By Kate Taylor and Nancy Luna
- Subway is presenting franchisees with a tough choice: higher fees or a “draconian” new agreement.
- The agreement lets Subway control hours, requires participation in deals, and bans criticism.
- If franchisees don’t want to sign, their royalties rise to 10%, up from an already high 8%.
- See more stories on Insider’s business page.
Subway is forcing franchisees to choose between higher fees and a “draconian” new agreement, creating yet another conflict at the struggling chain.
In recent weeks, insiders have been buzzing about a new deal that Subway presented to franchisees at renewal time. The agreement is significantly stricter than the prior one, granting Subway control over hours of operation, requiring franchisees to participate in menu promotions, and banning negative comments about the company “in any forum.”
A representative for Subway told Insider that the agreement was “competitive and comparable with other franchise agreements” in the restaurant industry. John Gordon, an expert on the restaurant industry, said that “no one in their right mind” would sign Subway’s new “draconian” agreement.
Subway franchisees have another option if they don’t want to sign the new agreement, but it’s financially onerous.
Franchisees can stick with their original terms if they pay a 10% royalty fee. Subway franchisees pay corporate 8% of gross sales every week, already higher than industry rivals such as McDonald’s and Jimmy John’s. Gordon said Subway would be the only restaurant franchise to have a 10% royalty fee. A rate so high that it would immediately stand out like a sore thumb to potential franchisees, he added.
The Subway representative said the option to remain on the old agreement in exchange for 10% royalties was included in the prior franchise agreement, introduced in 2001.
“Franchises are desperate, livid, angry, frantic,” a West Coast franchisee of more than two decades told Insider.
Hundreds of Subway locations have closed in recent years. The new agreement is going to make it even harder to turn a profit, said the West Coast franchisee, who discouraged new franchisees from buying stores.
“The changes to the new franchise agreement are just outlandish, and I don’t think any franchisee 20 years ago could have even contemplated the vast changes that they’re taking now,” said another veteran operator who wished to remain anonymous.
Insider spoke with five Subway franchisees about the new agreement. While their identities are known to Insider, they were granted anonymity to avoid professional repercussions — especially in light of the proposed agreement, which some said would even ban criticizing Subway in private franchisee forums.
“It’s just silly that they have a clause in there like that,” an operator said. “There’s always going to be disagreements, but to say that we’re completely prohibited from our First Amendment rights of free speech is outlandish.”
Subway’s new agreement overhauls existing terms
Ron Gardner, an attorney for the North American Association of Subway Franchisees, outlined some of the new conditions in a document — sent to franchisees in mid-May — reviewed by Insider.
In the document, Gardner said that this was the “first major overhaul in the Subway franchise agreement in over 20 years,” and that franchisees looking to sign new agreements or renew agreements will be asked to sign on to these new terms.
The document and franchisees who spoke with Insider said that changes include:
- The company can control hours of operation, which franchisees said is particularly worrisome as they struggle to hire and retain enough workers to stay open.
- Franchisees “cannot make any disparaging or negative comments about Subway in any forum or on any medium,” Gardner said.
- Franchisees are required to participate in reward programs and marketing promotions (some of which, such as the $5 Footlong, have been a point of contention among franchisees).
- Anything in stores with the Subway name on it, such as furniture, signs, and decorations, will remain Subway’s property when the franchisee leaves the business.
- Subway could require franchisees to “invest in and implement new technology digital initiatives” at their own expense, the document said.
- Subway can terminate a franchise agreement if a store is closed for any two days in a 12-month period.
- If a franchisee leaves the system before their agreement expires, Subway can require them to pay up to three years’ worth of “future lost royalties.”
One of the veteran Subway operators Insider spoke with said the proposal to give franchisees a choice of paying a higher royalty fee of 10% or agreeing to new franchisee terms was first introduced 20 years ago. The Subway representative confirmed this, saying that the “first franchise agreements containing that provision became effective in 2001, so with a 20-year term, they are now expiring, and that provision is being implemented for the first time.”
So when the increase from 8% to 10% was presented as an alternative to a new franchise renewal agreement, it came as no surprise. But franchisees said they were blindsided by the level of control that Subway demanded in the new agreement.
The veteran franchisee was especially upset by a provision to force franchisees to comply with national menu promotions, deep discounts that kill revenue and profits. Operators often don’t participate in these promotions so they can stay afloat. Last year, some franchisees even filed complaints with the Federal Trade Commission in response to a “$5 Footlongs when you buy two” deal, Restaurant Business reported.
This operator called the new terms borderline “price-fixing.”
Subway franchisees fear they’re being squeezed out
Some franchisees said the new agreement was part of a larger plan to force operators — specifically those with fewer stores — out of a business that’s already in free fall.
The chain, which denied that it was up for sale, permanently closed more than 1,600 Subway locations in the US in 2020. Subway’s US sales fell to $8.3 billion in 2020, down from $10.2 billion in 2019, Technomic reported.
Franchisees interviewed by Insider said Subway was doing whatever it could to boost revenues amid declining store sales.
Under CEO John Chidsey, who joined in November of 2019, Subway increased its franchisee start-up fees in 2021 and cut other franchisee benefits. One operator from the eastern US described Chidsey as “jonesing for money.”
If stores close, Subway wants a bigger payout, franchisees said. According to the new franchise agreement, franchisees could have to pay three years’ worth of royalties and advertising fees if they leave the system prematurely.
“This is a squeeze on the franchisees,” the veteran operator said. “If they can’t make a profit off royalties, they’re going to squeeze as much money out of that bottom third of stores until they all close.”
Over the past year, the company has downsized its development agents, a middleman position that oversees franchisees in large regions, and rebranded the role as “business developer.”
Between May 20, 2020, and December 1, 2020, 11 development agents left the system, according to corporate documents reviewed by Insider. Those territories, which include oversight of nearly 2,000 Subway restaurants in US states, are now overseen by corporate.
A Subway representative confirmed that the chain had adopted this more traditional franchisor/franchisee model in certain markets with the introduction of Subway Market Operations.
“The SMO team is led by franchise industry experts who work directly with franchisees to drive operational excellence in their territories,” the representative said. “Subway’s business developers have and always will play a key role in our brand development and franchisee operations.”
With development agents out of the picture, Subway gets a larger cut of royalty fees, as these agents typically received about one-third of those fees. The diminishing ranks of these development agents have left franchisees without a layer of protection from leaders who might question these new terms by corporate. Most development agents owned their own stores, so they had skin in the game.
“The development agents publicly will not say anything, but behind the scenes, they’re going to say that this is terrible for them as well. So the fewer that there are, the less they’re going to push back,” said a veteran franchise operator.
The new agreements could also make Subway a more appealing acquisition target, Gordon said. A franchise agreement that guarantees a 2 percentage-point increase in royalties “tends to make the Excel and PowerPoints look better,” especially at a company that has some issues, Gordon said.
Some franchisees want to take a stand
In May, a group of Subway franchisees wrote an open letter to owner Elisabeth DeLuca, calling for her to fix the myriad problems they have with the business and reduce royalties to 4.5%. DeLuca, the widow of cofounder Fred DeLuca, owns Subway along with cofounder Peter Buck.
Instead, Subway proposed an agreement with higher royalties. To some, this felt like a slap in the face.
Some franchisees want to take a stand against the new agreement. One franchisee Insider spoke with said he and others were planning to contact their elected officials, while another suggested a walkout across the system.
“All they got to do is lock together, and close the doors for a week,” said the operator from the eastern US. “It would cripple Chidsey.” He added, “You can bring him to his knees.”
Fighting as one is the only way, he said. If everyone protests, that makes it that much harder for Subway to fight back as the company would have to take some 22,000 US units to arbitration over any alleged breach of contract. The operator said that Subway is run by executives hired by Chidsey, many from his previous position running Burger King, who know nothing about Subway.
“He’s effectively backed Liz and Dr. Buck into a corner — they can’t fire him,” the operator said. “There’s effectively no one at the company that understands that universe.”