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For Franchises, Growing Rapidly Isn't Always Best

Not so fast: When expansion trumps controlling costs and other goals, operations can turn sloppy.

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When Rubio's Fresh Mexican Grill, a chain specializing in fish tacos, started offering franchises in 2000, it hoped to make a big splash in the world of quick-casual Baja Mexican cuisine.

The unit of Rubio's Restaurants Inc., Carlsbad, Calif., embarked on an ambitious plan to open franchises in several Western states over the course of a few years. But after a handful of franchises opened in 2002, some meaty problems soon surfaced. Sales were floundering at the new franchises, analysts say, and even the signature dish wasn't luring enough customers outside of the California market.

One Rubio franchise defaulted on its agreement within months of opening, and the company ended up buying back two franchises, management says. Rubio's froze its franchising initiative before problems spread. The company then refocused its efforts on reorganizing management, diversifying the menu and lowering prices before thinking about growth.

"We outgrew ourselves," says Ralph Rubio, founder of the company and current chairman. "We thought we had a prototype such that we could just franchise it, but it wasn't working." Recently the chain decided to start franchising efforts again -- this time with a more disciplined approach.

As many businesses discover too late, rapid expansion doesn't always mean success when building a franchise. When growing quickly trumps other goals, such as grooming competent leaders, controlling costs, picking prime locations or building a customer base, the company's operations can turn sloppy.

"It's definitely possible to kill off a good concept by trying to grow too fast," says Scott Shane, an economics professor at Case Western Reserve University.

Several franchising experts point to Boston Market as a prime example. The company, formerly Boston Chicken, grew from 20 stores in the late 1980s to more than 900 franchises by 1998. But while costs at the chain were mushrooming as it tried to build more stand-alone restaurants, the individual stores couldn't sell enough food to pay the bills and repay company loans. The chain ultimately filed for Chapter 11 bankruptcy reorganization, bought back nearly all of the franchises and closed almost 200 stores in 1998, before getting eaten up by McDonald's Corp. in 2000. The problem, experts say, was the company became so obsessed with growth that it overlooked principles of good business like grooming good managers and building relations in the community.

Any franchiser has to be especially careful in the beginning to evaluate its growth, says Mr. Shane. "If you're not making money at a single outlet," he says, "chances are pretty great that you're not going to make a lot of money at a lot of outlets."

It's not uncommon for companies to get overly ambitious in their franchising plans, especially since many are first attracted to franchising because they want to grow faster than their own capital allows. Some want to penetrate target markets quickly before competitors do.

And the income stream from franchising can be alluring, so much so that growth becomes the overarching objective. Franchisees normally pay the company an initial fee of anywhere from $5,000 to $75,000. Some of that may pay for new-franchisee training, equipment and administration, but much of it is profit for the franchiser. So the more franchises that open, the more profit for the company. And franchisees pay royalties to the company, from 2% to 25% of revenue, regardless of whether the franchise is profitable.

"There are still some that focus more on the initial sale and making money and not as much on how well they treat the franchisee on the back end," says Stephen Story, a franchise lawyer in Norfolk, Va. However, to grow quickly, franchises usually need an overabundance of prospective franchisees, which isn't normally the case in the first few years of franchising, he adds.

Bad Word-of-Mouth
Mario Herman, an Adamstown, Md., lawyer who represents franchisees in suits against franchisers, says the companies that focus too much on their own profits and not enough on the franchisees' success tend to end up hurting themselves. Disgruntled franchisees network and share their gripes, and that can make it difficult to get prospects in the door. He likens the franchise relationship to marriage. "If, in a marriage, it's a one-way street where one person is always getting their way," he says, "it's probably not going to last."

Of course, not every rapidly growing franchise fails. In fact, some thrive on fast growth.

Although Subway Restaurants, a unit of Doctor's Associates Inc. of Milford, Conn., began with relatively modest growth in 1974, it expanded quickly in the 1980s and 90s, growing from 166 outlets in 1981 to more than 24,000 world-wide today. But the company was able to effectively help keep individual stores profitable and control the burgeoning growth by hiring area developers who oversaw and sometimes owned multiple stores in a region.

In the early years, Subway closely monitored whether the system was hitting targets that the company had set, and whether new franchises were outselling older stores, says Don Fertman, Subway's development director since 1981. The company also strived to keep costs as low as possible for franchisees -- an important component to success as a franchiser, Mr. Fertman says.

So, how can a franchiser balance the desire to grow with not letting growth become a burden? There's no particular growth formula, although the median number of franchises sold is four to five in the first year, says Mark Siebert, chief executive of iFranchise Group, a consulting firm in Homewood, Ill.

While growth is important, it must be balanced with picking highly motivated managers and owners, training the franchisees about the business and helping them build a customer base.

And a company needs to make sure that the franchises are getting ongoing support and making sure brand standards are being met. "You have 1,000 outlets, and all of a sudden a dozen outlets are having trouble with a recipe," says Case Western's Mr. Shane. "You can really quickly ruin a reputation that way."

Moving Fast
Some businesses have legitimate reasons for wanting to franchise quickly, such as trying to gain market share before a competitor can. One way companies try to keep growing pains under control is to do what Subway did: by using multiunit rather than single-unit franchisees.

Fantastic Sams hair salons, part of Fantastic Sams International Corp., uses master-license agreements, which give regional owners control over growth. Using this strategy gives a company a better chance to recruit talented owners, who wouldn't have been interested if they could only invest in a few stores, says Jack Keilt, chief executive and president of Fantastic Sams.

That way, the company isn't responsible for managing all the growth itself -- provided it can find the talent it needs.

And hiring the wrong developers isn't the only risk of the strategy, says Bob Gappa, president of Houston franchising consultant Management 2000. Some area developers, for instance, don't fulfill their commitment to open the agreed-upon number of franchises.

Mr. Gappa usually recommends that companies grow slowly, at least in the first few years. The most successful franchisers, he says, track customer loyalty and frequency at the first franchises so they can gauge whether the franchise plan is working. "You need to make sure that your first franchisees are very successful, because they're going to validate your next group of franchisees," Mr. Gappa says. "Otherwise you're in trouble."

From StartupJournal.com
Copyright © 2005 Dow Jones & Company, Inc. All Rights Reserved



Kelly K. Spors is a freelance writer in St. Louis Park, Minn.

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