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Restaurant Franchise Profitability

BlueMauMau recently had an article about the increase in “better burger” franchises.  I too have seen in the past two years an increase in the high-end burger space from both independent stores like The Daily Grind in Port Orange, FL (great store-baked buns) and franchises like Cheeburger Cheeburger and Five Guys.  I recently performed a valuation on a group of high-end burger franchises for a client and I walked away with mixed feelings.  The key driver of profitability was the lease costs, and the key driver for sales was location.  The basic formula for a decent ROIC (return on invested capital) was convenient, high traffic location with a rent at or below 6% of gross sales.  This ends up being the simple formula for most restaurants.   Your restaurant’s cost targets should be: Prime Costs (Food and Labor) a combined 60% (about 30% each depending on type of restaurant), rent below 6% of gross sales, interest costs below 1.2%, owner’s net profit at least 10%, which leaves about 22% of your gross sales left for overhead, maintenance, royalty payments, advertising, and other costs. As you can see, an 8% royalty and advertising costs for a franchise cost takes a big chuck out your remaining 22% budget.The HARDEST part of predicting a restaurant franchise’s success is forecasting sales.   Forecasting sales requires an analysis and comparison of other local restaurants, proximities (closeness to road, attractions, anchor stores, etc.), parking/drive thru, local demographics, competition, signage, brand awareness, and many other details.  If your sales projections cannot confidently support sales at least 20% more than your break-even point, don’t do they deal.

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Cutting Costs with the Thermostat

  Thermostat controls help Arby’s cut costs But someone always forgot to shut off the air or would poke a straw or toothpick through the lockbox on the programmable controls to lower the temperature. If employees are so desperate for cool air conditioning that they will stick toothpicks through a locked thermostat, then you probably are keeping the temperature too high.  Yeah, you can cut costs by reducing the climate controls, but grumpy hot employees are not worth the savings, in my opinion. The restaurants now use Web-based controls accessible only to top managers, ensuring the air is on only during business hours and never gets cranked too high. Those moves saved $800 in a month at one location. I agree with automating a reduction in heat and cool air during non-operating hours.  But I am very skeptical of over-managing the temperature during operating hours for morale reasons.

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The Hurdles of Co-branding

Image by RACINGMIX via Flickr I’ve always been very interested in co-branding. It seems to just make sense to combine operations and leverage resources. An early co-branding franchisee of KFC and A&W speaks about his co-branding experience. “I think the real lesson is, you’ve got to spend the money and do it first class,” he says. “If you try to go in and nickel and dime it, not buy all the equipment, not buy all the seating, not buy all the signage, not train all your people, not have a great manager—it’s just all the same things that we know will work in any restaurant. If we want to be successful, we’ve got to do it right.” White’s results are exactly the same as what Tricon franchisees discovered when co-branding KFCs and Taco Bells. “When we started introducing Taco Bells into KFC in the multi-brand program,” says Gary Masterson, senior director of franchise development for KFC, “we referred to the early program as ‘lick and stick,’ where we just took a KFC and put a Taco Bell sign over the drive thru, changed the pylons from KFC to Taco Bell, and maybe a couple of minor changes to the decor elements, but nothing major. It was just an investment of maybe less than $50,000. “The impact on sales was nowhere near as great as the current program,” says Masterson. “Today, if you want to build a Taco Bell in a KFC, you have to reskin it. You have to tear off the outside of the building and introduce the Series 6000 multibrand look, which is an equal mixture of Taco Bell and KFC. Those restaurants are performing at much higher levels of sales performance than the early ones.” It would be nice if the story could end here, but …

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Houlihan’s Still Trying to Figure It Out

Looks like Houlihan’s still can’t find the right balance of seating capacity, location, and affordable rent.  Their Stamford franchisee was open 6 months and then closed after not paying for those 6 months. "There’s a lot of competition, and 250 seats is a lot to fill and a lot of rent to pay," he said. "Sometimes, smaller is better."

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Pulling 401(k) Cash to Fund a Franchise

There has been a lot of talk lately, from Joel Libava’s Franchise King blog to recent MSNBC article, looking at whether 401(k) retirements savings should be used to fund a new franchise.  Many franchisors for obvious reasons like this idea, such as Westshore Pizza & Cheesesteaks who focuses their sales pitch as a great 401(k) investment.Use 401(k) money to buy a franchise?  My legal and financial opinion is almost always a NO!  It is too risky to gamble your needed retirement funds in a franchise.  If you need to tap your 401(k) to buy a franchise, you cannot afford to buy a franchise.  If your entire retirement life is already FULLY funded and you have plenty of cash, then use your excess cash for the franchise opportunity. Professional investors always take a little cash off the table, and your 401(k) is what you took off the table.   Keep it there, don’t risk it away.  You could easily lose ALL your money in a franchise, but you couldn’t lose all your money in a 401(k) even if you tried.  Additionally, a single unit franchise will almost certainly not make enough money to payout and match a six-figure retirement account in less than a decade. Tax and Match Advantages – Big DifferenceIs 401(k) a good investment in the first place?  YES!  Since your 401(k) investments are done with pre-tax income, you are saving about 30% more than you would have with after-tax income.  Plus, an employer match will nearly double the money that goies into your 401(k) than if you just invested the income from your final paycheck.  Upon retirement, you can control the 401(k) withdrawals to minize income taxes.  Even if the employer is not matching, the certainty of pre-tax investing is powerful because it is taken out automatically, but once the paycheck hits your bank it …

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Franchisor Liable for Shooting in Franchisee’s Parking Lot

Day’s Inn paid $600,000 for a shooting that occurred in a franchisees parking. Details and arguments below: The national chain argued that it was a separate entity and that it did not maintain sufficient control over the local franchisee such as to establish an agency relationship. …. The one area not specifically dealt with in the manual was guest safety. The victim’s lawyer argued that the chain’s failure to address security did not relieve it of liability for the negligence of the franchisee. The Trial Court agreed. Both the local motel and the franchisee were liable to the victim because the area of Exit 97 off Interstate 95 where the Selma Days Inn was located had a long history of criminal activity including a pair of armed robberies at a hotel next door just two weeks before the victim was shot. Evidence would have been that the motel franchisee and the chain failed to take adequate precautions to protect their guest, including the victim. After the Judge refused to release the national chain, the defendants agreed to $600,000 to settle the case. The actual photo of the Selma Day’s Inn is to the right.

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Where’s the Beef? You’re Terminated!

Imagine if you were a franchisee and a mystery shopper from the franchisor anonymously visited your store and ordered a sandwich.  The meat in the sandwich you served happened to be 1/2 an ounce smaller that the standard 4.5 ounces.  Would it be fair to lose your franchise because of default?  You did break the rules, eh?  But what if was really a charade to encourage compliance?This was the situation a Denver court had to deal with.    The final judgment was that Quiznos had in fact breached the contract by wrongfully terminating the defendants, and awarded them $349,797.http://blogs.westword.com/cafesociety/2009/01/quiznos_gets_grilled_in_a_new.php

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Columbus, Ohio Meal Prep Industry Tanking

I would hate to be a franchisor in the meal assembly business right now.  They have been getting hammered in the press almost weekly across the United States.  Here are articles JUST IN THE PAST WEEK! Losing Their Appetite, The Columbus Dispatch (I am quoted in the article) Investor Sues Failed Suzanne Somers’ Meal Prep Business, Lexington Hearld Leader The only bright spot is that pre-assembled carry-out meals seems to be working, which ironically is opposite of the initial premise of the business.   Can this pre-assembled model save the industry?  Probably not, because most people know that business model simply as a “carry-out restaurant”. The meal assembly business concept sounds enticing – a fun business with an obvious benefit where professional women socialize as they prepare healthy meals for their households, leaving the mess behind.  If you were thinking of getting into this business and asked your friends their opinion, most would say “Yeah, that sounds like a cool business.  I’d use it!”  But, your friends would be leading you estray.  Unfortunately, “good ideas” alone won’t make you money or ensure a sustainable business.  The primary problem with this industry is getting customers in the door and keeping customers coming regularly (like most businesses).  Franchisees had everything going against them and stood little chance of succeeding – higher rents in high-trafficed streets, no initial brand recognition, requires change in customer habits, requires times and hours on the customers part, most need to be educated on the concept and its benefits easy concept for franchisors to develop and launch, so competitors came fast customers’ brand loyalty is negligible most ingredients more expensive “all natural” and “organic”;  higher rate of perishables I hope this industry can work things out, primarily because it does offer a convenient service that can help families be healthy.  And healthy, less stressed families are generally happy families.  …

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How to Make Subway Look Like a Good Opportunity

Entrepreneur.com’s Janean Chun posted an article entitled,  Can You Buy a Big Franchise?  The topic seemed interesting so I read it.  The article essentially says you too can own popular franchise brands, if you meet the net worth requirements.  She supports her proposition by interviewing a Subway agent in California as a credible source, where he implies that Subway is a strict selector of franchisees who only work with entrepreurs, not investors.  What a hoot.  Disgruntled franchisees would disagree.

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Renegotiating Leases

In the forum, a visitor proposed a question whether a buyer of an existing franchise can renegotiate the lease.  Paul Steinberg as always provides great guidance: As previously noted, most landlords will not agree to a novation but most leases contain provisions relating to assumption. Viz the personal guaranty, I have had leases which provide that upon assumption, the incoming tenant signs a personal guaranty whereupon the outgoing personal guarantor is released. Of course, this works only if the outgoing (selling) entity will be a shell after the sale, but if that is not the case then you can tweak the language to achieve the desired result. If you are the seller and are unable to get a release from the guaranty, you should make sure to have appropriate language in your contract (or addenda thereto) to enable you to go after the purchaser and the natural person/guarantor which stands behind the purchaser. This will avoid the purchaser defaulting and leaving the original guarantor stuck. Of course, this will only work if the defaulter’s guarantor has assets…but judgments are good for many years (depends on state law). At very least, the new (purchaser) tenant will think twice about defaulting. Inc. magazine tackled this question. ….If the landlord is reasonable, Go to the landlord and say, ‘We really want to stay here, but we just can’t make it at the rent we’re paying. Here’s what we can afford as a base rent right now.’ And explain how you came up with the figure. Take him through the numbers, and show him why you’ll be able to survive with the lower base rent but you’ll go out of business if the rent remains at the current level. “At the same time, I would make it very clear that you have no …

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Starbucks Back is Back to Breakfast

Source Starbucks plans next week to launch warm sandwiches, called Piadini, on artisan breads filled with sausage, egg and cheese or Portobello mushroom, spinach and ricotta cheese. …. He says about 30% of McDonald’s U.S. business comes from breakfast, and credits breakfast with “a majority of McDonald’s growth in the last two to three years.” I thought I read they were ending the warm English-muffin based egg sandwiches. Appaprently it was all a ruse. “We are not reversing our decision to replace the breakfast sandwiches. Rather we are continuing to evolve our food offerings,” says a spokeswoman. “We have found small ingredient changes that address the aroma issues of our current breakfast sandwiches, and have implemented these already.” The company says it recently changed the kind of cheese it was using in its warm breakfast sandwiches to neutralize the cooking smell. Starbucks has ovens in about 3,000 locations and plans to add them in 800 more stores. Over time it wants ovens in 90% of its stores, according to Michelle Gass, the company’s senior vice-president of marketing.

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Customer Experience, Franchising, and Resources

I’ve become much more interested lately in the study of Customer Experience, a rapidly growing field especially in retail and restaurants.  Every touch point with the customer, both before, during, and after the visit,  impacts the customer’s decision to buy.   In franchising, the customer experience is mostly defined by the franchisor, with only minor execution responsibility for the franchisee.  The store layout, marketing, the parking lot, the type of flooring, the web site, the lighting, the registers, employee training, customer service processes…all contribute to the customer experience, which in turn, contributes to repeat and referral sales. Understanding the elements that make a customer experience successful is critical when evaluating a franchise opportunity.   Before you can evaluate it, you need to understand what makes a good and bad customer experience.  Learning and keeping tabs on the trends in customer experience is easy with blogs.  Here is a list of 36 blogs in the area of brand and customer experience.

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5 Pizza Franchises for $1

Well, you have to go to Australia to buy these Pizza Hell franchises. Hell has been torture for Matt Blomfield – so he’s auctioning his $830,000 Auckland store for a $1 reserve. Mr Blomfield, a Hell Pizza franchisee, is so fed up with the New Zealand owner TPF Group’s handling of the business that he’s willing to take a loss selling up his five stores. “I just want to get the business sold, pay all the bills and move on with my life.” Why is this business model not making money? Here are potential reasons from the article: The Herald has also sighted emails from franchisees complaining of the lack of support from TPF, the high cost of ingredients – which they can only purchase from TPF’s own supply and distribution operation – and what they say is unsatisfactory marketing.

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‘Homework’ Key to Restaurants

Great advice to aspiring restaurant operators from veteran Larry Ross who was there from the founding of Darden Restaurants and has been in the industry in various capacities for decades. Q. Someone comes to you for advice on starting a restaurant. What do you say? A. Do your homework, do your homework, do your homework. I’ve done a lot of business plans and I’m very good at putting together a 15-page assignment that’ll look like a home run, but it’s packaging. Don’t do that. It’s your life, it’s your money, it’s your dream … do your homework. What’s it really going to cost? Worst-case it: How many restaurants are there, and how much business are they really doing? What’s the national trend? My advice has been for years and will continue to be, ‘Why don’t you not open a restaurant?’ It is a brutal business, the odds are against you.  Really, if you want to invest in a restaurant, go buy a meal once a week and invest as you go. If you really want to get it out of your system, go work in somebody else’s restaurant. But if I can’t talk you out of it, then do you homework, in every way. Another piece of advice: Do not underestimate the importance of the location. And things like size, keep it small. You have to make one hugely successful before you can even talk about two. There are no real success stories of marginally successful single units that become multiunit chains. It doesn’t work like that. Here are a few other insightful nuggets: Q. We recently wrote about Sam Seltzer’s Steakhouse, Roadhouse Grill and some other restaurants’ closing in Lakeland and interviewed James Bronkhorst (owner of Reececliff Restaurant in Lakeland and Christy’s Sundown Restaurant in Winter Haven), who …

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