Franchisees Find Strength in Numbers

The days of the mom-and-pop shop as the backbone of franchising may be numbered.

First franchisees were snapping up 50 to 100 or more outlets. Now “mega-franchisees” are taking root, diversifying into multiple franchise concepts in search of growth.

The trend toward larger franchisees started in the fast-food industry, the oldest and largest sector of franchising. It is also the most crowded and considered by many to be overbuilt, despite a decade-long industry consolidation. That makes economies of scale important to restaurant operators.

Easy access to capital also has spurred the increase in franchisees that have expanded beyond a single restaurant concept.

Forty-five of the 100 largest restaurant franchisees owned more than one restaurant system last year, more than double the number in 1992, according to Restaurant Finance Monitor.

“Once you have established a certain amount of overhead in accounting, real estate and marketing, the goal is to run more sales through that same overhead and gain some economies of scale,” said John Gray, senior vice president of corporate communications for Atlanta-based RTM Inc., the largest restaurant franchisee in the country.

His company, Arby’s largest franchisee with 694 of the roast beef sandwich shops, recently signed up to build and operate Del Taco Mexican fast-food outlets and has plans to add fast-food restaurants from additional chains.

Consumers are likely to see little immediate impact from the growing number of giant franchisees. Stiff competition in the fast-food business, for example, has meant rock-bottom burger and sandwich prices for several years.

Small franchise business owners, though, could feel the competitive pressure in several ways. When prices fall, they are likely to take a bigger hit than a giant competitor that can spread fixed costs over a larger store base. Small franchisees don’t have the purchasing power of their bigger competitors. And they may also have a harder time competing for employees in today’s tight labor market. Big franchisees can afford richer employee-benefit packages.

Savvy management is the key to survival for small entrepreneurs in the new era of franchising, said Matthew Schoenberg, who, as president and chief executive of San Ramon, Calif.-based Sydran Services, has built his company into one of the largest Burger King franchisees in the nation.

“Mom-and-pops do an excellent job and create great value, but I will tell you that their ability to operate the way they used to is changing and . . . to be successful they will have to change the way they’ve done business in the past,” Schoenberg said.

Once frowned on by franchisers, the trend toward diversification has been fueled in part by their recognition of the benefits of keeping or adding big, experienced and well-capitalized franchisees. These big franchisees often prove ready buyers when a franchiser wants to sell a large block of company-owned stores. Plus it’s cheaper and easier to sell 200 outlets to one company rather than to recruit and train 200 individual franchisees.

Most franchise agreements still prohibit a franchisee from operating stores for a direct competitor, however. A McDonald’s franchisee, for example, would not be allowed to buy the franchise rights to a Burger King outlet. Mega-franchisees account for a large share of industry revenue. Of the 10 largest restaurant franchisees, those that operated more than one restaurant concept accounted for $1.7 billion in revenue, more than half of the $3.2 billion generated by the group last year, according to Restaurant Finance Monitor. No. 1 RTM posted franchisee-related revenue of $575 million. No. 10, Cimm’s of Glendale, which owns 130 Burger King and 10 Tony Roma’s restaurants, rang up $176 million, according to the industry newsletter.

Branching out into another franchise system is the next step for many large franchisees interested in growth. When Irvine-based Diedrich Coffee Inc. announced its first major franchisee agreement last year, it named Tacala Inc., the largest franchisee in the Taco Bell chain with 145 restaurants, as its franchisee. Tacala of Birmingham, Ala., agreed to develop 44 coffeehouses over five years in what is the company’s first franchisee venture outside the Taco Bell system.

Los Angeles-based Franchise Mortgage Acceptance Co., which funded the Tacala deal, has seen an increasing number of large franchisees cross over into other systems.

“In certain markets, some of the franchisees have built out in a given system so they will look at other brands trying to grow in their areas,” said Thomas Schuldt, president of FMAC’s diversified finance group. FMAC and other franchise finance companies have had plenty of money to lend in recent years as institutional investors eagerly sought shares of their securitized loans.

Sydran Services, the eighth-largest U.S. restaurant franchisee, tapped more than one franchise finance company when it decided to look outside of the Burger King chain, in which it owns 224 restaurants, for growth.

Schoenberg, who got his start running the food service operations at his college, evaluated many concepts before deciding on Chili’s Bar & Grill, a casual dining chain. His company, which expects to post about $300 million in revenue this year, has opened 29 Chili’s to date.

“We had a large amount of capital . . . and when we did the Chili’s deal there may not have been the amount of opportunity we wanted in the Burger King system, so we sought elsewhere,” Schoenberg said.

Schoenberg is an example of the business-savvy entrepreneurs heading many of the mega-franchisee companies. After a stint with a national food service company, he worked as a real estate developer and then for a Miami investor before launching Sydran in 1992. Along the way he earned an MBA from New York University.

Schoenberg said he gets an average of one pitch letter each week from different franchisers who hope he’ll sign on as a franchisee. But he is cautious about diversifying too far, too fast.

“Nobody has unlimited resources and I’m not talking money, I’m talking people,” Schoenberg said. “While the business principles are the same, [the chains] all have their individual nuances and they all require their own individual attention.”

Gray, of Arby franchisee RTM, agreed but noted that diversification is key to long-term growth for his company.

“Arby’s is the goose that laid the golden egg,” Gray said. “But if we are going to be a billion-dollar company by 2001 and $2 billion by 2020, then we’ve got to have other brands.”

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Cyndia Zwahlen can be reached by e-mail at [email protected].