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Inflationary costs tend to better benefit franchised brands that charge royalties.

Why franchising is expected to grow in 2023

Inflated costs tend to benefit brands charging royalties and one expert expects an uptick in franchising this year accordingly

In inflationary environments such as the one we’re currently navigating, franchising becomes a particularly attractive business model. For companies, it means they’re using someone else’s capital and collecting revenue from the topline.

“Inflated costs tend to benefit brands charging royalties,” said Kevin Maher, partner at Baker & McKenzie LLP. Maher leads the firm’s international commercial practice group and works with several major restaurant brands. Because of the current macroeconomic picture, he predicts a continued uptick in franchising in 2023 and is basing that forecast on what most of his clients are saying. Others share this observation: According to a recent survey from FranConnect, about 50% of franchisors say they anticipate double-digit increases in franchise sales in 2023.

This could very likely lead to a big-getting-bigger scenario and in the past few years, we’ve witnessed this trend manifest as restaurant companies and their franchisees work to bolster their rosters and better insulate themselves amid various crises.

“We have ginormous franchisees now and I don’t see that trend going away,” Maher said. “It’s attractive to not have all of those (locations) on the balance sheet – just positioning yourself as a brand company versus a restaurant company. We saw some of that after the previous downturn, where companies sold off company units to be franchised units. All that comes off your balance sheet. You don’t have the upside of profit potential, but you have the guaranteed royalty stream. In these markets, those with a stronger balance sheet will do well and find an opportunity in a down cycle.”

That’s certainly not the only opportunity, of course. The bigger the operator, the more benefits of scale come into play. Maher also believes this will lead to more vertical integration opportunities across the industry – specifically supply chain vertical integration. Starbucks uses a vertically integrated supply chain, for instance. So does McDonald’s.

“The pandemic made restaurant companies realize vulnerabilities they have in their supply chains, and I think vertical integration is where bigger brands will continue their focus,” Maher said. “How can brands continue to acquire within verticals to be able to control supply issues and de-risk? Not having that control over signature items is top-of-mind in the c-suite and we’ll see more strategic acquisitions to get more control.”

Those acquisitions are likely to extend to technology as well. We’ve seen this from Yum Brands, Chipotle, McDonald’s, and others, and are likely to see more, Maher predicts.

“Acquiring tech startups so their tech stack isn’t owned by a third party that might get tied up or acquired by a competitor will be a bigger focus,” he said. “Being able to bring technologies in house has become more attractive for competitive advantages and data and we’ll see bigger players looking more at this.”

What about the little guys?

As franchisees get bigger and scale more effectively and perhaps flex some acquisition muscle, where does that leave the smaller players? Maher believes there is a big opportunity for them as well, as pent-up demand remains strong for dining out. But Peter Cadigan, consumer products partner and senior analyst at RSM U.S., adds they also have to start operating with a tech-and-data-focused mindset to survive.

“There are going to be some struggles ahead. The smaller restaurants may have a tough time because they don’t have scale and they don’t have customer data. Repeat customer usage will be one of the only ways for growth ahead and they need data to drive that,” Cadigan said. “They have to learn what their customers want so they don’t lose them. They have to get creative.”

Getting creative means adopting strategic partnerships, he said, gathering data in a variety of ways (surveys, social media, etc.), and investing in repeat customers versus new customer acquisition. Also, as consumer budgets are expected to tighten up, it will be critical for those smaller concepts to make sure they execute against a simple, high-quality menu and that they offer a consistent digital experience despite a return to dine-in.

“If you’re just trying to cut costs, that could hurt because the consumer has become really sophisticated. Consumer expectations of quality have really gone up,” Maher said. “At the same time, it’s important to lean into digital because it is going to continue to be huge. If you don’t have an easy way to order, you’ll lose business with huge segments.”

Contact Alicia Kelso at [email protected]

TAGS: Finance
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