Broken Wing

Growing restaurant chains through the sale of franchises has been a commonly accepted practice for decades. From McDonald's to today's juice bar craze, franchising is alive and well in the restaurant industry.

But Boston Market didn't use a standard franchising model.

"It was a Harvard Business School example of what not to do with a franchising program," Kaufmann says. "They set up a franchising program that ignored the cardinal rule of franchising: Start on the unit level. If you can't make money on the unit level, you'll die."

Instead, Boston Market brought in Franchise Area Developers (FADs), people responsible for opening a number of outlets in a given market, usually at least 10. Fees for opening these stores were not cheap-a $35,000 franchise fee, a $10,000 grand opening fee and another $15,000 for a sophisticated software program. After a franchise was up and running, there were more fees: a 5 percent royalty, a 4 percent local advertising charge and another 2 percent for national advertising.

The FADs were lent the money to open all these restaurants by Boston Market itself. The company, in turn, got its money from Wall Street.

The company set a market record when its stock jumped 143 percent the first day it went public in 1993. For three years, Boston Market's stock stayed above $40 per share. Between stock and debt financing, about $2 billion was put into Boston Market, according to Restaurant Finance Monitor. That money allowed the opening of more than 1,200 locations between the summer of 1996 and early 1997.

But the company was opening too many sites too quickly, according to Kaufmann. What's more, he adds, Boston Market's openings were spread across the nation in disparate markets, rather than focused on a region where advertising and word-of-mouth can help develop an identity. "The reason you concentrate on one area is to get a proper return on your advertising curve," says Kaufmann. "Boston Market didn't do that."

Wall Street investors saw a company that reported profits as late as the first half of 1997 ($41.1 million). But what Boston Market was counting as profits included royalty fees and loan payment interest from the FADs-money that was essentially recycled from those same investors.

Meanwhile, the restaurants were losing money-lots of money. In total, the FADs lost $51.3 million in 1994, $148.3 million in 1995 and $156.5 million in 1996, Restaurant Finance Monitor reported. While restaurant-level profits were falling, the FADs stayed in because the money they were making on the stock outweighed their losses, says Richard Papiernik, financial editor of Nation's Restaurant News and author of a series of reports on the Boston Market debacle.

In 1997, the stock started to fall, and Boston Market announced it would convert the FADs to company-owned locations. However, the FADs still owed the company $754 million-of which Boston Market could recover very little. With no new financing coming in, it was only a matter of time before Boston Market's house of cards came crashing down.

Store Economics

People may have liked the food, but they weren't coming through the doors of Boston Market fast enough to keep the restaurants in the black.

Why? The key reason, our experts say, was probably the restaurants' high overhead-they needed too many people to come through the door to stay afloat.

"They had an expensive box," Papiernik says. "They had an expensive software system, and their cost of food was also high." Food and paper costs at Boston Market are around 38 percent, which most restaurants want at least 6 percent lower, Papiernik says.

Boston Market's high overhead started from the ground up. Literally. Boston Market was well-known for overpaying for real estate, according to Papiernik. "In a restaurant industry professional roundtable we had, one of the people there was glad when Boston Market filed [for bankruptcy] because he said the restaurant real estate market might start to return to normal," Papiernik says. Landlords would play Boston Market off other people interested in their land, he adds, thus driving up the rent.

Competition was another factor cutting into Boston Market's patrons. When the home-meal-replacement market started to take off, the bandwagon started getting crowded, and no one jumped on it faster than grocery stores. Newer, larger grocery stores started offering precooked chicken as well as other prepackaged meals. Companies such as Kenny Rogers Roasters and the also-struggling Koo Koo Roo entered the fray as well.

"[Boston Market] didn't expect grocery stores to come around as quickly as they did," Papiernik says. "Boston Market's idea of competition was to go into a market and saturate it."

Kaufmann adds that the problem extended to such details as restaurant design. Each Boston Market had a single customer line-which easily turned into a very long one.

"My wife was in Boston Market one night ordering food for our family, and there were about 15 people in one line and it wasn't moving, while the girl next to the to-go phone was just standing there doing nothing," Kaufmann says. "My wife took out her cell phone and called in a pick-up order, switched lines and picked up the [food]. It was clever of my wife, but it slowed down the regular line even more while our order was made."

This article was originally published in the February 1999 print edition of Entrepreneur with the headline: Broken Wing.