Wray Executive Search – A Deeper View of Current Restaurant Conditions, from the Finance and Development Conference

By John A. Gordon, principal and founder of Pacific Management Consulting Group

I had the opportunity to attend the 26th annual Restaurant Finance and Development Conference last week. This is an excellent conference to get beyond the headlines and spin from earnings calls. Here are a few observations of themes heard: Read more

Wray Executive Search – Subway’s Face Lift: Fixing Franchisor Flexibility

Posted Mon, 2015-08-31 22:16 by john a. gordon

By now news of Subway’s version 2.0—it’s hoped for rebirth and revival– are available via the New York Post’s Monday piece. Insiders in the restaurant industry knew it was inevitable. Still, there are several
lessons seen in the Subway experience to date—and not coincidentally McDonald’s, too– that are gaining steam at approximately the same time in the US (McDonald’s problems in certain world markets like Japan
were building for years).

Here is a list of observations to speed Subway’s revival process along:

Fix the over store development: Certainly in the US—with over 1 million foodservice venues– can be jammed with too many restaurants. There is no life or death need to go out to eat, just to eat. Subway is aimed at the lunch market, which itself is finite, and has been declining in market share the last few years. With over 27,000 US restaurants—and negative same store sales for three years, the general upward bound of Subway US unit counts has been reached, (though certainly there are some good replacement locations can be found.) Subway is not publicly traded and does need to put up big store development numbers every quarter. Pause the US store growth, smooth it out, and let the market catch up. As US
Subways stores close, don’t replace them. Try to find that point of reverse cannibalization where the closures benefit the remaining franchisees.

Test, test, and test: one of Subway’s strengths is that it has 27,077 test stores in the US, where a multitude of new products and techniques can be tested. But yet, they didn’t, apparently until now. Both
Subway and McDonalds have hit dead momentum. System wide national rollouts, like this one, should be tested in whole markets. Unfortunately, Subway has no company stores and it has to rely upon getting the
franchisees on board or bludgeoning them with the franchise agreement and operations manual to agree. There should be hundreds of tests underway.

Not everything has to be the same everywhere: rigid restaurant consistency from unit to unit was a selling point in the 1950s and 1960s, when restaurants chains began to develop after World War Two, with
the birth of the Interstate System. Back then, consumers were turned off by lack of consistency experienced along the country roads. Since then, franchisors have perfected inspection rights, to insure everything is
the same. As circa 1948 Dairy Queen Franchisee in Minnesota (not bound by the same contracts as today) said recently, “The corporations want everything to be the same”.

Today, the US is hundreds of times more diverse than the formative 1960s, with different consumer socioeconomic, national heritage, communication, income, work and education patterns; vastly different traffic,
neighborhood and psychographic consumer behavior drivers everywhere. Does everything need to be the same everywhere? A good Subway example is the sliced prepackaged apples: I’m glad they are on the
menu. But it must be considered to be a never out item, and this is enforced by the franchisor inspectors. If the sliced apples don’t sell in some units, figure it out and get to a lower, build to on hand level, by unit.
Once the store is out, it is out. A sure sign is if the store is throwing out more than are sold. A product yield for products like this should be 90% plus.

The business shouldn’t be run for the ease of the ad agencies and franchise field consultants. Subway now has a new ad agency—BBDO, replacing the long time incumbent. This is a sure sign of corporate unease. It is easy for ad agencies to devise discounting and big TV media heavy spending plans,
and for franchise field consultants to work off one inspection checklist if everything is the same everywhere. But this is how all the restaurant chains begin to look alike, where everything is the same everywhere. Subway had years of lazy marketing—discounting—which is puzzling since it was not publicly traded and didn’t have to put up quarterly same store sales numbers. What makes it worse is that Subway measured ad spending rose in 2014 despite negative sales. Advertising levels cannot solve brand momentum problems.

Fix the bread and the aroma marketing: my high school memories of walking in Subway was a yeasty bread baking aroma. Today, however, that is not experienced, other mixed food and burnt odors predominate. The bread isn’t toasted fully and is a mouthful of carbs. Dirty ovens? Too many products? Changed bread formulation? It is important because it is the first bite, the first impression.

Starbucks had this same aroma problem in 2008/2009 but fixed it, and once again smells like a coffee store when arriving. They had to change the ovens. Is this something that Subway would have caught if it owned and operated some stores?

The New York Post – IPO lands Shake Shack’s Danny Meyer $342M in 1st day

By Richard Morgan

What started out as a hot-dog cart in 2001 has emerged as Shake Shack, the 63-store chain with a valuation of $1.63 billion after its first day of public trading.

New York restaurateur Danny Meyer, who conceived the cart to help restore a then-downtrodden Madison Square Park, saw his wealth increase by $342 million Friday as stock soared 118.6 percent above its initial public offering price of $21.00 per share to end the day at $45.90.

Meyer owns 7.4 million of those shares for a 21 percent stake in the hot-dog cart he turned into a humble hamburger kiosk in 2004.

 An even bigger winner from the IPO was Leonard Green & Partners — the private-equity firm took a controlling interest in Meyer’s Union Square Hospitality Group in 2012.

The splitting of Shake Shack from privately held USHP, which remains home to such upscale eateries as Gramercy Tavern, The Modern and Maialino, left Green with a 26.0 percent Shack stake — valued at $423 million after the IPO — in the new public company.

The share’s upward trajectory Friday didn’t completely surprise analysts, who noted the halo over Shake Shack’s so-called “fast-casual” eating category has burned brightly since Chipotle Mexican Grill conducted its IPO in 2006.

The dearth of publicly traded restaurants added to the IPO excitement, as did Meyer’s contacts in the media and top-tier ranking in the restaurant firmament.

That most Shake Shacks are in areas frequented by financial types — including Dubai, Kuwait and London, as well as lower Manhattan — created even more sizzle with just the right segment.

The chain is undeniably popular in Manhattan, where the average store rings up $7.4 million in sales annually.

Yet, even its domestic non-Manhattan Shacks, with average sales of $3.8 million, throw off enough business to stir the envy of the food industry.

That said, however, is a self-styled chain of “roadside” burger stands that offers classic American fare of upscale burgers, hot dogs, crinkle-cut fries, shakes and custard really worth $26 million an outlet?

Never mind that Meyer plans to expand the chain by 10 outlets a year; John A. Gordon of restaurant advisory Pacific Management Consulting Group dismissed its implied stock valuation as “unsustainable over a long period.”

This is especially the case, he said, on comparing metrics commonly used for restaurant companies. Gordon estimated Shake Shack’s EBITDA to be $18 million last year and its enterprise value at $1.7 billion as of Friday.

That suggests the chain began life as a public company with a 94.4 Ebitda multiple — compared with a 10.7 multiple for McDonald’s.

Granted, Shake Shack is no McDonald’s — but the multiple will move lower as the quest for finding what Gordon called “premier sites” and additional customers escalates each year.

At the end of “a very exciting day,” CEO Randy Garutti told The Post, “We gave options to every manager in our company. “They could also buy stock at the IPO price.”

The New York Post – Subway founder’s sister takes over operations

By Josh Kosman

Suzanne Greco, 59, whose official title is still senior vice president, has taken over day-to-day operations for the closely held company with some 40,000 outlets around the world.

DeLuca recently sent a memo to top executives with a new organizational chart that showed all departments now reporting to Greco, a source said.

“On paper, she is running Subway.”

DeLuca, 67, has declined to discuss succession plans despite chemotherapy and a bone-marrow transplant that sidelined him for months, leaving franchisees to grapple with the question of who will step in for the legendary founder.

Subway, which a teenage DeLuca borrowed $1,000 to start in Bridgeport, Conn., in 1965, has been secretive about its management and doesn’t have to divulge financial details as a private company.

“While Fred DeLuca actively leads our family-owned company, he’s sharing more responsibilities with Senior VP Suzanne Greco,” a Subway spokesman said.

Greco has taken the lead at a tumultuous time for the Milford, Conn.-based company, which will mark its 50th anniversary in August. Like other major fast-food chains, Subway is struggling with sagging sales, changing tastes and cutthroat competition.

In January, Greco took center stage at Subway’s annual franchisee meeting in Miami, where execs acknowledged “there had been problems and they are fixing the problems,” according to one attendee.

DeLuca was also at the meeting but appeared frail, the source added.

The ubiquitous chain has been making some substantive changes, such as distributing refrigerated roast beef instead of frozen, and is planning to roll out free-range chicken in some markets to appeal to more health-conscious consumers.

At least one franchise operator took a dim view of Greco as heir apparent, saying he doubted she would make the wholesale changes needed to reverse slumping sales and profit.

Greco started as a sandwich maker at age 16, and went on to head research. She gets credit for the cold cut combo and sweet onion teriyaki subs.

Keeping it in the family also sends the signal that there won’t be an IPO or sale of the chain in the near term — options DeLuca has long resisted.

While Subway surpassed McDonald’s as the biggest chain in 2011, it has never been as profitable. A Subway restaurant earned, on average, an estimated $40,000 to $55,000 before interest, taxes and depreciation last year, down from $70,000 in 2012.

During the same period, average annual sales fell 4.6 percent to $460,000, according to estimates from John Gordon at Pacific Management Consulting Group.

Subway, which saw explosive growth 17 years ago with Jared Fogle’s now-famous Subway sandwich diet, expanded too much and failed to roll out many new products, Gordon said.

“Like McDonald’s, Subway enjoyed a long run of success but has hit a sustained difficult patch,” he said.

Nation’s Restaurant News – How Starbucks operates like a tech giant

Jonathan Maze
Wed, 2015-06-17 16:49
This post is part of the Reporter’s Notebook blog.

Three years ago, Starbucks Corp. bought a popular local bakery chain out of San Francisco, called La Boulange Bakery, for $100 million — an extraordinary price for an 19-unit concept, at least back then.

At the time, Starbucks indicated it wanted to grow the brand. But it mainly
wanted access to what La Boulange did: Make quality food. Facing tough
competition from McDonald’s Corp. and Dunkin’ Donuts, the Seattle-based
concept wanted to improve its food offerings.

Three years later, almost to the day, Starbucks backtracked on that decision, announcing late yesterday that it will close the 23 La Boulange locations, as my colleague Lisa Jennings reported earlier. The company
“determined that La Boulange stores are not sustainable for the company’s long-term growth.”

Starbucks is instead focusing on building La Boulange as an in-house brand, to continue to build its food business inside coffee shops. In hindsight, $100 million is a lot of money for an in-house brand.

The move wasn’t really surprising, however. Starbucks has bought a few brands over the years and then integrated them into their operations. It bought Seattle’s Best in 2003 as a lower-end coffee option, and has
since turned that brand into a retail brand with licensing opportunities.
It also bought the Evolution Fresh juice bar in San Francisco, and now sells Evolution Fresh juice in its coffee shops. Indeed, tucked in the same release as the La Boulange announcement was this little nugget: The
Evolution Fresh retail location in San Francisco will close, too.

In 2008, the company bought the maker of the Clover French press brewing system and then rolled that machine out to its locations.

In this, Starbucks acts more like a tech giant than it does a restaurant chain. Rather than developing a juice line or a set of food offerings from the ground up, Starbucks spends a few bucks and buys an existing concept,
integrating that knowledge into its system and adding those products into its coffee shops.

That strategy is relatively rare in the restaurant business. In general, restaurants buy existing brands to grow and develop them, rather than to integrate their knowledge into their system.

To be sure, some will buy awfully small concepts. PizzaRev was a one-year-old chain with three locations when Buffalo Wild Wings scooped it up in 2013. Pizzeria Locale was a concept little known outside of Colorado when
Chipotle Mexican Grill decided to partner with the company in 2011.
But rarely do restaurants buy a concept for the talent and technology the way Starbucks does. When McDonald’s wanted to add a new beverage line a few years ago, it developed the drinks itself. It didn’t buy a small coffee
chain first.

“Most restaurant brands take pride in food engineering themselves — it’s a core competency — and feel creating internally has to be cheaper than a bolt-on acquisition,” said John Gordon, a restaurant consultant out of San

So while La Boulange didn’t quite become the national bakery chain that Starbucks planned back in 2012, the coffee chain did succeed in its primary goal to improve food sales at its coffee shops, which are up 16 percent.
That added 2 percentage points to the chain’s same-store sales number.
And investors care almost exclusively about what happens inside Starbucks’ 21,000 locations.

Contact Jonathan Maze at jonathan.maze@penton.com
Follow him on Twitter: @jonathanmaze
Source URL: http://nrn.com/blog/how-starbucks-operates-tech-giant
How Starbucks operates like a tech giant http://nrn.com/print/blog/how-starbucks-operates-tech-giant?group_id=…
2 of 2 9/24/2016 4:45 PM

The Los Angeles Times – For novice restaurateurs, risk of failure is high

Risk of failure is high for restaurants

Ari Taymor’s 3-year-old restaurant Alma basks in the kind of acclaim most young chefs can barely begin to fathom.

Within a year of opening, when Taymor and business partner Ashleigh Parsons were just 26 years old, the downtown Los Angeles eatery was crowned the best in the country by Bon Appetit magazine. Each of the eight tables was booked for three months solid.

Even now, the elegantly plated California cuisine continues to scoop up awards and remains popular with guests.

But Alma, Taymor said, is in constant danger of going out of business.

It’s a common state of existence for many hot young restaurants. Their wunderkind chef-owners are often culinary artists but financial novices, honing their skills through hours of grunt work, learning their way around a kitchen but not a business plan.

“They’re younger and generally don’t have the life experience — they know what they know, and they don’t know what they don’t know,” said John A. Gordon, principal of Pacific Management Consulting Group, which specializes in restaurants.

Despite entering an industry notorious for its slim profit margins and volatility, many new restaurateurs launch businesses without making allowances for sudden surges in ingredient costs, changing worker compensation rules, broken dishware and kitchen upgrade expenses. Their eateries get sucked into a cycle of hype perpetuated by foodie blogs and culinary cognoscenti, who laud innovation but also bore quickly.

Alma’s current cash-strapped status is partly due to a lawsuit that Taymor and Parsons have battled for much of the last year.

Michael Price, a business manager for entertainers and writers, filed a complaint last summer with the Los Angeles County Superior Court alleging that Taymor and Parsons reneged on a handshake agreement to give him 20% ownership of Alma after he “spent substantial money and time reorganizing the way Alma did business as well as resolving Alma’s numerous financial and legal issues.”

Price declined a request to comment but said in his complaint that “the most primitive understanding of business did not exist” at Alma — a situation “complicated by lack of available capital.” He alleges that he proposed “sweeping initiatives” after Taymor and Parsons asked him to bring the restaurant back from the “brink of ruin.”

Although Los Angeles is increasingly a magnet for ambitious culinary stars such as Taymor, new restaurants tend to make investment experts wary. More than half of restaurants fail within their first five years, they said.

To develop a 60- to 80-seat restaurant at a new site, owners need at least $1 million in capital or loans, according to Jeffrey E. Sultan, a Los Angeles attorney who specializes in restaurant start-ups. The money goes toward such expenses as lease negotiation, construction costs, kitchen appliances and fixtures, liquor licenses, inventory, furniture, rent and initial operating capital, he said.

“A lot of inexperienced restaurateurs go into a project under-budgeting,” he said. “Invariably snafus happen — the construction budget can go haywire, there are regulatory constraints depending on what city you’re in, there are delays during which you have interest costs and mortgage payments.”

But getting funding can be difficult.

“When it’s a first-time chef, they just don’t have a track record,” Sultan said. “It’s generally not the kind of economic investment for a sophisticated investor just because there is such a high failure rate for these kinds of ventures.”

Nguyen Tran endured the pressures after launching Starry Kitchen with his wife, Thi, out of their North Hollywood apartment.

In 2010, the underground phenomenon evolved into a formal business with a restaurant downtown. Fans swarmed the new outlet, eager for a taste of the Trans’ popular meatballs and Singaporean chili crab.

The recipes were a hit. But the Trans made mistakes, assuming that sales tax was automatically deducted from transactions, causing penalties to eat into already small profit margins. Less than three years after opening, their business partners sold the lease.

The Trans revived Starry Kitchen as a roving pop-up restaurant and launched a crowdfunding campaign this year to raise $500,000 for a permanent place. The effort failed, and the business closed in February.

“I was really young and naive when it came to running a business,” Nguyen Tran said. “Foodies want to say it’s all about the food, but that’s not true.”

In June, rising rents in the trendy Silver Lake neighborhood killed Heywood Grilled Cheese Shop four years after it opened, according to co-owner Michael Kaminsky.

“Every person I spoke with gave me the advice that it was going to take three times as long and twice as much money as we had planned,” he said. “They are right on the money.”

Casual burger bar Short Order opened in the Fairfax district in 2011 to intense press interest. On the restaurant’s second day, it welcomed 900 customers.

The huge volume exposed problems that the restaurant’s team hadn’t yet worked out, said Bill Chait, a veteran restaurateur who backed the operation. The eatery, hampered by its complicated two-story setup and high ingredient expenses, closed in April.

“There was a huge build-up and expectation for that restaurant before it opened,” Chait said. “It was pent up and consequently puts you under a lot of pressure.”

Restaurateurs have some options. Local chapters of various restaurant associations sometimes offer mentorship programs and business tutorials.

A year ago, a website called EquityEats launched in Washington, D.C., to help restaurateurs raise money from local investors, who invest at least $100 and receive an equity stake and returns on profits.

But without the help, many restaurants struggle.

“The industry has a tendency to spit people out,” said Alma’s Taymor. “People are chasing goals that don’t return an investment — Michelin stars don’t lead to financial stability.”

Alma was never intended as a cash cow, but rather, as an experiment in sustainable business, Taymor said. The business was regularly denied loans by banks and was initially funded by friends, family and Kickstarter donors.

“Traditional investors would laugh us out of the room,” he said. “We were week-to-week from Day One.”

Price’s lawsuit, set for trial in January, details the sorts of things that can go wrong in an untested business.

Price alleges that the eatery’s problems were “numerous and far-reaching”: blank checks left on an open table to be stolen by an employee, expensive wines stored next to dumpsters during hot days because the restaurant interior was too small.

In the complaint, Price alleges that he went from being a regular at Alma and a “sympathetic ear” to offering to help renegotiate the lease and shaping up shoddy bookkeeping.

Last year, the trio agreed over drinks that Price would become an equity partner, according to the complaint. But when Price pressed for documentation of the deal, Taymor and Parsons backed out with “buyers’ remorse,” Price alleges.

Taymor said Price offered his services as a friend and mentor with no strings attached.

He remembers the conversation as a potential “starting point to a more formal partnership.” He said that Price was never promised an equity stake and that the lawsuit came in response to a rough proposal Taymor and Parsons sent.

Last month, Taymor and Parsons launched an Indiegogo campaign to raise $40,000 through online crowd funding to finance the legal fight. Donors submitted half the amount within two days. Taymor says the amount may still be insufficient, but “we’re not beggars.”

“We’re not in this for material success,” he said. “We’d start again.”



Franchise Times – Many units sold, far fewer open for many

By Julie Bennett

Franchising has rebounded since the recession, with the nation’s franchisors opening new units at a pace of about 12,000 a year,
according to the International Franchise Association’s Economic Impact report. The report says that’s faster than non-franchised
businesses. But if you read the press releases and online promotions of dozens of brands, you’d believe that franchises are growing even
faster. In a press release last year, Menchie’s, in Encino, California, announced the frozen yogurt chain had 500 more stores in its
pipeline and was on track to open almost 150 of them in 2014.

On its website, Snap Fitness, of Chanhassen, Minnesota, claims the 24/7 fitness concept is selling 20 to 40 new franchises a month. Tom + Chee, a tomato soup and grilled cheese concept in Cincinnati that started franchising in 2013, projected by the end of 2014 it would be on pace to open one shop a week. And in 2013, Atlanta-based Schlotzsky’s announced that a factory owner in Riverside, California, had signed on to build 170 of its
restaurants in Southern California. At the time, the franchisee, Moe Vazin, said he expected to have all of them open by 2018. So far, there are seven Schlotzsky’s in Southern California. Menchie’s, Snap Fitness and Tom + Chee are also short of their projections.

What happened to all those promised units? As the recession waned and credit became looser, hundreds of franchisors went on selling sprees. Snap Fitness salespeople, for example, suggested that new franchisees sign on to open not a single gym, but a trio of units called a three-pack. Many other franchise concepts, including most hair salons, also sell three-packs, while restaurant and retail franchisors sell larger development rights to franchisees who agree to build scores of outlets within specified time
periods. If all those franchisees actually opened the units they signed up for, individual brands would be far bigger and franchising in
general would be growing much faster than its current rate. Instead, thousands of franchise sales fall into another category, called
Sold But Not Open (SBNO).

Franchisors must report unopened units each year in their franchise disclosure documents (FDD). We asked FranchiseGrade.com, a research and analytics company in London, Ontario, to provide a list of the 50 franchisors with the greatest numbers of Sold But Not Open units from its database of FDDs from more than 2,400 systems. In their 2013 FDDs, the top 50 SBNO franchisors alone reported 12,697 unopened units. Many of these units will never open because the franchisees who signed the agreements—and usually paid upfront franchise fees—are struggling to operate the one or two units they have opened; are having trouble finding sites for additional units; have lost interest or, in some cases, have run out of money and filed for bankruptcy. The most obvious victim when units don’t open is the franchisee, who might have opened a single unit and flourished. But the
franchisor also suffers, because the same territory could have been sold to other franchisees who might be thriving there. And franchising itself suffers, because more robust growth could strengthen the industry’s position in its legal battles against minimum-wage increases, healthcare reform and worker unionization.

Emptying the pipeline

Of course, many of the SBNO units from FranchiseGrade.com’s list have since opened or will soon. Subway, in Milford, Connecticut, for example, with 1,093 SBNO units at the end of 2013, opened 788 new sandwich shops last year, or 72 percent of its backlog.

But Five Guys Enterprises, of Lorton, Virginia, which tops the list, with 1,198 units sold but not open at the end of 2013, opened only 56 new franchises in 2014, or 4.7 percent of its backlog. Five Guys sold out all its U.S. territories years ago and some of the franchisees who purchased development rights are opening new restaurants right on schedule.
But competition in the “better burger” space is fierce and some Five Guys franchisees, including groups in Ohio and Florida, are closing stores instead and a franchisee group in Fort Lauderdale filed for bankruptcy protection in 2012. One franchisee opening on schedule is Marc Magerman, CEO of Massachusetts Burger Enterprises in Natick, Massachusetts. He
said he and three partners signed a contract to build 20 Five Guys in eastern, central and western Massachusetts in 2008 and have 12 open with the 13th under construction. “It was easier to open stores when we started and had our whole territory to choose from,” he said. “Now we have to be careful not to cannibalize an existing store, yet be as close as we can be to our
competitors.” (Five Guys corporate declined to comment for this article.)
Competition is also growing in the fitness sector and franchisors are offering incentives to new franchisees to sign on with their
concepts. At Snap Fitness, for example, CEO and founder Peter Taunton said it charges a franchisee fee of $19,500, “but offered franchisees three units for a discounted fee of $45,000, which they paid upfront. A lot of people bought three-packs just before the recession and never opened their second or third gyms.” In 2013, 130 franchisees were terminated or left Snap Fitness on their own; another 206 had paid franchise fees, but left before opening a single gym. Snap’s closest competitor is Anytime Fitness, a 24/7 gym concept in Hastings, Minnesota, with 329 units SBNO at the end of
2013; of those, 190, or 57.8 percent, opened in 2014. Anytime’s national media director Mark Daly said Anytime also sells multiple territories “but only to highly vetted franchisees. Less than 2 percent of our clubs close each year.” Anytime ended 2013 with 1,681 units, according to its 2014 FDD, and 222 franchisees were “terminated, canceled, not renewed or otherwise ceased to do business.”

Getting distracted

Tony Lutfi is CEO and president of Marlu Investment Group in Elk Grove, California, and has more than 150 franchised restaurants in eight states. He said newer operators can find it difficult to fulfill aggressive development schedules. “While operators are still struggling to meet their financial objectives for their first units and need to place a greater focus on operations and marketing, they get distracted by the pressures to build more stores,” he said. Instead of building an empire, many
franchisees end up with nothing at all.

“Development agreements tend to be better for franchisors than franchisees,” said Robert Berg, chairman and CEO of Interfoods
of America, in Miami, a multi-unit operator of almost 200 Taco Bells, Popeyes and Burger Kings. “Time and time again, we see
inexperienced, overconfident new franchisees sign agreements that are beyond their ability to fulfill.”

Two hair salons, Sport Clips, in Georgetown, Texas, and Great Clips, in Minneapolis, are high on the list, at No. 6 and 8, respectively. Sport Clips had 771 units SBNO at the end of 2013 and opened 152 franchise units in 2014, or 19.7 percent, leaving the company with a four-year backlog. CEO Gordon Logan said the SBNO number includes franchisees who are still completing their contracts for three-packs or larger development deals. He added, “over 90 percent of the licenses we award get built.” Great
Clips, which opened 23.7 percent of their 1,070 sold units in 2014, declined to comment.

Many franchisors and industry insiders defend the selling of three-packs and larger agreements as the best way to grow a franchise system. The Joint, a chiropractic center franchise in Scottsdale, Arizona, had 204 SBNO units at the end of 2013 and opened 73, or 35.8 percent of them in 2014. The Joint President David Orwasher said, “We have grown from eight to 246 clinics since 2010 by asking franchisees to open multiple units in an organized fashion, driven by a penetration schedule that is
intelligently implemented.”

Ben Amante, principal of Amante Franchise Consulting in Newport Beach, California, agreed that “carefully thought out development plans” can be beneficial to franchisors and their multi-unit franchisees. “But,” he said, “many of those sold units exist just on paper, because the salespeople who sold them focus more on their own commissions. They approach people who just qualified to open one unit and say, ‘Why stop there? I can give you a discount on two, or 10 more units, and you can build an empire.’”

“A franchisor may find it’s easier to sell the dream than the reality,” said Oak Brook, Illinois-based franchise attorney Michael Liss.
“Some franchisors ask new franchisees to sign development schedules without having opened that many stores at that pace

Stuffing the channels

The top five franchises with sold but not open units, according to FranchiseGrade.com and a Franchise Times analysis, are: 1.
Five Guys, with 1,198 SBNO units at year end 2013, and a 4.7 percent open rate in 2014. 2. Quiznos, with 137 SBNO and an 8 percent open rate. 3. Moe’s Southwest, 383 SBNO and a 16.4 percent open rate. 4. Zounds Hearing Center, with 105 SBNO and an 18.1 percent open rate. 5. Menchie’s, with 385 SBNO and an 18.4 percent open rate in 2014.

John Gordon, founder and principal of the Pacific Management Consulting Group in San Diego, said, “Wall Street likes to see a full pipeline, so franchisors tend to stuff their supply channels before they seek private equity investors or an investment banker to take them public. Franchisors backed away from selling big territories during the recession when franchisees were missing their targets big time, but many are again under pressure to show they have growth potential.”

Justin Klein, an attorney with Marks & Klein in Red Bank, New Jersey, noted franchisors who set unrealistic development schedules are ultimately hurting themselves. “This is one area where franchisees and franchisors should work together, sharing the common goals of growth and putting up more units.” Klein said.

The Economist – McDonald’s When the chips are down

After a long run of success, the world’s largest fast-food chain is floundering—and activist investors are circling

The company is planning to roll out its “Create Your Taste” burgers in up to 2,000 restaurants—it is not saying where—by late 2015, and possibly in more places if they do well. McDonald’s is also trying to engage with customers on social media and is working on a smartphone app, as well as testing mobile-payment systems such as Apple Pay, Softcard and Google

After a successful run which lifted the firm’s share price from $12 in 2003 to more than $100 at the end of 2011, McDonald’s had a tricky 2013 and a much harder time last year. When it announces its annual results on January 23rd, some analysts fear it will reveal a drop in global “like-for-like” sales (ie, after stripping out the effect of opening new outlets) for the whole of 2014—the first such fall since 2002.

In the past year Don Thompson, the firm’s relatively new boss, has had to fight fires around the world, some of them beyond his control. Sales in China fell sharply after a local meat supplier was found guilty of using expired and contaminated chicken and beef. Some Russian outlets were temporarily closed by food inspectors, apparently in retaliation for Western sanctions against Russia over its military intervention in Ukraine. And a strike at some American ports left Japanese McDonald’s outlets short of American-grown potatoes, forcing them to ration their portions of fries. (More recently several Japanese customers have reported finding bits of plastic, and even a tooth, in their food.)

However, the biggest problem has been in America—by far McDonald’s largest market, where it has 14,200 of its 35,000 mostly franchised restaurants. In November its American like-for-like sales were down 4.6% on a year earlier. It had weathered the 2008-09 recession and its aftermath by attracting cash-strapped consumers looking for a cheap bite. But more recently it has been squeezed by competition from Burger King, revitalised under the management of a private-equity firm, from other fast-food joints such as Subway and Starbucks, and from the growing popularity of slightly more upmarket “fast casual” outlets (see article).

In response, McDonald’s has expanded its menu with all manner of wraps, salads and so on. Its American menu now has almost 200 items. This strains kitchen staff and annoys franchisees, who often have to buy new equipment. It may also deter customers. “McDonald’s stands for value, consistency and convenience,” says Darren Tristano at Technomic, a restaurant-industry consultant, and it needs to stay true to this. Most diners want a Big Mac or a Quarter Pounder at a good price, served quickly. And, as company executives now acknowledge, its strategy of reeling in diners with a “Dollar Menu” then trying to tempt them with pricier dishes is not working.

McDonald’s says it has got the message and is experimenting in some parts of America with a simpler menu: one type of Quarter Pounder with cheese rather than four; one Snack Wrap rather than three; and so on. However, this seems to run contrary to the build-your-burger strategy it is trying elsewhere, which expands the number of choices. That in turn is McDonald’s response to the popularity of “better burger” chains, such as Shake Shack, which has just filed for a stockmarket flotation.

Fast food firms – see our comparison of outlets around the world

Some analysts think that McDonald’s should stop trying to replicate all its rivals’ offerings and go back to basics, offering a limited range of dishes at low prices, served freshly and quickly. Sara Senatore of Sanford C. Bernstein, a research outfit, notes that Burger King, having struggled against its big rival for years, has begun to do better with a simpler and cheaper version of the McDonald’s menu. For the third quarter of 2014 Burger King reported a like-for-like sales increase of 3.6% in America and Canada compared with a decrease by 3.3% of comparable sales at McDonald’s. That said, sales at an average McDonald’s in America are still roughly double those of an average Burger King. So the case for going back to basics remains unproven.

So far, McDonald’s looks as if it is undergoing a milder version of its last crisis, in 2002-03. Then, an over-rapid expansion had damaged its reputation for good service, its menu had become bloated and customers were drifting to rivals claiming to offer healthier food. Now, once again, “McDonald’s has a huge image problem in America,” says John Gordon, a restaurant expert at the Pacific Management Consulting Group. This is in part because of its use of frozen “factory food” packed with preservatives. In 2013 a story about a 14-year-old McDonald’s burger that had not rotted received huge coverage. Even Mike Andres, the new boss of the company’s American operations, recently asked bemused investors: “Why do we need to have preservatives in our food?” and then answered himself: “We probably don’t.”

McDonald’s doesn’t seem to be cool any more, especially among youngsters. Parents say their teenage children have been put off after seeing “Super Size Me”, a documentary about surviving only on McDonald’s food; and “Food, Inc”, another about the corporatisation of the food industry; and by reading “Fast Food Nation: The Dark Side of the All-American Meal”. It is hard to imagine the new McDonald’s initiatives getting the reaction Shake Shack got when it opened its first outlet in downtown Chicago in November: for the first two weeks it had long queues of people waiting outside in the freezing cold.

A lot of the negative PR that McDonald’s gets is the flipside of being the world’s biggest and most famous fast-food chain. This has made it the whipping-boy of food activists, labour activists, animal-rights campaigners and those who simply dislike all things American. In America it has been the focus of a campaign for fast-food workers and others to get a minimum salary of $15 an hour and the right to unionise. Last month the National Labour Relations Board, a federal agency, released details of 13 complaints against McDonald’s and many of its franchisees for violating employees’ rights to campaign for better pay and working conditions. The alleged violations relate to threats, surveillance, discrimination, reduced hours and even sackings of workers who supported the protests. McDonald’s contests these charges, while arguing that it is not responsible for its franchisees’ labour practices.

Not all the criticism McDonald’s gets may be merited—or at least it should be shared more fairly with its peers. However, the company’s troubles have begun to attract the attention of activist shareholders, who may prove somewhat harder to brush aside than labour or food activists. In November Jana Partners, an activist fund, took a stake in the firm. Then in December its shares jumped, on rumours that one of the most prominent and determined activists, Bill Ackman, intended to buy a stake and press for a shake-up.

McDonald’s says it welcomes all investors and is focused on maximising value for its shareholders. Even so, Mr Thompson’s new strategy needs to deliver results quickly. Mr Ackman’s Pershing Square Capital has done well out of its 11% stake in Burger King, because the chain’s main shareholder, 3G Capital, has pushed through a drastic cost-cutting programme and a merger with Tim Hortons, a Canadian restaurant group. “If McDonald’s were run like Burger King, the stock would go up a lot,” Mr Ackman mused recently. It looks like Mr Thompson may soon have to fight on another front.