Franchising has changed dramatically over the last five years. There are more multi-unit and area developers, more high-tech ways to optimize sales and leaner and meaner corporations honed by the recession. At the same time, franchising remains subject to the challenges it has always faced: the fads, the bubbles and the whims of public taste. We can't say for sure how the next year in franchising will shake out, but here are our picks for the trends that will have the biggest impact.
When the economy headed south, franchisors did, too--and east and west and north. A soft franchising market in the U.S. sent many franchisors overseas, and the lesson they learned is that area development is the way to go. Instead of searching out dozens or even hundreds of mom-and-pop franchisees, many American concepts are partnering with a deep-pocketed overseas developer who can navigate the culture and open and operate numerous units at once.
It's a lesson many franchisors have brought home, and after several years of increasing growth, area development is settling in as the new normal. According to research firm Frandata, more than 50 percent of franchises are held by multiple-unit owners, and many of them act as area developers, building out entire metro areas, counties or even states.
"Franchisors are realizing the advantage of dealing with area developers," says Bret Lowell, a partner at the Reston, Va., office of business law firm DLA Piper and author of Multiple-Unit Franchising: The Key to Rapid System Growth. "When they open their second, third and fourth units, the franchisor doesn't have to go through the sales process and doesn't have to deal with six people opening six different units. There are economies of scale and added efficiency with area developers."
Other economic factors have also driven area development in franchising. Banks are more likely to lend to franchisees with successful track records, and franchisors reduce risk by letting proven operators open stores, rather than rolling the dice with a newbie. Lowell believes that even as lending continues to unfreeze and the economy improves, franchises will still favor area developers and multi-unit operators. "I think the economy and efficiencies will cause it to remain," he says. "My sense is, franchisors like to have that multiple-unit arrow in their quiver. In many cases, it's a good option."
Mark Siebert, CEO of Homewood, Ill.-based franchise developer iFranchise Group, also sees a rosy future for area developers. "There is still a lot of real estate available, and landlords are still aggressive on pricing," he says. "Franchisors targeting area developers are going to continue to do well in this economy."
Refranchising Rambles On
Refranchising--in which a company sells its corporate-owned stores to franchisees--is often taken by the marketplace as a sign that a business is in distress. But if that's the case, then franchising must be in a free fall. In recent years, Arby's began divesting itself of corporate units, while Burger King, Pizza Hut, KFC, ampm and dozens of other high-profile franchises launched refranchising efforts. In the last year, Taco Bell announced plans to refranchise 400 units.
Kevin Burke--managing partner of Los Angeles-based Trinity Capital Management, which has financed billions of dollars in refranchising deals over the last two decades--says the trend should be interpreted not as weakness but as vitality. "In the beginning, a lot of refranchising was about franchisors trying to pay down debt, but now it's a strategic move," he explains. "A franchisor's skill set is very different from the disciplines needed for a franchisee to run store operations. They want to have a lineup of executives who are well-versed in policing brand standards, working on products and promotions and overall strategy. They don't need to be running the stores themselves. From a strategic point of view, companies are saying, ‘We want to stick to our knitting and what we're good at.'"
There are economic incentives for getting out of running company stores as well. Collecting royalties is much easier than actually selling mufflers or sandwiches, and securities analysts are more enthusiastic about royalty streams than store revenue. At the same time, as units begin to age, franchisors question the logic of investing $500,000 or $1 million in a remodeling effort when they can sell the location off to a franchisee who will foot the bill and still pay royalties for the next decade. "A lot of things can go wrong between sales and the bottom line," Burke says. "Franchisors have realized that collecting royalties is the purest play."
Fast Food Gets Healthy (Really)
Remember the McLean burger? The Burger King Baguette? The Frescata sandwiches from Wendy's? The fast-food road is littered with failed bids to get Americans to eat healthfully from the drive-thru window.
It once seemed like an exercise in futility, but after throwing slimmed-down burgers and other dietary monstrosities at the wall for the last two decades, franchises are finally creating healthful fast food that sticks. Case in point: The introduction of a low-cal turkey burger last year at sibling chains Hardee's and Carl's Jr. may have been one of the franchise's most popular product launches ever. Meanwhile, Burger King's Garden Fresh salads and chicken wraps spearheaded that company's largest menu expansion. At McDonald's, consumers seem stuck on oatmeal, and the chain has slimmed down its Happy Meal, as well as added calorie counts to its drive-thru menu boards--a move now required, per healthcare legislation, of restaurant chains with 20 or more outlets.
So have the fast-food chains finally gotten the menu right, or have Americans finally awakened to their button-popping waistlines? According to Darren Tristano, executive vice president of the Chicago-based restaurant research firm Technomic, the answer is a little of both. "Yes, they've found appealing flavors," he says, "but consumers are also interested in taking control of their diets."
It also seems that the big franchises are interested in getting ahead of concepts like Energy Kitchen and Evos, which are luring health-conscious consumers with bison burgers and air-baked French fries. Even fast-casual burrito and burger joints are often seen as smarter choices than the traditional fast-food options. But the big guys seem most concerned about LYFE Kitchen, a Palo-Alto, Calif.-based concept run by former McDonald's bigwigs, which is recruiting franchisees and reportedly may build up to 250 units over the next five years.
For most of its existence, franchising has been a strange combination of intuition and research. Franchisors have to know instinctively which candidates will do well in their system, and they use traffic patterns and local income levels to choose real estate--though in the end it's been primarily a gut decision. But more and more are seeing the advantages of digital-age data collecting, and services that aid franchisors in site selection, franchisee selection and customer retention are becoming must-haves.
Site Analytics and other services, which use hard data and detailed traffic patterns to help franchisors decide where to place their stores, were used by just a handful of franchises a few years ago. Today companies are clamoring for these services. Google and Facebook recently launched features designed specifically to help franchisors and franchisees collaborate on social media branding and promotions, both of which will see wider adaption in the coming year.
Even something as simple as digital menu boards, which franchises resisted for the better part of a decade, will see wide deployment as companies realize the opportunities they present, such as the ability to add happy-hour offerings, hold one-day promotions or disseminate personalized messaging. Meanwhile, the Franchise Business Index (launched by the International Franchise Association) is tracking monthly growth of the sector and providing insights into the direction it's headed--a strong symbol of how far and how quickly franchising has moved into the information age.
How much is too much? For certain franchising food trends that have proliferated at a rapid rate--and will likely continue to do so in the coming year--the saturation point may be approaching.
Frozen-yogurt franchises like Red Mango, Pinkberry, Menchie's, Yogurtland, 16 Handles and dozens of regional players are almost as thick as Starbucks--but without the caffeine-addicted customers and with limited winter appeal. Because they're cheap to open, frozen-yogurt franchises are multiplying like locusts.
"The problem with frozen yogurt is that it's location-driven and largely undifferentiated," says iFranchise Group's Siebert. "It has low barriers to entry and a lot of players. I'm not sure if it has totally run its course, but we're rapidly coming to the point where winners will be sorted out from losers."
James Sinclair--founder of OnSite Consulting, a Los Angeles-based hospitality consultancy that analyzes the restaurant industry--says he and his colleagues have determined that a fro-yo store can be opened for about $20,000. "Granted, it would be a horrible store," he admits. "The point is, I think we're reaching the down-slide of the cycle. It's been just as much driven by property owners. These stores open quickly and don't take any significant modifications, so landlords have encouraged these places to open in the down economy. Everywhere you go you see three yogurt stores on any given corner. And there've been tremendous closures."
Another franchising craze, quick-serve "better burgers," also seems close to saturation. Five Guys opened more than 1,000 franchises in less than five years; other companies in the category include Smashburger, The Counter and BurgerFi.
"I think the whole burger concept is reflective of the marketplace and the fact that people were craving somewhere in the middle," Sinclair says. "They don't want to have a long, drawn-out meal with table service, but they don't want a cheap environment, either. That's what sprouted this whole burger thing."
"The American appetite for burgers seems almost endless," says Technomic's Tristano, pointing out that so-called better burgers aren't necessarily cannibalizing sales from fast-food joints, but are going head-to-head with fast-casual concepts like Chipotle and Noodles & Company, a market segment in which there seems to be plenty of room for growth. Still, the CEOs of better-burger franchises are getting nervous about market saturation, with almost all of them giving recent interviews explaining why their concept will survive the coming "shakeout."