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Why restaurant brands refranchise

Restaurant chains can’t seem to sell enough locations to franchisees. A major chain has announced a new refranchising plan nearly every month since last fall.

In September, TGI Friday’s launched a refranchising plan to sell most of its 247 locations to franchisees. In November, Famous Dave’s said it planned to refranchise company outlets. Jamba Juice did, too, and then it added more stores to the sale shelves in December.

This week, a year after completing a strategy to sell more than 400 restaurants to franchisees, Wendy’s announced plans to sell 500 more company units to operators. Earlier today, Yum Brands said it would step up refranchising efforts in China with a goal of getting franchisee ownership there to 10 percent of the system in three years.

As anybody who reads this publication knows by now, refranchising is nothing new. Chains have been doing it for years. And they will continue to do so as long as investors push management teams to unlock “shareholder value” and acquiring private equity groups look for easy strategies to improve profitability.

Still, it’s worth reminding why restaurant chains opt to refranchise in the first place.

It’s more profitable. It’s more profitable for a company to sell the right to operate a brand than it is to sell food to diners.

The franchising business has lower capital requirements than a restaurant operator. It doesn’t have to worry about fluctuations in food costs. It is insulated some by the recessionary swings in sales.

A good example comes from Burger King. In the first quarter of 2014, the Miami-based burger chain saw its revenues decline by 26.5 percent. But adjusted EBITDA, or earnings before interest, taxes, depreciation and amortization, actually rose 10.1 percent over the same period a year earlier. The reason: Burger King sold the vast majority of its restaurants to franchisees that previous year.

Franchisees are better operators. Plenty of evidence suggests that franchisees improve the operations of stores they take over from franchisors. While franchisors have divided responsibilities, and often concentrate more on running the franchise business, franchisees concentrate on operating profitable locations.

It’s not uncommon to hear franchisees talk about having to do a lot of work to get acquired locations up to standard. For instance, Carrols Restaurant Group bought 278 units from Burger King in 2012. In the second quarter of 2013, the company improved profits at those locations by more than 400 basis points in a single quarter after implementing its changes.

There is some debate about this, to be sure. Plenty of franchisors are pretty good at operating restaurants and a few, such as Chili’s, have resisted the refranchising trend. 

And, a number of operationally strong and growing concepts like Buffalo Wild Wings and Panera Bread are actually buying out franchisees.

But in situations where legacy brands are primarily franchised, the stores that get sold are often put in the hands of better operators.

It helps with remodels. Many legacy chains are in need of remodeling at the moment, and some of those remodel projects are costly. For a brand like, say, Burger King, all those costly remodels can add up.

When a brand owns many of its locations, it then has to pay the bill for the remodels. By refranchising stores, brands put the responsibility of remodeling locations into the hands of franchisees.

While this might not be a primary reason brands refranchise stores, it’s certainly a side benefit. Wendy’s required franchisees buying company-owned stores to remodel locations. So did Burger King when it refranchised locations. These requirements speed those remodel programs along and provide examples for other franchisees.

Investor pressure. A number of franchise brands have historically held onto a certain percentage of locations for company ownership in part to show franchisees that they have skin in the game.

But these policies have crumbled over the years under the weight of investor pressure to sell more locations, while those investors cite the above reasons we just mentioned. Famous Dave’s has activist investors on its board. Jamba Juice was targeted by activists when it announced its refranchising (and has since put two on its board). The chairman of Wendy’s is Nelson Peltz, himself an activist.

And, we might add, Darden Restaurants’ activist investor, Starboard Value, mentioned franchising as a potential plan to improve the value of that business. And then investors placed all 12 of Starboard’s nominees onto the Darden board.

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