Why franchising is a terrible comeback strategy

Investors really love franchising and apparently can’t get enough of it. That’s at least judging by the number of brands that view franchising as a way out of whatever financial or expansion hole they’re in.

But that’s not always the right course of action. In fact, companies would usually be far better off keeping the units themselves.

We’ve been reminded of this on a number of occasions of late.

Franchisee struggles

For instance, we noted earlier this week that franchisees have profit problems, struggling with the rising costs coupled with limited demand. Chains like Wendy’s, Jack in the Box and many others are dealing with an operator base that is struggling to keep their locations open.

We also reported last week about the challenges at Subway, which is trying a more forceful approach to convince a large segment of operators to go along with its latest sales-generation plan.

McDonald’s, meanwhile, is planning to refranchise more of its corporate stores, citing their poor profitability.

There’s nothing wrong necessarily with franchising if it’s done the right way. The Philippines-based chicken chain Jollibee, for instance, just opened its first franchised location in the U.S., in California.

But that company invested its own funds and resources into developing the U.S. market. Jollibee grew average-unit volumes to a healthy $5 million per location, becoming a known commodity. It then decided it was ready to expand faster, by franchising.

Franchising pros and cons

Franchising fundamentally enables companies to expand more quickly than they can otherwise, because it puts the hands of financing expansion into the hands of many investors. That makes it easier to finance and open new locations. The franchisor can then concentrate on the brand, and over time the royalties it gets from those franchisees become more and more profitable.

Yet, in exchange for this, brands lose full control over their restaurant operations, because they must work with the franchisees that operate the stores. That makes it a lot tougher to get things done.

Too many companies, eyeing the former, ignore the latter. And many view franchising as a way to rescue them from stores they can’t fix. So struggling brands frequently use franchising as a fallback option or others just give up and sell the stores to operators.

Others see their growth hit a wall and then opt for franchising in a bid to attract investors. Jack in the Box was a mostly company-run operation, then organized a massive refranchising strategy that spanned years.

The company has been perpetually stuck on between 2,000 and 2,200 locations. A succession of chief executives has been unable to spur growth and they’re now actively working to convince franchisees to close locations. Refranchising has helped the franchisor generate more profit. But the brand remains largely what it was 20 years ago. And each new CEO the company hires has a tougher task than their predecessor.

Loss of control

When companies opt to franchise, they lose full control of the way their brands operate. That is the price they pay for all those profits.

As we’ve noted before, for instance, franchising can worsen sales declines because franchisees, which must pay the franchisor off the top, cut whatever costs they can to generate a profit. In one extreme case, a Hardee’s operator in Alabama closed its restaurants after 2 p.m. because it lost too much money.

We’re seeing this now with Subway, which has closed 8,000 locations, a third of its restaurants, since 2015. Operators are so skeptical of everything that three out of 10 refused to honor a marketing partnership with the Moana movie.

The franchisor, clearly frustrated, is now demanding compliance, “reminding” franchisees that they could owe future expected royalties if they close too early.

Here’s the thing: It’s far easier for brands to take the steps necessary to fix a brand when it has a large number of corporate stores than it is for a brand to be fixed by offloading stores to franchisees. Better yet, franchisors get the full benefit of such fixes, because they get 100% of the store revenue, rather than just 5%.

Fifteen years ago, Arby’s eschewed refranchising, watched its unit volumes soar, paid large dividends to its owners, then used the brand as the foundation for Inspire Brands. Chili’s, meanwhile, bought up large numbers of corporate stores before the pandemic. That 71% increase in same-store sales over five years? Chili’s gets all of that.

Franchising is great when it works. But it’s terrible as a fix-it strategy.