The modern franchise business model was created by Isaac Singer, a highly successful entrepreneur whose automated machine revolutionized sewing in the 1800’s. Prior to Singer’s invention, most sewing was done by hand, a slow and labor intensive process. Singer’s machine could produce 900 stitches per minute - a huge advancement for professional and amateur sewers alike. Mr. Singer knew that his product had the potential to change the industry, so he formulated a plan to get his sewing machines into the hands of as many consumers as possible. Initially, he came up with the first ever installment payment plan as a way to make his machines more affordable to the masses. While important, this only solved part of Singer’s problem; he still needed a way to distribute his machines across the country and eventually the world. The impact of Singer’s sewing machine was obvious, so he could easily attract business people across the country that paid him an up-front, licensing fee for the right to sell his sewing machines in a specific geographic territory. Mr. Singer’s franchised business plan proved to be incredibly successful, with many other companies in various industries ultimately recognizing the benefits of his model and adapting it to fit their respective businesses.
However, it was the McDonald’s model under Ray Kroc’s leadership that forever changed the way in which multi-unit concepts do business. Kroc saw so much potential for a franchised business model at McDonald’s that he acquired the brand from the McDonald brothers, took it public in 1965 with 500 stores, and grew it to the global franchised brand that is McDonald’s today.
Franchising has proven to be a successful business model across a wide spectrum of industries utilizing multi-unit retail distribution. At its heart, franchising allows everyone to focus on what they do best – manage, support, and grow the brand in the case of the Franchisor with Franchisees focused on delivering a high quality, consistent product or service to the ultimate customer. Refranchising – the sale of franchisor owned units to new or existing franchisees – allows franchisors to address both financial and strategic goals in their business by optimizing the mix of company and franchised ownership. Refranchising has been a hot topic in the restaurant industry in particular with a number of national chains executing large scale refranchising initiatives over the past 5 years. The Cypress Group led most of these large scale refranchising programs and sees this activity continuing for the foreseeable future, and likely spreading to multi-unit segments outside of the restaurant industry.
Historically, most franchised restaurant concepts have operated under an ownership structure that had the franchisors owning and directly operating a “material” percentage of their overall system. While this ownership percentage has varied from brand-to-brand, it was historically significant – generally in the 25% to 50% range. The thinking was this level of ownership meant franchisors would lead by example, essentially showing their franchisees how to operate the business. Additionally, this direct ownership was seen as the best way to align the interests of the Brand and its operators.
As it has matured, the chain restaurant business has become much more complex. Increased competition, governmental regulation, changes in the workforce, and consumer preferences make the business more challenging today than ever. Many chains have concluded that new thinking is needed to address today’s environment, with Refranchising initiatives becoming an important Brand strategy. Although Franchisors have historically fine-tuned their ownership of units, today’s refranchising initiatives tend to be larger in scale with more strategic implications. Franchisors in recent restaurant initiatives have seen franchisors go as far as zero company-owned restaurants. The trend towards larger and more sophisticated restaurant franchisees has helped operators deal with the more complicated business we see today, as well as create demand for large scale refranchising initiatives in national systems including Wendy’s, Burger King, Applebee’s, and TGI Fridays.
So can refranchising be a “win/win” for franchisors and franchisees? In our experience the answer is “Yes” if designed and executed correctly. Benefits can include:
Improved Financial Metrics:
- Comp Sales growth driven by renewed focus on menu, marketing, technology, reimage initiatives, etc.
- New unit growth with expanded franchisee footprint ideally in combination with new prototype, and corporate initiatives including enhanced RE & Construction resources, incentives, etc.
- Entrepreneurial / Growth Opportunities for Brand Employees
- Reduced volatility in Revenue, Earnings, and Free Cash Flow
- Capital re-deployment to System growth initiatives
- Ability to optimize capital structure
Improved Financial Metrics:
- In core brand – from both acquired units and franchisor’s broad brand initiatives
- As a supplemental brand
- For People – enhanced career paths
Stronger Overall System
- Frequent ability to improve unit level profits
- Leverage existing overhead
- Encourages partnership with strong players – both new and existing franchisees
- Growth creates opportunities for all
Ultimately, we believe refranchising is here to stay. These initiatives have the ability to revitalize and improve the operational strategy of major franchised organizations. Franchisors undergoing the process are finding they have a renewed sense of purpose, focusing on new innovations and brand management without having to worry about daily restaurant operations. Franchisees are granted the opportunity to grow their store portfolios large enough that they become capable of streamlining operations, leading to greater efficiencies, sophistication, and success. While restaurant refranchising initiatives remain a hot topic, we expect to see the discussion quickly expand into non-restaurant, multi-unit retail systems that can benefit from the same sort of dynamics experienced in restaurants.