How to Make Money as a Franchisee

Leveraging people and assets across multiple operating businesses is what enables most companies to make money, including franchisees.    The leveraging action turns what would otherwise be an individual, high-overhead and high-risk investment into a portfolio of lower-overhead and risk-managed investments.

In a previous job I worked for a commercial real estate investment and management company.   The company made money because they were able to use the same employees to manage dozens of leased properties, and leveraging one employee across dozens of properties increased the profit margins.

In franchising, a multi-unit operator can leverage skilled managers across multiple units.  And, the $25,000 saved across 50 restaurants adds up quickly to a nice income.

A great example of leverage in franchising is Frank Heath and David Paradise of Mississippi-based Mid River Restaurants.   Between them they own:

  • 12 Applebee’s in Louisiana,
  • 26 Hardee’s in West Virginia, North Carolina and Kentucky,
  • 10 Taco Bell restaurants in Louisiana and Mississippi, and
  • 12 IHOP restaurants in Ohio, Indiana, and Kentucky.

And, they are in the process of acquiring 33 St. Louis area Applebee’s for the rock-bottom price of $25 million ($757k each, below build out cost).  The seller is DineEquity Inc., the parent company of Applebee’s Neighborhood Bar & Grill and IHOP restaurants.

Mid River Restaurants has several advantages over other small and individual franchisees:

  • profit per restaurant is higher than most because of their controllable costs are lower with centralized management, accounting and service teams
  • cash flow is large enough to finance large, well priced acquisitions
  • the greater cash flow also enables them to hire and retain smarter employees who are likely to further enhance the profitability
  • the whole enterprise learns from four very well developed franchise systems, exposing employees to “best of breed” methods

Individual franchisees as a group tend to be lower skilled, lower financed, micro-managers, unleveraged and over worked, which is why franchisors prefer experience multi-unit operators.

Applebees Bucking the Discount of Chain Restaurants

DineEquity, owner of Applebees and IHOP brands, is trying smartly trying to avoid discounting their menu like the rest of industry. Their strategy to get customers in the door focus on appealing healthy “skillets” price at $9+ which currently make up about 10% of sales.

The “2 for $20” deal of an appetizer and two entrees now makes up 18% of Applebee’s sales mix, down from around 20% in previous quarters, Stewart said. Applebee’s promoted that offer through most of last year but has since made it a mainstay on the menu that’s not supported prominently by ads.Applebee’s margins rose slightly last quarter, to 14.1% to 14%, helped by lower food costs, although that was offset partly by more marketing to try to bring in guests.

Same-store sales were down 1.6% at Applebee’s systemwide, an improvement from prior quarters, while guest counts continued to decline on year.

Terminating a Franchise by Krispy Kreme

You’re a franchisee and your financial and operational problems are snowballing out of control.  The result is you’re not operating in compliance and you’re late on payments to the franchisor, and the franchisor decides that you need to stop operating.   How does the franchisor shut down your store using the courts?

See Krispy Kreme v Satellite Donuts (franchisee)

Franchising Family

Nick Lanni, the founder of Great Steak & Potato Co. (founded in 1982, sold in 2004 with 260 locations), is starting a new sandwich concept at my alma mater, Miami University in Oxford, OH. The concept is called “SoHi Grilled Sandwiches” and is supposed to be a fresh grilled build-your-own cheese steak and burger place.

Coincidentally, his sons started the 25 locations Currito: Burritos Without Borders.

Donatos Shedding Corporate Stores

This relates to the previous blog post as it illustrates another great company selling its corporate owned stores. Donatos, who happens to make my favorite pizza, announced it sold 39 locations to a franchisee, Titan.  Titan now owns all 23 Donatos stores in Indianapolis and 16 of the 22 in Cincinnati. The other Cincinnati locations are owned by other franchisees.

The focus on franchising was originally announced in 2007 by the Columbus-based pizza chain. At that time, about three-quarters of Donatos’ locations were owned by the company. That has changed. Including the Titan deal, Donatos has 179 restaurants in six states, and 63percent are owned by franchisees.

McDonald’s Margins

A stock research company called Trefis who is blogging at Forbes.com noted that McDonald’s company owned stores had a combined EBITDA margin of 24%, while franchised stores provide McDonald’s corporate with an 88% EBITDA margin.  Trefis doesn’t detail how they sourced information to arrive at these margin calculations, but there point was McDonald’s earns 4x as much by franchising a store rather than owning it directly.

McDonald’s owns about 6,200 (20%) of its 30,000 restaurants.

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Wingstop average sales $770,000

I love comparables.   The average unit sales were higher than I expected:

source: Chicago Business

Wingstop has 465 restaurants around the country, with most in Texas, California, Florida and Louisiana. The chain does about 80% of its business in takeout orders and averages $770,000 in annual sales per restaurant, Mr. Evans said.

The chain sells 10 wings for around $6.30 in the Chicago area. Popular flavors include original hot, lemon pepper and hickory barbecue.

Self Service Fro-Yo

There has been an uptick in self serve frozen yogurt, and I think that is a smart move.  Why pay employees to do a task that customers would get the pleasure of doing, and they’ll pay for whatever they use?  You can run a busy store with two employees, one at the cash register and another cleaning up and refilling toppings.

The self service works like this – the customer fills their cup with as much frozen yogurt as they like and put on their own topping, and then proceed to the checkout where the yogurt is weighed and priced at $.30/ounce.  I’ve seen cookie shops in London, UK sell cookies by weight, and it works as people typically will make things a little bigger and end up paying a little more.

One player that “looks” good is the almost 100 location Yogurt-land (and it should with a $350k build out cost – see pic ).  They like to move into former Cold Stone Creamery locations, another smart move.  Others are Fiji Yogurt (5 locations), Yogurtini (1 open, 8 about to open). They have a new location in Weston, FL which I saw and it looks great.

See my previous post about rolling your own frozen yogurt shop if this concept interests you.

Forums back up

Forums were down for about a week. They are now back up!

Why a Smoothie franchise failed; Rule of Thumb Sales

I spoke with a former franchisee of Nrgize, a smoothie bar by Kahala Corp of Stone Cold Creamery fame.  Nrgize has very good tasting healthy smoothies and complementary healthy foods.

The franchisee was open for about a year before closing its doors.  The location was in a popular suburban fitness center.  At first, the thought of exposure to all the healthy clientèle sounded like a sure win.  However, sales were lower than expected from gym members and public walkins from non-members to buy smoothies was extremely rare.

It’s a good lesson on understanding visit rates from a given population and repeat visits.  I’ve heard this rule of thumb and it seems to makes sense —– If you have a great food product and are the only provider, you will likely get close to 20% of the population to visit you twice a month.  With competition and a less than unique food offering, you should figure less than 12% will visit you twice a month.  You will quickly see that a 5k regular visiting member gym would yield at best 66 transactions per day.  If your average ticket is $5 at a 12% capture rate, your sales will be $118,800/year which is probably nowhere near profitable territory.

News: Quiznos, Chipotle, Fuddruckers, Pizza Fushion

Quiznos

  • Quiznos renegotiated it’s debt load and took in an infusion of equity capital from JP Morgan and other existing shareholders.   You can read both good and bad into this.  The good being the investors saw enough upside to invest more, the bad being Quiznos desperately needed this to happen so their financial soundness probably isn’t strong.

Chipotle

  • Chipotle still showing a growing customer base with 1st quarter same-store sales up 4.3%.  They plan to open a new store every three days in 2010.

Fuddruckers

  • Fuddruckers filed for bankruptcy a few weeks ago.   It received approval to sell 62 Fuddruckers and a dozen Koo Koo Roo (similar to Boston Market) for $65 million.  It also plans to close 20 restaurants with “lease issues or low-foot traffic” stores.  Sales were down 10% in 2009.
  • I woudn’t consider Fuddruckers part of the “better burger” craze of Five Guys and Counter, the brand is simply too old and retail square footage is way too large.  Red Robin’s are large in size too, but it invested plenty of capital in marketing and bradning to keep its brand appealing to the next generation of customers…much more so than Fuddruckers.

Pizza Fusion

  • Plans to offset its entire “carbon footprint” by paying a percentage of sales to a company to construct renewable energy facilities.

Are Non-compete Agreements enforceable if signed by employee after being hired?

Test time!  Is the following non-competition agreement enforceable?

“Frank, a Jimmy John’s franchisee, hired his nephew, Nick, to begin working at his Jimmy John’s franchise in Ohio.  Three months after Nick started working, Frank realized that Nick never returned the noncompete agreement he gave Nick during their initial discussions about the job.  The non-compete agreement states that Nick is prohibited from participating in another sub shop within 15 miles while employed and for two years following employment.

Frank has trusted Nick with recipes and procedures that are proprietary and trade secrets of Jimmy John’s, so Frank wants to be sure his entrepreneurial minded nephew doesn’t get any funny ideas about starting his own neighborhood sub shop.

When Frank approached Nick about signing the non-compete agreement, Nick said he forgot and promptly signed and returned the agreement to Nick.  Two months later, Nick quits to open up Nick’s Original Gourmet Subs a few blocks away.  It’s modern decor and authentic rocker vibe is attracting Frank’s customers away, and Frank’s sales drop 40%.   Frank sues Nick for breaching his non-compete agreement.  Who wins?

Hint:  The issue is whether an employee’s continued employment is sufficient consideration (is it enough benefit) for the employee to make the agreement enforceable.

The short answer is… it depends what state you are in.  In Ohio, it would be enforceable.  In Washington, South Carolina, Colorado and Minnesota, the non-compete agreement would not be enforceable because continued employment IS NOT sufficient consideration, courts require more benefit such as a pay raise.  In Illinois, the outcome is uncertain.  Illinois courts have held that continued employment for a “substantial period of time” will constitute sufficient consideration.  The length of time that the employee remains on the job, along with the manner in which the employment ends, are relevant factors for Illinois courts to consider when examining the validity of afterthought covenants.

In the above example, not only is Frank going to have a tough time stopping Nick, but Frank likely violated his franchise agreement which has it’s own set of ramifications.  So the lesson is don’t do casual hires!   Seemingly minor legal oversights can sink you.

My Take on Papa Murphy’s Acquisition (updated April 7, 2010 @ 8pm EST)

As you’ve probably heard, Papa Murphy’s was acquired by a private investment firm for $180 million, about $150,000 per store.  I think it will turn out to be a good acquisition even with the steep price.  Papa Murphy’s has a combination of economic advantages that no other pizza chain has – 1)  it doesn’t have the overhead and capital costs of in-store baking, AND 2)  it is gaining strong penetration in grocery stores.

I admit, from the consumer’s stand point, a take and bake concept is a little confusing at first. “You mean I have to bake my own pizza?”   But that impression soon fades.   The pizza in its raw form looks fresh and the final product cooked in the home oven is as good as pizza delivery.   One hurdle overcome by the industry was the difficulty of using a home oven to cook a pizza because it doesn’t brown up well with the ordinary pizza dough recipe.   To solve this, chains like Papa Murphy’s increase browning by increasing the sugar percentage and providing a disposable reflective baking tray.

Another potential acquisition target is Homemade Pizza, a regional 25 unit chain in IL, MN and DC of classy take-and-bake stores where the average price of an “unbaked” large pizza is almost $20.   It seems to be doing well and has great branding.  Homemade Pizza pizzas are still priced on the high end because it is made with fresh and local ingredients.  The dough is prepared in a commissary to simplify store operations and reduce size requirements.

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Update:  Below is more interesting history on Papa Murphy’s from a November 2009 article in Portland Business Journal.  Average store sales are about $535k.

Papa Murphy’s is a holding of Charlesbank’s Equity Fund V, a $590 million private equity fund that holds several other food-related concerns, including Captain D’s Seafood and Del Taco.

Charlesbank teamed with Papa Murphy’s current president, John Barr, and company management, to recapitalize the pizza chain in a deal announced July 7, 2004. As part of the transaction, Wells Fargo Bank provided a revolving line of credit.

Terry Collins formed Papa Murphy’s in 1995 by merging Petaluma, Calif.-based Murphy’s Pizza with Hillsboro-based Papa Aldo’s. Together, the two chains had 140 locations.

By the time it partnered with Charlesbank, Papa Murphy’s had grown to about 800 stores in 24 states.

In late 2009, it has 1,153 locations in 32 states and two Canadian provinces. It has expanded largely by franchising its concept.

The company owns about 50 stores. The balance are operated by a network of more than 450 franchisees

More than half its franchisees own only one or two stores.