are close: Domino’s is about 95% franchised, worldwide. Several more companies are refranchising, especially in the QSR sector, further increasing franchisees’ ownership.

And all of this franchisee business activity is off the books.

Other than the royalties and fees paid by the franchisees, and supply chain profits (in the case of Domino’s and a few others with captive supply chains), none of these publicly traded companies report franchisee financial results. Some analysts may ask but are always given general responses.

The company and franchisees are separate legal entities after all, and many but not all companies do report franchisee same store sales data: Brinker started doing so this year, and Papa John’s has such displays, for example. But not all do. And almost no one, save McDonald’s in one of its Investor Day presentations, directly proactively presents franchisee profit or cash flow.

For most publicly traded restaurants, a spike in bad debt (unpaid royalties) or net opens/closes is about the only way to divine franchisee and overall system health.

This lack of visibility is unhealthy for investors, franchisors, franchisees, lenders and the markets, overall. Some lenders have already taken the industry to task for such unclear disclosure, and situations of imminent system or brand decline and collapse can be muted.

For example, the deteriorating state of the Arby’s operation throughout 2009 to its being placed for sale in January 2011 could not be been divined other than guesses via the number of closures or bad debt expense. Investors and the market would have been interested.

We propose a better way: once companies hit a tip point, such as 80% of units franchised, they should make a voluntary minimum annual disclosure of franchisee average weekly net sales (not gross sales), and store level EBITDA, excluding franchisee G&A, dividends, debt service and other “below the store line” influences. This could be through the annual investors’ presentations almost all companies compose, or through the SEC 10K/10Q reporting cycle.

We are not proposing reporting franchisee personal shareholder returns or owner’s salaries or any of that. Just the store level data.

It would provide for more visibility for investors, and demystify the process, for lenders and potential franchisees, at the very least.

Every franchisor is interested in getting its royalties paid, and the sales data and a mechanism to audit it, now exists. For companies audited, we bet that their auditors do a representative sample of franchisee sales, now.

Likewise, every bank or lender is interested in EBITDA, and franchisors have or should have visibility to that metric since (1) the franchise agreement may specify it be reported and (2)franchisors typically approve sales and transfers, and thus have that visibility.

This could be reported in the management discussion and analysis section of the 10K (or, if it takes time to accumulate year end data, the Q1 10Q next quarter). With the last update of the SEC MD&A disclosure rules in 2003, unit sales and other statistical measurements can be reported simply.

SEC Rules: the 2003 update to SEC Regulation G made clear the basic standard, that a reporting company shall not make public a non-GAAP measure, that taken with the information accompanying the measure, and any accompanying measure, contain an untrue statement of a material fact, or omits to state a fact necessary in order to make the presentation, not misleading. That is all controllable by the discloser.

We’d suggest the company present two single values, average weekly net sales (weekly gets us out of the 52 v. 53 week problem), and store level EBITDA (as a percentage of net sales), for current year and prior two years, and /or it could tier display the data in a simple quadrants (top fifth, second fifth, so forth) view (which we think might be more useful). If less than 100% of data was available, the percentage polled could be noted.

These two metrics are among the most fundamental indicators to restaurant economic vitality.

Other non-public 100% franchised companies like Dairy Queen (99% franchised) and Subway (100% franchised) can take the same recommendation.

This is a voluntary disclosure, a best practices proposal. While everything takes time and effort, it works to solve problems and give visibility to important data that the industry already has, or should have.

John A. Gordon is the principal at the Pacific Management Consulting Group. You can reach John Gordon at jordon@pacificmanagementconsultinggroup.com.

The Dangers Of Going Dark – Restaurant Finance Monitor

The Dangers Of Going Dark

Mexican Restaurants’ decision to “go dark” by voluntarily de-listing its shares is hardly an unusual decision, Hundreds of companies have made the same decision since Sarbanes-Oxley became law eight years ago, Yet it’s hardly risk free, Such companies see a big stock decline (Mexican’s stock has fallen 10%) and trading on the Pink Sheets is more limited and more volatile Companies that go dark have a tougher time raising money and financing. They’re more susceptible to shareholder lawsuits, And the company may not even save that much because it will still need to be audited. “It seems penny wise and pound foolish,” said John Gordon, principal at the Pacific Management Consulting Group. Still, Mexican’s share price, now at $2,05, has fallen steadily since its $13 a share peak in 2006. In addition, the company is losing money amid big declines in camp sales and it has all but stopped making capital expenditures, It probably needs to save money anywhere it can.

Jonathan Maze, November 2, 2010

Burger King $1 double cheeseburger results questioned – QSR Web

The following article can be viewed here: http://www.qsrweb.com/article.php?id=17192

Burger King $1 double cheeseburger results questioned by Christa Hoyland * • 03 Feb 2010

Burger King’s $1 double cheeseburger has met with controversy since the chain first presented the pricing change to franchisees. First, franchisees voted it down — twice — and then a number of them filed suit against the company when it moved ahead with the pricing promotion. Now, The Miami Herald has uncovered a discrepancy between the numbers the chain is providing to franchisees about the sandwich’s success and data found by Restaurants Services Inc., the chain’s independent purchasing cooperative.

According to the story, Burger King has reported to franchisees that the burger’s promotion has boosted sales and gross profits, comparing a five-week period before the promotion began in early October and an 11-week period since it started. RSI reports that sales were up only marginally and gross profits were down, comparing the 12-week period prior to the promotion and the 11-week period after.

Burger King will report its second quarter earnings on Thursday and analysts are eagerly awaiting the report. Many of them have downgraded Burger King’s stock in recent months, some from “buy” to “neutral” and others from “neutral” to “hold,” as they report that sales have continued to decline in recent months despite the promotion.

Seeking Alpha contributor John Gordon said in a recent post that Burger King’s $1 double cheeseburger promotion is only a short-term stop-gap to the company’s sales decline. Instead, the chain needs “a theme to promote.”

The company has many new products in the wings, including the Steakburger XT, due to roll out this month. But while the company was waiting for franchisees to finish installation of the new batch broilers to handle the new burger line, other chains have moved aggressively with product rollouts. Carl’s Jr. and Hardee’s continued their rotation of limited-time premium burgers, McDonald’s added its McCafe beverages and Angus Burger line, Wendy’s added boneless wings and spicy chicken nuggets, and Jack in the Box added its own $1 burger as well as other product innovations.

The $1 cheeseburger results discrepancy is just one more issue in a long list of beefs many Burger King franchisees have against the franchisor. In May, franchisees filed a class action suit against the company when the chain announced it intended to divert 20 percent to 40 percent of the franchisee’s soda rebate fund in order to boost its national advertising spend. The diversion of funds was supposed to begin this month, but the company has decided to allow franchisees to keep their full rebate until the pending litigation is resolved.

Last month, Burger King filed suit against a small number of franchisees who failed to meet a Dec. 31 deadline for installation of the chain’s new point-of-sale system. Some franchisees indicated their failure to meet the deadline was a means to voice displeasure over the franchisor’s recent decisions.

Breaking Out – QSR Magazine

Breaking Out Jody Maroni’s Sausage Kingdom is going mainstream with its first traditional location. By Jamie Hartford

Since opening its first restaurant in 1984, Jody Maroni’s Sausage Kingdom has been confined to non-traditional locations, such as stadiums, airports, and outlet malls. Not anymore. In February, the Venice, California-based quick-serve opened its first traditional location.

Franchisee Anina Siddiqui opened the 1,200 square-foot site—her first—in mid-February in Arcadia, California, a suburb of Pasadena. “I’m happy with the franchise, and I am happy seeing repeat customers,” Siddiqui says.

Rich Leivenberg, executive vice president of Jody Maroni’s, says though the company had previously shied away from locations on the street, they were happy with the site for Siddiqui’s restaurant. It is located in a strip mall and is close to a library, local government buildings, a city golf course, and a 4,000-student high school. “We liked the demographics, and we liked that the strip mall had been recently redone,” he explains. “We think we have a great product, and we’re pretty excited about bringing it to the masses in a new way.”

The restaurant has been open only about a month and a half, but Leivenberg says it is already beating expectations. Sales are trending about 20- to 25-percent higher than the company had anticipated. “She has opened very strongly—much more strongly than we thought,” Leivenberg says. Jody Maroni’s started as a stand on the Venice boardwalk in 1979, and in a way, Leivenberg says the company held on to that type of destination location. The chain has opened shop in airports, outlet malls, and on Universal CityWalk in Los Angeles. “We were so successful in the [non-traditional] avenue that we didn’t even look at [traditional locations],” he says. “You have to choose a direction, and we really liked the non-traditional.”

The leadership of Jody Maroni’s was also afraid that the prices of its premium sausage products—$6.99 for a sausage sandwich combo, including fries and a drink—might make it hard to compete on the street with lower priced quick-service sandwich shops. Many customers thought of Jody Maroni’s fare as a special occasion indulgence, Leivenberg says. “We’re not a cheap hot dog stand, and we don’t want to be,” he explains. “We have gourmet sausage.” The chain currently has 20 locations, mainly in California, but also in Las Vegas, Phoenix, Houston, Cleveland, Indianapolis, and St. Louis. Jody Maroni’s has also built its name through sponsorships with sports teams, such as the Los Angeles Dodgers baseball team and the Los Angeles Kings hockey team, and through a branded retail program that began in the 1990s.

The company’s sausage products were available in Costco, Trader Joe’s, and other grocery stores. That program ended about two years ago because the company wanted to concentrate on being a quick-service restaurant brand.

John Gordon, principal at Pacific Management Consulting Group, a San Diego-based restaurant-consulting group, says starting in non-traditional locations and moving to the street is not the typical trajectory of a restaurant. “It’s true that it’s more typical to get started in a traditional environment, largely because foodservice operators get used to acquiring sites, and there’s less of a barrier, in theory, to using a traditional site,” Gordon says.

In a way though, Jody Maroni’s and other chains that start in non-traditional sites such as stadiums or airports enjoy high visibility that can carry over when they do decide to open traditional locations on the street, he reasons. Jody Maroni’s is hoping that will be the case.

Four or five other potential franchisees have already showed interest in opening traditional locations elsewhere, and the company will soon be launching a new web site to better communicate with interested parties. Even so, Leivenberg says Jody Maroni’s is still not ready to abandon entirely its strategy of growing in non-traditional sites. “We will continue to expand in that arena,” he says. “Our biggest growth is currently in premium outlet malls. We’re about to open our fourth location in Houston, and we hope to continue to grow that side of the business.” Besides the Houston location, the company also has two other stores coming on line in the next few months. “We’re prepared, we’re ready for growth, and we hope it will be substantial,” Leivenberg says.

Cheap Marketing Tips that Work – QSR Magazine

Cheap Marketing Tips that Work

When it comes to marketing on a budget, there’s a fine line between terrific and terrible.

In the teeth of the recession, Back Yard Burgers developed a new, slimmed-down marketing strategy. The roughly 200-unit, Nashville, Tennessee–based chain cut costs across the board, developed a slick-looking website, and created a social media strategy centered on Facebook and Twitter.

But Ken King, a senior consultant with National Restaurant Consultants Inc., says this was a disaster.

“Their same-store sales in some stores are down as much as 20 or 30 percent,” King says. “They’re just not reaching the public at all.”

Marketing on a budget isn’t an easy thing. Although some concepts have been able to reduce their expenses while gaining sales, others have discovered that cutting can be dangerous. Figuring out the balance requires careful planning and a willingness to learn from the mistakes of the competition.

Cheap Marketing Gone Wrong

Experts say that quick serves should never use a cheap marketing strategy that compromises the brand image. John Keuning, creative director for Out There Advertising, has worked on several campaigns for the Steak Escape chain. He says that while easy-to-make coupons can get people in the door, it will cost a concept in the long run.

“Get out there and highlight the benefits of your product, but don’t do it by discounting,” Keuning says. “As soon as you start discounting to get traffic, people will start to expect that they’ll get that deal every time.”

Another common mistake operators make when marketing is to stick to their strengths. One expert says streamlining marketing so it only focuses on one main item can be a serious blunder. As CEO of the Pacific Management Consulting Group, John Gordon has seen chains struggle because they ignored certain dayparts, like breakfast and afternoon snacks.

“The reason why McDonald’s has been able to take their commanding position in the fast food hamburger segment is that you can get snacks and food items of any type at any time of day,” Gordon says.

“If you’re not going to be putting an insert in the paper, send workers out. Either sweat equity or money, it’s going to take one or the other.”

Finally, quick serves cannot skimp on the implementation of marketing efforts. Although no one sets out with the intention of doing a half-hearted job, some companies end up budgeting so little for marketing that they’re unable to complete what they start, says Melissa D’Aloia, account executive for Out There Advertising. She says that was the case with Out There’s initial efforts on Facebook.

“A couple years ago, when we entered social media with Steak Escape, we didn’t dedicate enough resources to it,” D’Aloia says. “It didn’t really have much of an impact.”

The lesson for operators, D’Aloia says, is that it’s better to carry through with a smallscale plan than come up with a big plan that operators are not ready to pay for.

Cheap Strategies That Work

As Back Yard Burgers discovered, saving money on marketing isn’t simply a matter of cutting back. Instead, it involves rethinking the whole idea of marketing.

King says one of the most efficient cheap ways to get a customer interested in a product is to hand him a sample. Free food generates warm feelings toward a brand, and it gets customers hungry for more. Garbanzo, a Denver-based Mediterranean concept, used this strategy with great results in its stores, King says.

“Talk about guerrilla marketing,” King says. “When you walk through the door, an employee hands you a falafel ball. Look at Chick-fil-A—they invented that model by having a girl handing out a piece of fried chicken in the mall.”

Attention-grabbing signage can also be a successful cheap marketing method. Simple signs that advertise new products or encourage a combo meal are one of the most effective methods of generating additional business, Gordon says.

“Point-of-purchase (PoP) materials are No. 2 or No. 3 in the total scheme,” he says. “Instore PoP posters [and] outdoor PoP is right behind television and radio.”

Loyalty programs are now entering the world of cost-sensitive marketing as well. Though card-based loyalty programs failed to capture the mass public’s attention and were costly investments, new technology is making loyalty easier—and cheaper—than ever to implement.

QR Loyalty, which launched publicly in September, helps brands build loyalty with a vehicle they already have well in stock: receipts. The company provides a specialized QR code on receipts for customers to scan with their smartphones. As consumers collect points by scanning, operators collect information on their purchase habits.

“It enables the restaurant owner to remarket to those customers knowing what their preferences are,” says Nigel Malkin, cofounder of QR Loyalty. “If you have someone who only orders chicken or vegetable dishes, you know how to market to those customers. That kind of customer data is incredibly valuable.”

Malkin says QR Loyalty’s pay-for-performance program costs slightly less than 1 percent of an operation’s gross annual sales after adding up its licensing fees and the rewards given out, but that it can generate a sales lift of 5–10 percent.

Of course, operators who truly want to streamline their marketing can trade time for money.

“If you’re not going to be putting an insert in the paper, send [workers] out,” Keuning says. “Do doorhangers, put them in windshields, etc. Either sweat equity or money, it’s going to take one or the other.”

Some local stores become destinations for kids’ birthday parties, some provide food for events, and some have special incentives for mall employees. This September, a Steak Escape location in Sacramento, California, had success by commemorating an important moment in its own history.

“[They] chose to do an anniversary celebration and they had their entire crew fired up about it,” D’Aloia says. “Through that excitement they have seen their store sales increase in a very slow month over 20 percent.”

Cheap marketing strategies ultimately depend on the quality of the product. Poor service or mediocre food can drive even the best-marketed property into the ground. On the other hand, a very good company can pull off the ultimate frugal marketing move.

Just ask Mary McLeese, brand manager for Five Guys Enterprises. The burger-and-fries chain became a national name solely by word of mouth.

“We do not advertise at all,” McLeese says. “[And] we advise our franchisees not to advertise. If you concentrate on the customers and concentrate on the food, it will grow naturally.”

Darden aims for growth abroad – Nation’s Restaurant News

Darden aims for growth abroad

Development deal in Middle East sets stage for more int’l expansion, analysts say

Ron Ruggless | Oct 19, 2010

Darden Restaurants Inc. said Tuesday it signed an area-development agreement with one of the Middle East’s largest restaurant franchising companies, marking a major step abroad for the casual-dining giant and its first into a region that has proven ripe for U.S. brands.

Orlando, Fla.-based Darden has tapped Americana Group of Kuwait to develop and operate the Red Lobster, Olive Garden and LongHorn Steakhouse brands. The agreement calls for Americana to develop at least 60 restaurants in Bahrain, Egypt, Kuwait, Lebanon, Qatar, Saudi Arabia and the United Arab Emirates over the next five years.

This is Darden’s first area-development agreement. The company has five franchised LongHorn Steakhouse units in Puerto Rico, which it inherited from the 2007 purchase of Rare Hospitality, and 25 licensed locations in Japan, which existed before General Mills spun off Darden as a separate company in 1995.

Analysts said it is likely Darden will continue to expand in international markets through franchise partners, especially as the restaurant industry in the United States continues to mature.

“Today is an exciting milestone in Darden’s history,” Clarence Otis, Darden chairman and chief executive, said in a statement. “We’ve been exploring international expansion for some time now as part of our ongoing focus on additional growth opportunities. The Middle East is an attractive, growing market that has shown a strong affinity for American brands, especially American dining brands.”

The company said it would continue to own and operate its restaurants in the United States, and to look for operating partners abroad.

Americana’s system comprises 1,200 restaurants in the Middle East, through such brands as KFC, Pizza Hut, Hardee’s, Krispy Kreme and T.G.I. Friday’s. It operates eateries in 14 nations and also manufactures retail foods.

“Consumer demand for casual-dining brands in the Middle East market has grown over the past decade, and we expect that growth to continue in the future.” said Marzouk Al Kharafi, chairman and managing director of Americana. “The addition of these three highly regarded brands to our portfolio enables Americana to build on its long legacy as the leading restaurant operator in the region.”

Analysts: More international growth expected

Additional international agreements are expected from Darden, securities analyst Brad Ludington of Key Banc Capital Markets Inc. said a report to clients Tuesday. “We are encouraged by [Darden’s] first foray into international development outside of the United States and Canada, and believe that further area-development agreements could be forthcoming,” he said.

“The company has previously stated that growth would be focused around the three major concepts — Red Lobster, Olive Garden and LongHorn Steakhouse — and we believe international franchise growth opportunities are significant for these brands,” Ludington added.

John A. Gordon, principal in the Pacific Management Consulting Group, said the Middle East, along with Asia, is among the most appealing expansion areas for restaurants today.

“The U.S. is very much over-restaurant-developed,” Gordon added. “DRI was facing … the specter of running out of U.S. sites that could fit its $4 million approximate average-unit-volume baseline.”

Since the mid-2000s, Gordon added, Darden needed to show growth beyond U.S. sites and margin expansion to meet the Wall Street expectations of 10 to 15 percent annual earnings growth. “DRI got a fair amount of push-back [from analysts] in September about how it could hit its 2011 numbers, with the Red Lobster at negative 1.7 percent,” Gordon said.

“A good amount of its EPS growth is due to stock buybacks; that is hardly organic growth,” he added. “This international move sets the right direction for more meaningful growth.”

Gordon also noted that Darden’s use of a local operating partner is a strong move.

“The Americana local-nation partner fits the profile of good expansion practices: find a multi-concept operator, with sufficient units, infrastructure, access to capital and local nation/region expertise,” he said.

Contact Ron Ruggless at rruggles@nrn.com.

 

Darden maps overseas expansion – Nation’s Restaurant News

Darden maps overseas expansion

Company looks abroad as U.S. markets become more saturated

Ron Ruggless | Nov 08, 2010

Despite having a couple dozen licensed Red Lobsters in Japan and a handful of franchised LongHorn Steakhouses in Puerto Rico, Darden Restaurants Inc. has shown little appetite for overseas growth.

But in October, Darden bit off a big chunk of international development in the Middle East, prompting industry observers to question whether the United 
States still offered room to grow.

Over the past two decades, other restaurant operators, both small and large, have staked out territory abroad. But the Orlando, Fla.-based casual-dining giant has held back, growing its concepts, which also include Olive Garden, Seasons 52, Bahama Breeze and Capital Grille, as corporate-owned operations chiefly in the United States and Canada.

The prospect of expanding Darden’s concepts was on the mind of Clarence Otis, chairman and chief executive of Darden. He called October’s Middle East agreement with Americana Group of Kuwait “part of our ongoing focus on additional growth opportunities.”

Americana will develop and operate at least 60 Red Lobster, Olive Garden and LongHorn Steakhouse outlets in Bahrain, Egypt, Kuwait, Lebanon, Qatar, Saudi Arabia and the United Arab Emirates over the next five years.

The agreement, Otis said, “is an exciting milestone in Darden’s history” and will firmly plant the company in “an attractive, growing market that has shown a strong affinity for American brands, especially American dining brands.”

Seeking fertile grounds


Growing markets are what restaurant companies need — and they are increasingly difficult to find stateside.

The foodservice industry’s domestic growth is forecast to grow only 8 percent over the next
10 years, The NPD Group reported earlier this year, noting that the projection spreads a rate of increase that had come to be expected in a single year before the Great Recession over an entire decade.

And Darden is not alone in looking for new, more financially fertile lands across the seas.

Dallas-based Brinker International in May staked the growth of its flagship Chili’s Grill & Bar concept on international partners.

And international results are more robust than domestic ones for many brands with a global presence. For instance, Yum! Brands Inc. of Louisville, Ky., last month reported that system sales growth for the quarter ended Sept. 4, before foreign currency translation, was 5 percent, with gains of 18 percent in Yum’s China division, 5 percent in Yum Restaurants International and a pallid 1 percent in the United States.

Still, the domestic market is not yet an abandon-all-hope-ye-who-enter-here region, say observers, who note that domestic growth potential varies by segment and concept.

“The U.S. domestic market may appear to be somewhat saturated at first glance,” said Jay Goldstein, principal with Advance Foodservice Consulting in Allen, Texas, “but there still is significant room for growth in the right segment with the right concept.”

Bonnie Riggs, restaurant industry analyst for NPD’s foodservice division, agreed.

“What typically happens during a recession is that we do pull back in terms of unit expansion,” she said. “Operators will close underperforming stores and then stop building for a while. Typically, things will expand once again. I do not believe that will happen this time around. I do feel that we are a mature market.”

She added, however, “There will be pockets of growth. One that has continued to build, even throughout the recession, has been fast casual. Even the doughnut category has been a growth area in terms of unit expansion.”

Much of the difference in growth potential lies in the maturity of the market segment — but even then, innovative ideas can take off, Goldstein said.

“Fast casual is still in its initial growth phase and has a very promising future with terrific potential for growth,” he said. “There is a good mix of local, regional and national concepts either ready for or already showing strong growth numbers.

“While casual dining is a more mature and crowded segment, there remains room for fresh, distinctive and not ‘me-too’ concepts,” he continued. “Saturation really is a concept-by-concept issue. The ‘built out’ concepts will struggle to grow and may seek other avenues for growth through acquisitions, new concept development or brand extensions.”

Opportunity knocks


The U.S. restaurant industry has experienced a dramatic shakeout in the past two years, which is both a sign of the difficult competitive environment and the room for opportunity.

The NPD Group’s “Spring 2010 ReCount” found the number of restaurants in the United States had fallen by 5,204 units, a 1-percent decline from the total number of eateries recorded in the spring of 2009.

ReCount, which takes stock of domestic commercial restaurant locations twice a year, in the spring and fall, found that for the 12 months ended March 31, the number of quick-service restaurants declined by 2,521 locations, and the number of full-service restaurants fell by 2,683 units, resulting in a 1-percent decrease overall for both segments.

Meanwhile, the global foodservice industry experienced slight growth as a result of increased consumer spending in the quarter ended June 2010 compared with the same quarter a year ago, NPD found. Bright spots were Canada and China; the economic recovery and increased consumer confidence of the latter caused its foodservice traffic to increase by 13 percent.

It’s in that landscape that Darden entered into its first area-development agreement abroad. The company already has five franchised LongHorn Steakhouse units in Puerto Rico, which it inherited with the purchase of Rare Hospitality in 2007, and 25 licensed locations in Japan, which existed before General Mills spun off Darden as a separate company in 1995.

In Americana, Darden found a company that already had more than 1,200 restaurants in the Middle East — including KFC, Pizza Hut, Hardee’s, Krispy Kreme and TGI Friday’s units — and operates eateries in 14 nations. It also manufactures retail foods.

“The Americana local-nation partner fits the profile of good expansion practices: find a multi-concept operator with sufficient units, infrastructure, access to capital and local nation/region expertise,” said John A. Gordon, principal in the Pacific Management Consulting Group. He also noted that the Middle East, along with Asia, is among the most appealing expansion areas.

“The U.S. is very much over-restaurant-developed,” Gordon added. “DRI was facing … the specter of running out of U.S. sites that could fit its $4 million approximate average-unit-volume baseline.”

Since the mid-2000s, Gordon added, Darden has needed to show growth beyond U.S. sites and margin expansion to meet the Wall Street expectations of 10 percent to 15 percent annual earnings growth.

“DRI got a fair amount of push-back [from analysts] in September about how it could hit its 2011 numbers with Red Lobster at negative 1.7 percent,” Gordon said.

Darden owns and operates 1,800 restaurants that generate more than $7 billion in annual sales.

Brad Ludington, an analyst with KeyBanc Capital Markets Inc., said he believed “further area-development agreements could be forthcoming.

“The company has previously stated that growth would be focused around the three major concepts — Red Lobster, Olive Garden and LongHorn Steakhouse — and we believe international franchise growth opportunities are significant for these brands,” he continued.

Marzouk Al Kharafi, chairman and managing director of Americana, is optimistic about the partnership.

“Consumer demand for casual-dining brands in the Middle East market has grown over the past decade, and we expect that growth to continue in the future,” he said. “The addition of these three highly regarded brands to our portfolio enables Americana to build on its long legacy as the leading restaurant operator in the region.”

As for U.S. concept owners, consultant Goldstein said domestic growth “will be done in a much more deliberate, discriminate manner.”

He added, “Site criteria and metrics will play an increasingly critical role in determining total growth potential for a concept and where the growth opportunities exist.”

Riggs of NPD added that the U.S. restaurant industry is “in a mature market. It is going to be a battle for market share.

“There are going to be winners and there are going to be losers,” Riggs said. “The winners will continue to expand.”

Contact Ron Ruggless at rruggles@nrn.com.

Lower-priced, less volatile brands targeted by private-equity firms – Nation’s Restaurant News

Lower-priced, less volatile brands targeted by private-equity firms

Peter Romeo | Oct 04, 2010

According to an old adage, those 
who forget history are destined to repeat it. That wisdom hasn’t been lost on private-equity firms during their latest run on restaurants, say observers of the ongoing shopping spree.

The recent wave of deals — including 3G Capital’s $4 billion bid for Burger King — shows marked differences from the deluge of the mid-2000s, which weighted many of the purchased brands with difficulties beyond the economic slump, the analysts note. They point out that a number of the chains acquired back then are still feeling the ill effects, from bankruptcy to piddling reinvestment budgets.

Their pain and the hard lessons delivered to their buyers may spare the companies being acquired today from similar anguish, according to those who’ve handicapped the recent deals. They suggest the brands and their surviving management should benefit from adjustments in private-equity firms’ valuations of prospective purchases
and the timetables for recovering their money.

Buying time


Those accommodations to the times might sweeten what experts call the traditional benefits of being owned by a private-equity firm: less short-term pressure and investor meddling than public companies or strategic acquisitions typically feel.

Chains on the sales block often are contending with critical brand issues, noted John Gordon, a principal of the financial advisory firm Pacific Management Consulting Group.

“To fix sales and marketing, to restart product development, to fix a franchising model, to upgrade sites — those all take time, and you don’t always get it as a public company,” he said. “I can’t tell you how difficult the quarterly calls [with stockholders and analysts] can be. They can shape the whole bean.”

“We tend to be much more patient,” said Steve Romaniello, managing director of the private-equity firm Roark Capital Group. He’s experienced private-equity ownership from both the buyer’s and the chain executive’s perspective. Before assuming his current post, he ran Focus Brands, the Roark-owned franchisor of the Moe’s Southwest Grill, Schlotzsky’s, Carvel and Cinnabon brands, and still serves as its chairman.

“I’ve managed public companies,” he said of his earlier career. “It’s a very unusual situation when you’re not spending considerable time worrying about your quarterly results and the analyst calls. When I was at Focus, 99.9 percent of my time could be focused on running an excellent operation.”

Being part of a private-equity portfolio also means you have access to the expertise and talent of other holdings, he noted.

“I had access to people I surely wouldn’t have as an independent operator,” Romaniello said.

Along the same lines, the Brazilian-backed buyer of Burger King, 3G Capital, recently announced it would shift the 40-year-old chief executive of its Latin American transportation company to the burger brand’s CEO post after the $4 billion deal is consummated. Among Bernardo Hees’ new duties would be overseeing BK’s international expansion push.

A deep executive bench may be available to the management of a private-equity holding, but at the same time, management is “going to have a much greater say in how the company is run,” Romaniello said, also noting that Roark differs from many firms in that it owns an operating company that stewards most of the restaurant brands it buys. Typically, “PE companies don’t run the companies they buy,” he said.

Post-purchase anxiety


Still, when the Great Recession hit and private-equity companies were stuck with ambitious deals predicated on better times, those benefits might have been akin to having the orchestra play while the Titanic sank. Many of the mid-decade buyers had purchased chains for 10, 11, even close to 13 times the acquired companies’ earnings.

“The multipliers historically had been five, six, maybe seven times [earnings],” Gordon said.

“You had higher-leveraged transactions with higher transaction prices, which meant trying to get higher check averages,” said Mike Locker, a principal with mergers and acquisitions advisor TM Capital Corp. “Then the softness hit. They tripped their covenants, they had to renegotiate with lenders, and it became a vicious cycle. With the leverage being so high, you’ve got less margin for error.”

The near-universal response was lowering expenses so more dollars would be left to pay backers — a solution with sometimes detrimental repercussions.

“You can cut costs to a point, but after that … well, how much can you take?” Locker said. “You run the risk of cutting muscle instead of fat and turning the customer against you. When that happens, things get out of whack. You have to decide whether you can continue or not.”

“A lot of people went through a lot of learning,” said Phil Friedman, an experienced chain operator who most recently served as CEO of Roark-owned McAlister’s Deli. “The good things about private equity hadn’t changed so much as the macro-economic environment had.”

Against that backdrop, many private-equity brands decided not to persist. Claim Jumper, acquired by Leonard Green & Partners for what Gordon calculates at roughly 11 times the family chain’s earnings, filed for bankruptcy protection last month after a prolonged slide. It’s currently being acquired by Canyon Capital Advisors for an undisclosed amount.

Uno Restaurant Holdings Corp., parent of the Uno Chicago Grill casual chain, has moved in and out of bankruptcy already. Vicorp, operator-franchisor of the Bakers Square and Village Inn family chains, also sought protection from creditors. Ditto for Max & Erma’s and Buffets Inc., parent of HomeTown and Old Country Buffets.

Smarter shopping


Success or failure is predicated on more than earnings multiples, however. Bain Capital Partners teamed up with The Carlyle Group and Thomas H. Lee Partners to buy the franchisor of Dunkin’ Donuts in 2006 for about 12.8 times earnings, or roughly $2.42 billion. The privately owned Dunkin’ has drawn praise for recasting itself from a doughnut shop into a café specializing in baked goods and beverages. Franchisees showed their confidence by opening 338 stores last year.

The major difference between those deals and the ones making headlines today, Gordon said, are the valuations.

“The multiples thus far in 2010 have been well-behaved,” he said.

Apollo Global Management bought CKE Restaurants, parent of the Carl’s Jr. and Hardee’s burger brands, for about $1 billion, or about six times earnings, he noted.

“The good companies are still selling for good prices,” said Romaniello, whose company recently purchased the Wingstop Restaurants chain for an undisclosed amount. But “the companies that are challenged are trading at lower prices,” he added.

“Papa Murphy’s set what’s become the high-water mark for recent deals with a multiple of about 10 times,” Gordon said.

At the same time, many of the private-equity buyers are showing more patience about cashing in their investments.

“The outlook went from three to five years, to five to seven or even to 10 years,” said TM’s Locker. “I don’t see expectations for the market being out of sync anymore.”

“It’s the new normal, where they’re more careful about where they’re spending their money,” Friedman said. “They have more homework to do now. But the private-equity business model is still fundamentally sound.”

Retail and Restaurant Valuation Distortions – G+

Retail and Restaurant Valuation Distortions

Analysis Of John A. Gordon

June 03, 2010

Premise

The Wall Street Journal on May 29th discussed the effect of depreciation expense capital spending decisions and how it will affect earnings and valuations, highlighting mature retailers. But, one must look closely at the whole picture. This viewpoint holds for both retailers and chain restaurants.

Discussion

On May 29th, in his well written Financial Analysis and Commentary column, John Janarone of the Wall Street Journal discussed the variability of depreciation expense and the outlook for earnings, for various retailers, such as PetSmart (PETM), Best Buy (BBY), Barnes and Noble (BKS), among others. It highlighted a mature retailer, PetSmart, and the premise of the article was that valuation measures may make stocks look artificially expensive, as companies cut back on expansion and eventually depreciation expense falls.

The article points out correctly that retail (including restaurants) are way overbuilt in the US and slow up is needed.

To us, the article once again highlights the faculty metric and displays the limitations upon focusing on short-term company GAAP earnings trends.

Depreciation is a non-cash expense (but still a charge to earnings) that is a proxy for capital assets charges. On the sources and uses of cash schedule, depreciation is an add to arrive at free cash flow, or roughly, cash flow from operations less capital spending.

The problem is that a decline in depreciation expense, while providing a momentary short-term boost to earnings, is a sign of lack of vitality and business expansion. In reviewing companies, I look for declining depreciation expense as a signal. Even if store openings slow, CAPEX should be spent on remodels and reimaging.

Buffalo Wild Wings (BWLD) faced questions last year as it missed its depreciation target as it was building a lot of new stores. With its comparable sales momentum problems the last two quarters duly noted, it was doing what an underpenetrated US national company should do: build new units.

Retail businesses and chain restaurants battle minute by minute for customer attention and to make a splash. Too old of a store base means something is wrong—the company is in cash cow mode, or it can’t find sites, or that its new stores are not economically viable.

In the chain restaurant arena, refranchising is underway in many companies, driven by the belief that franchising makes company cash flows more predictable, and the royalty stream is worth more than building and maintaining company operated restaurants. So when a chain sells its company units to franchisees, it takes a book gain or loss, and hopefully eliminates some G&A and depreciation expense.

With company operated restaurant margins optimally in the 20-25% range (McDonald’s (MCD) and Chipotle (CMG) are industry leaders), and franchising profit margin at around 70-80%, refranchising seems like an easy decision. But which throws off more free cash flow? It will be interesting to watch YUM and Jack in the Box (JACK) long term as their US refranchising ramps up. In the last year, both have mentioned the earnings shortfall after refranchising and noted plans to cut G&A.

Refranchising can drive percentage margins higher but once completed, the company must rely on franchisees making their growth unit goals. And with franchisees paying more in cost of money (since they are smaller) and have lower unit economics than company operations (franchisees pay a royalty); the growth pattern will be a bit cloudier. Most chain restaurants don’t even discuss franchisee sales, let alone profitability. Earnings disclosure needs to be revamped in the US.

Frugality Fatigue – Franchise Times

Frugality Fatigue
Jonathan Maze

Same-store sales at Ruby Tuesday restaurants began falling in 2005, and the rest of the casual-dining sector soon followed, beginning a period of struggles that’s lasted nearly four years. “Ruby Tuesday was like the canary in the coal mine,” said John Gordon, principal Pacific Management Consulting Group.

If that’s the case, then casual dining chains may have reason to be optimistic. Teetering on the verge of bankruptcy a year ago, Ruby Tuesday saw modest sales growth in January — not enough to bring same-store sales higher for the quarter, but enough to give the chain confidence in its comeback.

The vast majority of casual-dining chains cannot make the same claim, but there is a growing belief that the restaurant industry, and the casual sector in particular, is finally recovering.

In a recent note to investors, Paul Westra, analyst with Cowen & Company, went so far as to “officially declare that the restaurant consumer recovery began in March 2010.” Economic indicators point to a more favorable environment for the industry.

Unemployment has stabilized and employers have finally starting adding jobs, albeit slowly.

Consumer confidence is up, though it’s still considered to be low. And the National Restaurant Association’s Restaurant Performance Index, a monthly measure of how restaurants are performing, hit its highest level in two years.

Casual-dining chains’ same-store sales fell 3 percent in January and 3.2 percent in February, according to the Knapp Track Index. That was the best performance since mid-2008, and it might have been better had there not been a Super Bowl or bad weather in the East. “They’re doing better than I expected,” Knapp said on a Bank of America Conference Call. “We’ve had several weeks of positive numbers.” Investors have responded to the improvement.

The Barclay’s Capital Restaurant Index of publicly traded restaurant stocks is up 32 percent, year-over-year — compared with 7 percent for the broader, S&P 500 Index.

Several chains are trading at pre-recessionary levels, including O’Charley’s, Famous Dave’s, Brinker International, DineEquity and Red Robin Gourmet Burgers.

Restaurants continue to face headwinds — unemployment is high and gas prices are rising.

But many analysts see a broad recovery. Jeff Bernstein, an analyst with Barclays, believes the improvement in casual dining is no illusion.

“We have had in casual dining some improvements for three, four months over the last year or two, only to go down again,” he said. “Now we’re seeing it over a multiple of months, supported by a larger number of restaurants. It’s more broad-based than in the past.” The NPD Group, a market-research firm, reported that fewer consumers are now trading down to lower-cost restaurants and fewer are sacrificing a restaurant visit. Still, total restaurant traffic was down 3 percent in February, the 14th straight decline, its research found.

Westra said part of the reason consumers have started returning to restaurants could be explained by “frugality fatigue.” After the 2001 recession, he noted that consumers began dining out in 2003, even though employment hadn’t started picking up steam. The same thing is happening here. In effect, he said, consumers have a limit to how long they’ll cut back.

Some longer-term concerns remain for casual dining, namely a “preference shift” in the babyboom population toward casual-dining chains with a more polished feel. So “mass casual” chains, like Ruby Tuesday, T.G.I. Friday’s or Applebee’s, will have to change to lure those customers, or shift focus to compete directly with fast-casual chains.

Ruby Tuesday is targeting the boomers. The chain’s struggles had many observers questioning its survival — burdened with more than $430 million in debt and a lengthy string of big sales declines, its stock in March 2009 was trading below $1. It was also shuttering existing restaurants and adding no new ones.

Yet it was also shifting its business to become more upscale. It avoided discounting during the recession and instead focused on improving check average — it’s currently at $12 and the company wants to increase that to the $13-$14 range. Once known for burgers, the company began offering higher-quality fare like lobster.

It also added brunch and a bar menu. It began making assistant managers more specialized, so those good at customer service will work with customers, while culinary specialists will work on food. “That’s smart, that makes sense,” Gordon said. “They might not have done that three or four years ago.” The efforts, along with cost cuts, were just enough to lure some investors back. The stock more than doubled, and the company was able to sell stock to raise funds to pay off some debt.

Its sales numbers, meanwhile, have gradually improved, and the stock now trades at nearly $12 a share, its highest level since 2007. The company feels strong enough that it is planning to boost advertising to speed up its improvement.

“It’s been a difficult two years for us,” said CEO Sandy Beall in a recent earnings call with investors. “We worked hard. We worked smart, to get the results we got now.”

Fast Food Restaurants Have Right Menu for Recession – Research Recap

Fast Food Restaurants Have Right Menu for Recession

As the U.S. restaurant industry struggles through the economic downturn, quickservice operators such as McDonald’s, Burger King and Wendy’s may enjoy a comparative advantage that helps them navigate the weakness better than their competitors in the casual-dining and higher-end segments, according to Moody’s Investors Service.

“Fast-food restaurants have a lower average check, greater convenience and increased food choices that resonate well with today’s financially stressed consumer,” says Moody’s VP-Senior Analyst William Fahy.

However, one threat to quick-service restaurants (QSRs) is the option of eating at home, or “trading out,” which is almost always less expensive than dining out. “As more consumers choose to eat their meals at home, QSRs will be negatively affected, but to a lesser degree than casual dining,” said Fahy.

With a lower price point and an increased emphasis on healthier food options, QSRs should be better-positioned to satisfy the consumer’s desire to dine out and save money. This will help QSRs better weather the “trading out” effect, the report says.

In addition to these operating advantages, QSRs also benefit from their predominantly franchise-based business model, which should reduce earnings volatility and capital spending. Yet amid a weak economy that shows little sign of near-term improvement, QSRs are not immune to reduced traffic, forcing them to cut costs and offer promotions or discounts to stay competitive and attract customers in order to stem deterioration in operating leverage.

Further, a recent history of generous share repurchases and dividends across the industry —- often funded with debt and other non-operating cash flows —- has placed greater pressure on restaurant operators to manage debt loads and maintain credit ratings as the economic downturn persists.

Key points of Moody’s report:

• Lower average cost of a meal at quick-service restaurants is an advantage as consumers become ever more frugal.

• Conveniences like drive-thru windows and late-night hours remain a competitive advantage over casual dining.

• New menu options at fast-food restaurants increase appeal for consumers that are more health-conscious.

• Franchise-based business model should provide greater stability to earnings.

• Discounting and promotions become key marketing tool to bolster traffic but squeeze margins.

• Many restaurants, including some quick-service operators, face weaker debt-protection metrics and eroding covenant cushions due to weaker operating performance.

A recent analysis by restaurant industry consultant John Gordon showed a mixed picture for fast food restaurants, with McDonald’s (MCD), Chipotle (CMG) and Steak N Shake (SNS) faring better than Yum Brands (YUM) and than Darden’s (DRI) Red Lobster and Olive Garden. All were faring much better than fine dining , where sales are down some 15% from a year earlier. Gordon also questions the wisdom of Wendy’s/Arby’s (WEN) following a multibrand strategy which has not worked well, with the exception of Yum Brands (KFC/Taco Bell).

Technorati Tags: (BKC), (CMG), (MCD), (SNS, (WEN), (YUM), Burger King, Chipotle, Darden, fast food, mcdonald’s, quick-service restaurants, restaurants, Steak N Shake, Wendy’s/Arby’s, Yum Brands

BK suit highlights franchisee friction – Nation’s Restaurant News

BK suit highlights franchisee friction

Ron Ruggless | Nov 30, 2009

The fight within the Burger King system over the $1 double cheeseburger could have far-reaching repercussions in a franchising world rife with value deals.

The lawsuit filed Nov. 10 in U.S. District Court for the Southern District of Florida by Burger King’s franchisee association claims that Miami-based Burger King Holdings Inc. does not have the authority under its franchise agreements to dictate maximum prices. It stems from a $1 double cheeseburger limited-time offer that began in October, which franchisees claim is forcing them to lose a dime or more per sandwich.

“This case, if you take the allegations in the complaint as true, is about whether a franchisor can impose on a franchisee the obligation to sell a product below that franchisee’s cost,” said Michael Dady, a partner in the law firm of Dady & Garner in Minneapolis. “The principle scares me. It has broad negative implications for other franchisees and dealers.”

In a statement, Burger King said it “believes the lawsuit is without merit.” The company noted that a U.S. 11th Circuit Court of Appeals earlier this year ruled that Burger King “has the contractual right to require franchisee participation in its BK Value Menu program.”
Still, the lawsuit has escalated frictions within the BK system—and others are watching closely.

A day after filing the suit, the Atlanta-based National Franchisee Association, or NFA, sent a letter to Burger King’s board, stating, “Your management team has pushed the franchise community to the brink.” The NFA represents about 80 percent, or 5,200 locations, of Burger King’s U.S. franchise base. Burger King has more than 12,000 stores in 74 nations.

Days later an e-mail from Charles Fallon, president of Burger King’s North American division, to some franchisees was leaked to the media.

“This negative publicity is detracting all of us from running our business and, just as important, lowering the value of our individual businesses,” Fallon’s e-mail warned. “Bankers, landlords, suppliers and potential new franchisees are watching and listening—potentially leading to less lending, at higher rates and increased equity participation.”

Dady, who specializes in franchise law, likened the case to an auto manufacturer requiring auto dealers to take a loss on every vehicle sale but to make it up on volume.

“I don’t like the equities of a manufacturer or franchisor setting a maximum retail price that forces the franchisee to sell below cost,” Dady said. “It’s a bad idea. There might be some short-term pleasures for the consumer, but there will be long-term pain when those car dealers or hamburger purveyors go out of business.”

The lawsuit concerning the $1 double cheeseburger is the second class-action lawsuit that NFA franchisees have initiated against their franchisor this year. In May, the NFA filed lawsuits against Burger King and its soda vendors over the diversion of soda machine rebates to corporate advertising. In the past, the franchised restaurants had used those rebates for repairs.

In addition, franchisees had twice since mid-summer rejected the $1 double cheeseburger promotion, saying they would lose money. Competitor McDonald’s had raised the price of its double cheeseburger late last year amid franchisee dissent that the item was not margin-friendly.

Burger King looked to a value-driven promotion to combat sinking sales—same-store sales fell 4.6 percent in the September-ended quarter. The $1 double cheeseburger promotion, which began in October, had improved traffic trends at Carrols Restaurant Group Inc., which is Burger King’s largest franchisee. At a securities conference in October, Carrols officials said sales were strong in the initial weeks of the promotion.

But other Burger King franchisees said they are losing on average between 10 cents and 15 cents on every $1 double cheeseburger sold.

“You could conservatively indicate that it costs us between $1.10 and $1.15 per double cheeseburger that we sell with all of our fixed and variable costs being covered,” said Dan Fitzpatrick, a Burger King franchisee from South Bend, Ind. “So when your revenue is only a dollar, it’s pretty clear that we’re not making money.”

The sandwich usually sells for between $1.89 and $2.39.
“The action that we took here is regrettable,” Fitzpatrick said. “When you look at what the management team has attempted to do with these two actions, they have fractured the relationship between themselves and the franchise community.”

The broader issue “is that the Burger King Corp. maintains that they have the right to set prices for our products,” Fitzpatrick added. “They imposed a $1 maximum price on a double cheeseburger. They could have just as easily picked other products on our menu. We reject the notion that they have the authority, either through our franchise agreement or otherwise, to force us to charge prices for products of their choosing.”

The case, Fitzpatrick said, could affect other franchise systems.

“When the franchisor crosses the line and begins to bully the system the way Burger King has done, it becomes concerning,” he said. “Our franchisor has a franchisee-revenue driven model. They make money when we ring up sales. We make money when we wring costs out of the revenue and make profit. When the franchisor crosses that line and says, ‘We’re now going to sell products at a loss, and we’re going to force this on your business model,’ and we have to deal with it, it gets to be very difficult.”

Steve Lewis, a former NFA chairman from 1998 to 2001 and a Philadelphia-based Burger King franchisee, said he was disappointed with Burger King’s deteriorating relations with its franchisees.

“In the past, we have been able to work through our differences in processes that worked very well,” Lewis said. “This particular management team, for one reason or another, opted away from that.… We believe they are so wrong in what they have done. And they forced us into this action. This is truly unfortunate that we are at this point. We should be trying to slay the competition, not each other.”

Julian Josephson, a former NFA chairman from 2001 to 2004 and a San Diego-based franchisee who has units in California, Texas and New Mexico, was concerned that the sale of items below price of cost could violate state statutes.

“There are quite a few states in the country—somewhere north of 20, and I’m in one of them, California—where it is illegal…to do this,” Josephson said.

John A. Gordon, the principal of the Pacific Management Consulting Group in San Diego, said he was surprised to see Burger King roll out the $1 double cheeseburger offer after such intense pushback from franchisees. However, he said September and October were the best months of the year to push value messages, before the interference from the Thanksgiving and Christmas holidays.

Costly promotions are risky, he said.

“Promotions involving big discounts and big portions of the product mix often need a 5-percent-to-10-percent traffic increase just to get back to gross margin breakeven, let alone pay for the incremental marketing,” Gordon said. “A key goal of any discounted offer is that customers will trade up or buy more add-on items when in the store.”

Joseph Buckley at Bank of America Merrill Lynch noted in a report that he was surprised at the level of discord within the BK system.

“In a soft QSR sales environment, BKC’s double cheeseburger promotion is ‘working’ and near term earnings implications are good, but franchisee relationships are in bad shape, in our view,” he wrote. “The latter is difficult to quantify but is a real-world issue that needs to be addressed for the Burger King system to prosper long term.”

Contact Ron Ruggless at rruggles@nrn.com.

Wendy’s parent interested in Krispy Kreme? – Nation’s Restaurant News

Wendy’s parent interested in Krispy Kreme?

Elissa Elan | Nov 23, 2009

An item in Briefing.com, as reported by Barrons, said that the parent of the Wendy’s and Arby’s fast-food brands was considering acquiring the 548-unit Krispy Kreme chain.

Denny Lynch, a spokesman for Atlanta-based Wendy’s/Arby’s, said the company does not comment on market rumors. Representatives for Winston-Salem, N.C.-based Krispy Kreme did not return calls for comment by press time.

Wendy’s/Arby’s has hinted in the past that it may be interested in acquiring a third brand, and with investor Nelson Peltz as its non-executive chairman, has a history of mergers and acquisitions. In June, Wendy’s/Arby’s closed on an offering of $565 million of senior unsecured notes, and the company said part of the proceeds could be earmarked toward the acquisition of another restaurant company.

Wendy’s/Arby’s itself is the product of a merger between Wendy’s International Inc. and Triarc Cos. Inc. That deal, which closed last year, was valued at more than $2 billion.

John A. Gordon, a financial consultant with San Diego-based Pacific Management Consulting Group, a group that focuses on the restaurant industry, said that the timing may be right for a merger between Wendy’s/Arby’s and Krispy Kreme.

“If you go back to Wendy’s last two earnings calls, there was discussion that led you to believe something could happen,” Gordon said. “It seems to me, and this is pure speculation, that Wendy’s unit economics is on the road to getting fixed; there’s been a lot of G&A reduction and, most significantly, their new product pipeline problems have been rectified.”

Wendy’s has been faring much better than sister brand Arby’s in the economic downturn. For the September-ended third quarter, same-store sales dipped 0.1-percent at Wendy’s North American stores. Same-store sales fell 9 percent at Arby’s. Wendy’s/Arby’s operates or franchises 6,608 Wendy’s units and 3,739 Arby’s locations.

Krispy Kreme, meanwhile, has been struggling to turn itself around after years of battling legal problems with executive management and sluggish sales at its doughnut stores. In its August-ended second quarter, the company nearly broke even with a net loss of $157,000, compared with a loss of $1.9 million in the same quarter a year earlier. Krispy Kreme pointed to lower commodity costs and a 5.9-percent increase in same-store sales at corporate stores.

Contact Elissa Elan at eelan@nrn.com.

The Indianapolis Star – Steak n Shake Merger Big for CEO

IN $22.9M DEAL, CHAIN TO BUY WESTERN SIZZLIN, WHICH BIGLARI ALSO LEADS engineering,” said Gordon, of Pacific Management Consulting in San Diego. “In terms of ongoing business streams, I’d be looking for any synergies, but I don’t think there will be. These STEAK N SHAKE WHAT: Full-service, casual-dining restaurants famous for Steakburgers and shakes. HEADQUARTERS: Indianapolis. HISTORY: Gus Belt started Steak n Shake in 1934 in Normal, III. EMPLOYEES: 20,000 (2008). CHIEF EXECUTIVE OFFICER: Sardar Biglari. LOCATIONS: 490 restaurants in 21 states; 70 locations in Indiana. 2008 NET SALES: $610 million. 2008 NET INCOME: ($23 million) loss. WESTERN SIZZLIN WHAT: Known for their flame-grilled steaks and fully stocked salad bars. HEADQUARTERS: Roanoke, Va. HISTORY: Nick Pascarella opened his first restaurant in 1962 in Augusta, Ga., and began franchising four years later. EMPLOYEES: Not available. CHIEF EXECUTIVE OFFICER: Sardar Biglari. LOCATIONS: 125 locations in 19 states. None in Indiana. 2008 NET SALES: $17.2 million. 2008 INCOME: ($6.3 million) loss. Biglari was fresh from the takeover of Western Sizzlin in 2007 when he launched a proxy fight for control of struggling Steak n Shake. The young investor, then 29, spent more than $16 million to amass a block of stock used to force out the Indianapolis company’s senior executives and place himself at the top in June 2008. Since then, Steak n Shake has trimmed its menu, focused on burgers, introduced lower-priced meals and begun sprucing up its white-tile eateries. The company earned $2.2 million in the quarter ending April 8 after running up losses totaling $22.4 million over the previous nine months. Reflecting the uptick in profits, Biglari’s annual salary rose in June to $900,000 from $280,000. But the bigger payoff could come in the merger. Under the terms of the deal, each share See Steak, Page A9

The Indianapolis Star – Steak n Shake parent set for a name change

The investor who took control of Steak n Shake wants to rename the Indianapolis cheeseburger chain’s parent company for himself.

Shareholders will vote at the annual meeting to rename their company Biglari Holdings Inc.

The parent is now called Steak n Shake Co., based in Indianapolis, and its restaurants are a subsidiary named Steak n Shake Operations Inc.

The proposed name change, disclosed in a filing last week with the Securities and Exchange Commission, follows Texas investor Sardar Biglari’s efforts to diversify outside the restaurant industry using cash from the burger business.

Under Biglari, the parent company’s chairman, Steak n Shake Co. launched a hostile takeover in December of a Michigan-based insurance company, Fremont Michigan InsuraCorp. Biglari earlier fell short in efforts to buy Itex, a West Coast bartering business, and the California-based burger chain Jack in the Box.

Renaming the parent could make it easier for Biglari to possibly spin off the Indianapolis-based restaurant chain in a few years without confusing shareholders, suggested restaurant industry analyst John Gordon, of Pacific Management Consulting Group, San Diego.

Steak n Shake’s annual meeting will be April 8 at the St. Regis Hotel in New York.

The burger chain, which has 485 sit-down eateries, surprised some analysts last week with its strong profit report.

After-tax income of $5.49 million was reported on revenue of $147.58 million. In the same period in 2008, Steak n Shake posted a loss of $3.44 million on revenue of $130.72 million.

Operating costs were relatively flat while sales revenue soared, Gordon said.

Call Star reporter Ted Evanoff at (317) 444-6019

To see more of the Indianapolis Star or to subscribe to the newspaper, go to http://www.indystar.com/.

Copyright (c) 2010, The Indianapolis Star

Reading Restaurant Results Properly

Many of you know I’ve been working complex restaurant analytical roles and engagements since the early 1980s. I’ve seen over that time advances in restaurant management systems, technology and data gathering has expanded exponentially. Restaurants today of course are complex blend of people, brand building and management systems bundled together; the outgrowth of this is numbers have become incredibly important.

Unfortunately, a series of suboptimal restaurant analytical viewpoints, reporting and practices continue to be seen. The same issues seem to carry over from decade to decade. Such perspectives result in confusion; lack of lessons learned and misdirected effort. Here are five that I see regularly, and suggested solutions are posed.

  • The comps trap. Everyone talks and worries about comps. Same store sales are typically calculated as percentage change of average unit sales over prior year period, for the units in the mature, “comp sales store base”. The press and investor community keys on it, a lot of decisions are driven by the comp. The problem is of course is that a one year view over last year is really a tiny snapshot. Let’s face it, weather, menu platform changes, competitive intrusion, national and global events happen every day. A better practice is to consider and report two year or even five year comps. This measure can be either “stacked” (values added together year after year) or on a compound annual growth basis (CAGR). If the sell side analysts keep focusing on the one year comp, report the longer measures anyway.

As an example, look at the very current extract from the February 2016 Miller Pulse report, which shows the industry comps strengthening, not weakening, on a two year basis, versus the flat to negative January 2016 trend on a one year basis. A vastly different two year view!

Restaurant Monthly Same Store Sales through January, 2016

graph

  • Transactions v. traffic v. customer count.  Of course, the amount of traffic the restaurant generates is a vital number, which drives food prep and staffing in store. But is it people, entrees or number of times the grand total key on the POS was hit? Restaurants chains report it all differently. For drive thru or catering transactions, it might be hard to know exactly how many customers are served; for bar only customers, there might be many seconds or thirds served. Is each a transaction? Both Panera (PNRA) and Zoe’s (ZOES) have gotten into trouble with this lately; in 2013 and 2014 Panera had rising entrée counts but reported the number “parties”, that is  the number of times the grand total key was pushed on the POS was down. Zoe’s had good comps but flat traffic because catering was up. Was that really a problem? If Panera got big table sizes in, they didn’t get credit for it, and the Investment Community became worried.

The practice that Ruth Chris (RUTH) utilizes is pretty simple; report the number of entrees sold as a proxy for customer count. A conversion factor for catering can be set (and updated annually), drive thrus might be too hard, but every sophisticated QSR brand has the ability to track the number of “menu units sold” and can be noted as color in earnings calls.

  • Dollars versus percentages: restaurant managers are taught percentage analysis early on; a fantastic amount of discussion and attention throughout the industry occurs to food cost and labor percentages; percentage restaurant margins are discussed endlessly. Investors get percentages but have to be told a fuller story. Sometimes, merchandizing and even refranchising decisions are justified on a percentage basis; e.g., the franchising margin percentage is greater than that of operating a restaurant. But what about the dollars?

A unit with high profit percentages but low dollars profit per store is not the goal.  A percentage is simply one number divided by another, it is a just a relative measure. The problem is of course percentages can’t be taken to the bank. The powerful effect of average ticket and gross profit cents per customer is not recognized if the focus is to percentages. The suggestion is to supplement “profit cents per customer” or even average weekly store contribution margin dollars per week as metrics, something to get the focus on dollars.

  • Misleading marketing event analysis. A lot of promotional events are underway right now, one QSR brand is running three concurrent major promotional efforts (for example, Restaurant Brand’s International’s Burger King (QSR) is fighting the burger wars) that makes it confusing to detect what worked.

There are a multitude of improvements possible in restaurant marketing analysis. First, brands can find and set a control market and measure impacts to remove “noise” from the promotional review. Not all brands do so.  Secondly, more attention to measuring the AUV impact after a promotional window ends is needed. Restaurants are open long after the promotional event ends. In my thirty plus years, I’ve rarely seen reports of the “post promotion lift”. And if the marketing event media spend is expensive, advertising expense over and above plan should be treated as a variable expense and subtracted from the sales lift and other variable expenses in figuring out whether the event worked. And finally, the promoted item hit rate itself is interesting but unless it drives sales and profits higher, it is just an incomplete metric. It is not the measure whether the media worked. To its credit, Burger King, which just announced its Hot Dog rollout, tested the dogs in five markets and had a control market. Honest testing and data gathering does wonder in building credibility in a franchised system and in a company operated system to read and learn from the results.

  • Remodel tracking and the first year sales pop: sales are vital of course, and remodels typically (but not always) drive incremental sales. But for how long? The first year lift gets all the attention (example, Wendy’s reported this week its Image Activation (IA) program returns are now lower than what they started with) but incremental sales and profit flow through are needed for years thereafter.

To be sure, stores that aren’t remodeled will trend negative over time, so the change from doing nothing (negative AUVs) to the actual lift is fairly included in the sales and profit lift analysis. Setting the right analytical perspective is also important in the heavily franchised brands; the franchisees fund the CAPEX. Answers like “remodeling is in the contract, so we won’t talk to that” (see Dunkin Brands example) is not productive.  For example, to its credit, in 2015 and 2016, Panera (PNRA) had excellent displays of the sales and profit impact of its Panera 2.0 initiative that helped explain a very complex undertaking.  Suggestions: keep and track the multiyear sales and profit lift trends, publish to franchisees for their planning.

About the author: John A. Gordon is a long time restaurant analyst and management consultant. He founded Pacific Management Consulting Group in 2003 and works complex restaurant strategy, operations and financial management analytical engagements.

What Does Restaurant Refranchising Mean?

In 2014, McDonald’s (MCD) announced it was to refranchise up to 1500 units out of the United States. In 2013, Wendy’s (WEN) announced refranchising of 450 units in its non core markets. In 2012, Burger Bing (BKW) and Jack in the Box (JACK) kicked into serious refranchising, so much so that Burger King now only owns and operates the 50 plus units in Miami out of a 130000 unit total. Even Starbucks (SBUX) is finally in franchising for its flagship Starbucks brand, refranchising stores in the UK and Ireland. It franchised its non premium Seattles Best Brand for some time. YUM has been furiously refranchising since 2009 but intends to keep China company operated.

To be sure, some brands have been defranchising—buying franchised stores back. Red Robin Gourmet Burgers (RRGB), Noodles (NDLS), Qdoba (JACK) and Texas Roadhouse (TXRH), among others. Chipotle (CMG) wont franchise—it would destroy its culture and they make more as company operated stores.

The debate in restaurant circles about the proper mix of company and franchised units has been legendary. In the 1970s and 1980s, the trend was towards company owned locations. In the 1990s, as return on invested capital (ROIC) and awareness of the free cash flow expanded, refranchising picked up.

Refranchising means the company can make more on the royalties, maybe rent spreads (if it owns the real estate) and reduced G&A and capital expenditures (CAPEX) associated with its former units. In almost every case, refranchising involves weaker stores beyond a certain profit or EBITDA point or weaker brands or geographies.

Benefits of refranchising 

Refranchsing can be a stock catalyst, some new news, particularly if it funds increased dividends or buybacks, or if it is associated with more debt that can fund dividends or buybacks. That what McDonalds is doing.

Optical improvement: refranchising takes the lower stores out ofn the base, and optically makes restaurant sales and margins improve, as both WEN and JACK have noted.

Refranchising should lower debt, improve credit ratios to allow for special dividends

Boost ROIC: with units sale proceeds and capital investment falling lower or to near zero if no real estate is involved, it provides a bump to ROIC.

It can help out franchisees, as large franchisees have a need to get larger (WEN example)

And, in some cases, if the company can’t operate stores well, refranchising is a type of outsourcing of the problems. See: YUM’s KFC, Burger King (BKW)

Limitations with refranchising 

The ultimate problem is the company becomes an outsourced restaurant provider—no expertise in running restaurants. Franchisees site “no skin in the game” as a perennial problem in brand management.

Adaptability/Flexibility: franchised concepts take longer to get new products to market and keep the physical plant remodeled and renewed. In the US, Starbucks will always have an advantage over McDonalds as it can make decisions and implement market change quickly, while in McDonalds case it takes years to attain buy in and effect market change.

Unit level economics: while there is the perception that franchisees run a tighter P&L,than company operations, franchisees do have to pay a royalty and are generally territory constrained. In addition, the availability of funds and cost of debt for franchisees typically are unfavorable versus that of the franchisor . This implies higher cost of debt and missed opportunities. Franchisees have higher debt to EBITDA ratios. For example, the McDonalds US franchisees debt/EBITDA is appx. 5.4 X, versus 2.2X at MCD corporate.

Company structure; good franchisors run their company units as a training and development ground for franchisees. If the company store base is deteriorated or nonexistent, quality development staffing comes at risk.

Once the refranchsing is done, that arrow is no longer in the quiver. What next?

Cultural bifurcation, franchisor v. franchisee conflicts.