Broadly speaking, restaurants can be segmented into a number of categories:
1- Chain or independent (indy) and franchise restaurants. McDonald’s, Union Square Cafe, or KFC
2- Quick service (QSR), sandwich. Burger, chicken, and so on; convenience store, noodle, pizza
3- Fast casual. Panera Bread, Atlanta Bread Company, Au Bon Pain, and so on
4- Family. Bob Evans, Perkins, Friendly’s, Steak ‘n Shake, Waffle House
5- Casual. Applebee’s, Hard Rock Caf´e, Chili’s, TGI Friday’s
6- Fine dining. Charlie Trotter’s, Morton’s The Steakhouse, Flemming’s, The Palm, Four Seasons
7- Other. Steakhouses, seafood, ethnic, dinner houses, celebrity, and so on. Of course, some restaurants fall into more than one category. For example, an Italian restaurant could be casual and ethnic. Leading restaurant concepts in terms of sales have been tracked for years by the magazine Restaurants and
CHAIN OR INDEPENDENT
The impression that a few huge quick-service chains completely dominate the restaurant business is misleading. Chain restaurants have some advantages and some disadvantages over independent restaurants. The advantages include:
1- Recognition in the marketplace
2- Greater advertising clout
3- Sophisticated systems development
4- Discounted purchasing
When franchising, various kinds of assistance are available. Independent restaurants are relatively easy to open. All you need is a few thousand dollars, a knowledge of restaurant operations, and a strong desire to
succeed. The advantage for independent restaurateurs is that they can ”do their own thing” in terms of concept development, menus, decor, and so on. Unless our habits and taste change drastically, there is plenty of room for independent restaurants in certain locations. Restaurants come and go. Some independent restaurants will grow into small chains, and larger companies will buy out small chains.
Once small chains display growth and popularity, they are likely to be bought out by a larger company or will be able to acquire financing for expansion. A temptation for the beginning restaurateur is to observe large restaurants in big cities and to believe that their success can be duplicated in secondary cities. Reading the restaurant reviews in New York City, Las Vegas, Los Angeles, Chicago, Washington, D.C., or San Francisco may give the impression that unusual restaurants can be replicated in Des Moines, Kansas City, or Main Town, USA. Because of demographics, these high-style or ethnic restaurants will not click in small cities and towns.
5- Will go for training from the bottom up and cover all areas of the restaurant’s operation Franchising involves the least financial risk in that the restaurant format, including building design, menu, and marketing plans, already have been tested in the marketplace. Franchise restaurants are less likely to go belly up than independent restaurants. The reason is that the concept is proven and the operating procedures are established with all (or most) of the kinks worked out. Training is provided, and marketing and management support are available. The increased likelihood of success does not come cheap, however.
There is a franchising fee, a royalty fee, advertising royalty, and requirements of substantial personal net worth. For those lacking substantial restaurant experience, franchising may be a way to get into the restaurant business-providing they are prepared to start at the bottom and take a crash training course. Restaurant franchisees are entrepreneurs who prefer to own, operate, develop, and extend an existing business concept through a form of contractual business arrangement called franchising.1 Several franchises have ended up with multiple stores and made the big time. Naturally, most aspiring restaurateurs want to do their own thing-they have a concept in mind and can’t wait to go for it.
Here are samples of the costs involved in franchising:
1- A Miami Subs traditional restaurant has a $30,000 fee, a royalty of 4.5 percent, and requires at least five years’ experience as a multi-unit operator, a personal/business equity of $1 million, and a personal/business
net worth of $5 million.
2- Chili’s requires a monthly fee based on the restaurant’s sales performance (currently a service fee of 4 percent of monthly sales) plus the greater of (a) monthly base rent or (b) percentage rent that is at least 8.5 percent of monthly sales.
3- McDonald’s requires $200,000 of nonborrowed personal resources and an initial fee of $45,000, plus a monthly service fee based on the restaurant’s sales performance (about 4 percent) and rent, which is a
monthly base rent or a percentage of monthly sales. Equipment and preopening costs range from $461,000 to $788,500.
4- Pizza Factory Express Units (200 to 999 square feet) require a $5,000 franchise fee, a royalty of 5 percent, and an advertising fee of 2 percent. Equipment costs range from $25,000 to $90,000, with miscellaneous costs of $3,200 to $9,000 and opening inventory of $6,000.
5- Earl of Sandwich has options for one unit with a net worth requirement of $750,000 and liquidity of $300,000; for 5 units, a net worth of $1 million and liquidity of $500,000 is required; for 10 units, net worth
of $2 million and liquidity of $800,000. The franchise fee is $25,000 per location, and the royalty is 6 percent.
What do you get for all this money? Franchisors will provide:
1- Help with site selection and a review of any proposed sites
2- Assistance with the design and building preparation
3- Help with preparation for opening
4- Training of managers and staff
5- Planning and implementation of pre-opening marketing strategies
6- Unit visits and ongoing operating advice
There are hundreds of restaurant franchise concepts, and they are not without risks. The restaurant owned or leased by a franchisee may fail even though it is part of a well-known chain that is highly successful. Franchisers also fail. A case in point is the highly touted Boston Market, which was based in Golden, Colorado. In 1993, when the company’s stock was first offered to the public at $20 per share, it was eagerly bought, increasing the price to a high of $50 a share. In 1999, after the company declared bankruptcy, the share price sank to 75 cents. The contents of many of its stores were auctioned off at
a fraction of their cost.7 Fortunes were made and lost. One group that did not lose was the investment bankers who put together and sold the stock offering and received a sizable fee for services.
The offering group also did well; they were able to sell their shares while the stocks were high. Quick-service food chains as well-known as Hardee’s and Carl’s Jr. have also gone through periods of red ink. Both companies, now under one owner called CKE, experienced periods as long as four years when real earnings, as a company, were negative. (Individual stores, company owned or franchised, however, may have done well during the down periods.) There is no assurance that a franchised chain will prosper.
At one time in the mid-1970s, A&W Restaurants, Inc., of Farmington Hills, Michigan, had 2,400 units. In 1995, the chain numbered a few more than 600. After a buyout that year, the chain expanded by 400 stores. Some of the expansions took place in nontraditional locations, such as kiosks, truck stops, colleges, and convenience stores, where the full-service restaurant experience is not important. A restaurant concept may do well in one region but not in another. The style of operation may be highly compatible with the personality of one operator and not another.
Most franchised operations call for a lot of hard work and long hours, which many people perceive as drudgery. If the franchisee lacks sufficient capital and leases a building or land, there is the risk of paying more for the lease than the business can support. Relations between franchisers and the franchisees are often strained, even in the largest companies. The goals of each usually differ; franchisers want maximum fees, while franchisees want maximum support in marketing and franchised service such as employee training. At times, franchise chains get involved in litigation with their franchisees.
As franchise companies have set up hundreds of franchises across America, some regions are saturated: More franchised units were built than the area can support. Current franchise holders complain that adding more franchises serves only to reduce sales of existing stores. Pizza Hut, for example, stopped selling
franchises except to well-heeled buyers who can take on a number of units. Overseas markets constitute a large source of the income of several quick-service chains. As might be expected, McDonald’s has been the leader in overseas expansions, with units in 119 countries.
With its roughly 30,000 restaurants serving some 50 million customers daily, about half of the company’s profits come from outside the United States. A number of other quick-service chains also have large numbers of franchised units abroad.While the beginning restaurateur quite rightly concentrates on being successful here and now, many bright, ambitious, and energetic restaurateurs think of future possibilities abroad. Once a concept is established, the entrepreneur may sell out to a franchiser or, with a lot of guidance, take the format overseas via the franchise. (It is folly to build or buy in a foreign country without a partner who is financially secure and well versed in the local laws and culture.).
The McDonald’s success story in the United States and abroad illustrates the importance of adaptability to local conditions. The company opens units in unlikely locations and closes those that do not do well. Abroad, menus are tailored to fit local customs. In the Indonesia crisis, for example, french fries that had to be imported were taken off the menu, and rice was substituted. Reading the life stories of big franchise winners may suggest that once a franchise is well established, the way is clear sailing. Thomas Monaghan, founder of Domino Pizza, tells a different story. At one time, the chain had accumulated a debt of $500 million. Monaghan, a devout Catholic, said that he changed his life by renouncing his greatest sin, pride, and rededicating his life to ”God, family, and pizza.”
A meeting with Pope John Paul II had changed his life and his feeling about good and evil as ”personal and abiding.” Fortunately, in Mr. Monaghan’s case, the rededication worked well. There are 7,096 Domino Pizza outlets worldwide, with sales of about $3.78 billion a year. Monaghan sold most of his interest in the company for a reported $1 billion and announced that he would use his fortune to further Catholic church causes. In the recent past, most food-service millionaires have been franchisers, yet a large number of would-be restaurateurs, especially those enrolled in university degree courses in hotel and restaurant management, are not very excited about being a quick-service franchisee.
They prefer owning or managing a full-service restaurant. Prospective franchisees should review their food experience and their access to money and decide which franchise would be appropriate for them. If they have little or no food experience, they can consider starting their restaurant career with a less expensive franchise, one that provides start-up training. For those with some experience who want a proven concept, the Friendly’s chain, which began franchising in 1999, may be a good choice. The chain has more than 700 units. The restaurants are considered family dining and feature ice cream specialties, sandwiches, soups, and quickservice meals.
Let’s emphasize this point again: Work in a restaurant you enjoy and perhaps would like to emulate in your own restaurant. If you have enough experience and money, you can strike out on your own. Better yet, work in a successful restaurant where a partnership or proprietorship might be possible or where the owner is thinking about retiring and, for tax or other reasons, may be willing to take payments over time.
Franchisees are, in effect, entrepreneurs, many of whom create chains within chains.
McDonald’s had the highest system-wide sales of a quick-service chain, followed by Burger King. Wendy’s, Taco Bell, Pizza Hut, and KFC came next. Subway, as one among hundreds of franchisers, gained total sales of $3.9 billion. There is no doubt that 10 years from now, a listing of the companies with the highest sales will be different. Some of the current leaders will experience sales declines, and some will merge with or be bought out by other companies-some of which may be financial giants not previously engaged in the restaurant business.