Suing the Franchisor

This article details the legal disputes and subsequent law suit between franchisor Quaker Steak & Lube and a franchisee in Pennsylvania.  The franchisee claimed:

  • [franchisor] lied to him about the restaurant’s prospects for profitability;
  • approved too large a restaurant for the State College market;
  • forced him to use a select list of food vendors and menu choices that hurt his chances for profitability; and
  • did not provide adequate training, startup marketing or operational support.

The franchisee claims a projected $100,000 weekly gross sales ($5.2 million annually) was given to him by the franchisor, when actual revenues were $80,000 a week in 2006, $61,000 a week in 2007 and $45,000 a week in 2008.  The judge agreed with the franchisor that the projections were simply that – projections and not historical fact or earnings claims.All other claims were also denied by the judge.  That’s how these law suits usually end unless there is real “smoking gun” evidence of a breach of the franchise agreement or fraud.

Tooting My Stock Predicting Horn

Back in August 2007, I gave a NexCen Brands an “I wouldn’t buy it” rating after they grossly overpaid for the Pretzel Time and Pretzelmaker acquisition by paying 5x revenue.  At the time the stock price was around $7…fast forward 2 years and yesterday it closed at 36 cents and has been as low 5 cents in 2009.Your welcome!

IT: Data Transfers to the Franchisors

Franchise IT tech guy Todd Michaud wrote an very thoughtful piece on the overlooked issue of data collection and usage by the franchisor.  He address the problems of the overt burden on franchisees to subsidize this data collection, and he exposes the fuzzy usage policies of the data.  His recommended solution involves compromises in the data collection costs and also urges franchisors share the data and analysis back with the franchisee.

Pizza Hut’s Franchisee Sees Flight to Lower Costs Pizzerias

Source: Dallas Morning News

Jim Schwartz, president and chief executive of NPC International Inc., said he was disappointed and “frankly frustrated” with the company’s 12.6 percent drop in same-store-sales from continuing operations for the quarter that ended June 30.

It was the third consecutive negative quarter for the Overland Park, Kan.-based company, due in part to difficult comparisons to last year’s sales tally. That’s when Addison-based Pizza Hut launched its line of Tuscani pastas. Schwartz noted that cash-strapped consumers have been looking for less expensive meals, even among the pizza players.

Franchisee loses his pizza franchise

A former franchisee of Pizza Pizza in Ontario lost his franchise for allegedly falling behind on payments to the franchisor.  This whole relationships seems to have gone mismanaged by both sides.  The franchisee wasn’t keeping good sales records and delivery drivers were impatient with customers, and the franchisor let bad practices continue for too long.

Who Controls the Ads, Franchisee or Franchisor?

source: USA Today

Which donut hole do you prefer, the “A Hole” or “B Hole?”  That is ruffling feather of some franchisees.

Unfortunatley, there is not much the franchisees can do about it legally.  Franchisees can only voice their opinion, sometimes it works:

Burger King recently acquiesced to franchisee pressure to tone down its advertising. In the spring, consumer groups and franchisees said that a kids meal with a SpongeBob SquarePants cartoon character giveaway was too sexy. In the ad, women with square derrieres dance to Baby Got Back. Same-store sales for Burger King are due at the end of the month, but on Monday, its largest franchisee reported a 5.5% sales drop in the quarter.

Tanning Beds As Deadly as Arsenic & Mustard Gas?

A recent study lumps tanning in tanning beds in the same caustic category as arsenic and mustard gas. The tanning industry is simply a rental business, and the rental business can be very lucrative.  Just ask my hero Wayne Huizenga who made billions from starting integrated rental businesses Waste Management, Blockbuster Video, and partly Autonation.

The franchise tanning industry has been positioning itself for a reduction in the ultraviolet tanning beds with the spray tan alternative.   Most have purchase Mystic tanning beds (see video below) that can be rented in the same manner as bulb beds, plus some locations are offering spray-on artists to spray on manually that perfect tan with a high-end spraying device. 

Spray tanning has been booming most evidently in the celebrity ranks, with many celebrities even hiring their own full time spra-on tan artists.  Lindsey Lohan is even being sued for allegedly stealing the formula for her new spray tan retail line.  All this points to tan growing trend (remember, the trend is your friend) of spray tanning consumers. 

Can traditional tanning franchises offering spray tans grab a sustainable piece of this emerging spray tan market?  

In the short term, probably yes. But it will take five-figures of investment and marketing for each location.  Customers previously visited tanning salons to rent 20-minute increments on tanning beds because tanning beds were too expensive to purchase for the home.  But, consumers can now buy spray tan bottles at Walgreens for $5.  The key for the tanning salons is offering customers 1) the “spray on artists” and 2) machines that spray the perfect tan.  Self application of tanning lotions can leave a person looking laughably orange if applied to heavily or unevenly, or left on too long.  So the edge for tanning salons is to have machines and people that can give the tan glow with the spray. Until the self tan sprayers improve it application devices, such as offering inexpensive sprayers and improved formulas that tolerate lazy applicators, the tanning salons that make the investment in spray-on tanning should be able sustain themselves. 

A key to growth is attracting woman over 30 years old who have all abandoned traditional tanning salons from their justified fears of UV-light skin damage.  These women are currently spending $35 per bottle at department stores for spray tans.  Below are a few videos on spray tanning.

Why Franchisors LOVE Multi-Unit Development Agreements

dollarFranchisors love to sell multi-unit development agreements, but some of the reasons may not be so obvious.

  • Multi-unit franchisee typically pre-pay a portion of the franchise fees for each potential location.  Similar to a non-refundable downpayment.  Lately, many franchisee haven’t opened their additional locations or have slowed the opening pace, but the franchisor still keeps their pre-paid franchise fees, which is typically $5,000 – $15,000 per location.  For example, if a franchisee signs an agreement to develop 10 units, then he may pre-pay a franchise fee of $10,000 per unit, or $100,000 for the rights to open 10 units.  He still would pay the remainder of the (oftern discounted) franchise fee as each location is opened.  The Development Agreements typically set a timeline for openings, and if you don’t keep to the schedule which is often opening at least one per year, then you lose your pre-paid franchise fee.
  • The parties are negotiating one franchise and development agreement rather than a new agreement upon each new opening.
  • Concentration of stores in one small area will help franchise sales in neighboring areas
  • Generally multi-unit buyers have more reserve cash, so stores are less likely to fail from lack of short-term capital.
  • A multi-unit franchisee is more likely to honor their penalty charges for closing a unit, compared to a single unit franchisee who has less assets.

NexCen Brands R&D Facility for QSRs

NexCen Brands is the franchisor for Great American Cookies, MaggieMoo’s, Marble Slab Creamery, Pretzelmaker and Pretzel Time.  The recently opened up a research and development facility for their restaurant concepts.  At first glance, this looks great, despite it being a tiny 1,200 square feet.   My nitpicking then creeped in.  Here are a few issues I see:

  1. The manager of the R&D center is the VP of Plant Operations.  I would much rather see someone with an innovation, marketing or chef background, not someone who coordinates a warehouse or manufacturing facility.
  2. The article states that the R&D facility is “supported” by NexCen’s top vendors – bread, chocolate and dairy vendors.  Ummmmm…..bias?  It’s a great deal for franchisor NexCen who gets their vendors to sponsor the facility and research, but do you think this will produce the best innovations for the franchisees?  Will the vendors spend their time “innovating” their particular product offerings more into the menu?

I’m being hard on NexGen, I know.  Hopefully the R&D facility will produce some winners, but the issues noted above make me believe NexGen chose the absolute cheapest way to create the image of R&D.

What’s the best way to create better and cheaper offerings, faster?

After professional research with customers and franchisees, you can identify promising ideas, develop them with your chefs, professionally test the ideas with customers, and repeat the process until you get a winner.  Let your marketing, finance and purchasing teams have input.  Then roll it out to franchisees.

Franchise Agreement Checklist

For those looking to familiarize themselves with franchise agreements, this checklist from the Jacksonville, Florida Chamber of Commerce provides a good start. 

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.

Who Control’s Pricing? Can you discount?

dimeIn the United States, resale price maintenance (RPM) is illegal under current U.S. Antitrust laws. In Japan, the Fair Trade Commission’s ordered Seven-Eleven Japan to end its refusal to allow franchise stores to discount bento boxed meals and other food items when the food is close to expiration. This will force all convenience store chains in Japan to review their policy of fixed prices for such products.Hat Tip: Chris Conner @ FranCorp’s Blog 

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.

Bad Co-branding Franchise Example

My previous post highlight the not-so-obvious hurdles of co-branding.  The omnipotent FuwaFuwaUsagi sent in photos of Brown’s Chicken attempts at co-branding.  See his Brown’s Chicken photos below.

Brown’s Chicken is trying to do the Chicago street food theme plus mexican.  It offers everything from pasta, ice cream, pizza, fried chicken, sausages, pasta, mexican, italian beef, and hot dogs.  The problem is not necessarily the menu, but the execution, presentation and customer experience.  It looks utterly silly to have so many brands in one cheap-looking tiny store. 

Offering multiple unknown brands under one roof requires significant investment in the seating, presentation and overall customer experience. I’ve only seen one successful Chicago street food restaurant and it is Portillo’s / Barnelli’s combination.  When you enter one of the premium stores you feel as though you have entered an old-fashioned carnival era.  It is plain fun and food is quite good.

The below photos provide a great illustration of what to do and what not to do – stuffing too many confusing brands under one roof.


IForgotBesidesTacosChickenIceCreamItIsPizzaTooIGuessThisSaysItAllForLowRentCoBranding NoticeChooChoosToTheLeftOfBrownsChicken WhatDoYouGetWhenYouCrossTacosChickenIceCreamPizzaApparetnlyAnEmptyParkingLot



The Hurdles of Co-branding

Taco Bell & KFC Menu CombinedImage 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 co-branding isn’t just about real estate. There’s also the human angle. Combining two brands under one roof is more than simply putting up some appealing signage and attracting a lot more customers to your restaurant. Once those customers arrive, the folks behind the counter have to be able to service the increased demand.

The article then goes on to discuss the labor issues.

For both Tricon and Yorkshire, operational simplification will not only make a difference from a management perspective, but also at the bottom line. “Intuitively, you would think that if your sales go up 50 percent, your labor percentage ought to really drop dramatically,” says Feltenstein. “But it doesn’t. That is a challenge for us and many others with whom I’ve spoken, to get the labor percentage to drop so you can flow through even more. The fact is you’re flowing through a lot of incremental profits because the sales are so much higher—but it could be even better if we find more efficient ways to manage it so as to take more labor dollars out of the store.”

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