So Here's The Thing: Finding $1.5 Trillion

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Hey friends, welcome to this week’s edition. So here’s the thing with my friend, Jack Monson.

So here’s the thing, where did we leave off last time?

Last time we were talking about the $1.5 trillion number that’s attached to the industry for this year. And I was asking the question, where the heck is this half a trillion dollars in growth coming from?

Yeah.

I’d love to know. And I think that one of the things I’ve been stewing on, is this was truly an open question for both of us when we asked it last time. And there’s been some really interesting comments, by the way. I don’t know if you saw those. But I think it’s actually coming from a lot of professional operators via franchisee consolidation. So here’s my thesis. Now understand everybody, these numbers are, I love validating with numbers. I’m a numbers geek, but instinctively I think this is true. I would love it if people have numbers to back this, because it’s hard to see how many franchisee deals are actually happening right now. When we talk about M&A in the restaurant industry, it’s usually at the brand level, unless it’s a huge franchise operator. I think that when times are golden, and the sales work, and we don’t need to worry too much about tuning our unit level economics, we can sell franchises very easily to anybody. That’s the idea, right? You can come in as an entrepreneur and have a guided experience where you are learning from people who know how to run this concept, and they’ve stamped it out so many times, they know how it works.

They’re selling them one by one by one.

To individual operators, what I lovingly call the onesies twosies, right? I’ll never forget, there was this moment when I was over legal and franchise administration at Focus, and there was this moment where one of our brands actually drew a line in the sand and said, we will not sell those anymore. We’re only selling three and five packs or above. And I remember, I was fairly new to the industry at the time. And I’m like, that seems kind of silly. Like, why would you turn away, like a good like mom and pop operator? Well, here’s why. Because when times get tough, if you are only diversified across one to three units, you are hovering like right at break even. Your efficiencies in running those are from you. And when you scale above that, you’ve got to build a team to run it. And that costs money. And there are just certain points at where you achieve leverage on that SG&A or that spend on overhead, right? Let’s, you know, administrative, accounting, HR issues, what have you, are usually the big three. When times are tough and revenue is depressed or profitability is under attack, as we are seeing now. I think those smaller operators have no choice, but to either ride it out and live on that razor margin of profit or sell and roll up to larger franchisees. And that’s what we’ve been seeing, the overall economic state of profitability in the restaurants, not the industry as a whole, because we’re still going up into the right.

Profitability of individual units.

Yes.

So the joke right now is good news, bad news. Good news, we sold 15 units. Bad news, we sold to 15 franchisees.

Exactly.

Right?

Exactly.

The real good news where we all want to be is, we sold 15 units to two franchisees, seven and eight, or whatever the numbers are, right? Like that’s where I think you’re getting to, that part of that 1.5 trillion is going to be these people who own dozens of units who are really good at running restaurants, and even better, really good at making money. That’s where the other 1.5 trillion is going to come from.

Well, and they can write it out. They can be partners with the brands, collaborate with the brand at that level, and still invest in the growth and stability of the brand, but they can ride out because why? They have a portfolio of stores where one or two might be on Razor’s Edge, but on the whole, they’re still doing average. And they know that if they can, on the whole, just do average and cover that spend at the top to run these units and to effectively just ride this out until it gets to sort of better economics, you can work with the brand on that, et cetera, et cetera. There’s so many more levers you can pull at scale than you can at an individual level. The stress on an individual operator is just 10 out of 10. It’s 12 out of 10.

And I love those individual operators. Don’t get me wrong.

Right, of course.

It’s the great American story, but the reality is the growth of this industry is not coming from some of the stories that we tell about whomever who came from wherever and fought his way into this country and started as a dishwasher, and now he bought the pizza shop that he started in. That’s a great story, but that doesn’t get us to 1.5 trillion. What does is when that same guy, because this has happened, also owns 95 other locations by the time he’s whatever age. So that’s, I think, where we’re getting.

And there’s another reason those operators, as we’re seeing the sort of emergence of sophisticated Mufos are now Mumbos, multi-brand, multi-unit operators.

And multi-sector. That’s the other thing.

Multi-state.

Like how many franchisees of restaurant brands are exclusively doing restaurants right now? Right. You know, you’ve got people who are suddenly involved in things like, you know, the tire industry or health and wellness.

Home services. Home services are so hot right now. Having a moment.

If you know how to run a business, you know how to run a business. So being diversified into all of these other sectors, you know, there’s nothing better than that right now.

So agreed. I mean, I think that’s the investment perspective as well. Look, this is not a knock on franchising as a system, but rather just me saying, I think that the growth for this year and arguably for most of last year has been around these mumbos around 100% since COVID, not even this year and last year, but let’s say in the past six years, that makes me wonder, what’s this going to look like five years from now?

Will there be any individual owner-operators within franchise systems? I say no. All it’s going to take is one more disaster, one more big crisis, and a lot of those onesy twosies, as you call them, could get wiped out. But the people who own, whether it’s an individual or a small corporation or a family office or whomever, the people who own 150 units, they’re going to get through the next crisis. And the crisis after that and the one after that. So yeah, I think that’s just where the landscape is taking us right now.

I’m going to wrap this topic with some things that I’ve observed as a strategic advisor in this space and things that you can be doing to facilitate this kind of growth in your system. Number one, is as a franchise where you cannot have your head in the sand about resales, you have to drive that bus. I have seen brands that do it exceptionally well. They have an organized portal. If the brand is selling units, corporate franchise, brand new opportunities, they go into a portal where the current franchisees can see them, because that’s a best case scenario. You transfer units between your current subset of franchisees who are available for growth. I think that’s one. Number two, have your deal team be incentivized appropriately on resales. You would not believe how many times I see this. Like your sales team is out there banging out new units. They should be just as equally excited about resales. Figure it out. Just figure it out.

And we can move our other topic to next week if you want, because I do have some questions for you on this. What are your thoughts on your development team also doing the resales versus having a completely separate team or process for doing resales? Because I’ve seen examples of both recently, and I’d love to get your thoughts.

I think you can’t have one without the other. So I think as a best practice, I would always recommend that you have someone else quarterbacking the resales. There’s a number of reasons for that, but you create tension if they don’t have alignment with people who are selling new units. And I think that is one of the reasons why I think you should have someone, if you have a significant number of resale opportunities, let’s just say that, there should be someone who you put in charge of quarterbacking that because it’s like listing a house. Like if you list it and it’s listed too long or listed inappropriately or at the wrong price, like there’s an art and science to resales and valuation and the levers you can pull as a franchise or to incentivize those resales to going through, whether it’s royalty abatement, marketing fund abatement, remodel schedules, whatever. That’s a very different type of deal structure, but you don’t want to disincentivize your new unit sales team by taking a prospect and pushing them that way when the best play is a blend of the both together.

The best play for that prospect might have been a resale, not pushing them into what was better for the salesperson.

Exactly. You don’t want them choosing which pipeline to put them in. They should come in as a prospect, be shown the resale opportunities and the incentives that are offered with them, and also given incentives to develop new units. So an example would be prospect comes in, you vet them, you clear them for a territory, and you say, hey, look, we’ve got these three units. You can build off that and look at what we can do to help you. Start with these three, and then we’ll give you territory rights at a discount. We’ll give you, right? So this is where the art of the deal really comes in. And I will scream this from the mountaintops. You will incentivize and get exactly the behavior you want. But if you have maligned incentives or incentives that have an accidental consequence, watch out. Because some of the most successful people that I have seen in our industry financially, and just in terms of numbers and return and growing businesses, are Frans Ailes, you know?

Yeah. And I love what you said about having part of that process where it’s all transparent to the current franchisees and maybe even, you know, they’ve got first dibs, for lack of a better term, on some of these new resales that are popping up. Because to me, it’s also a bit of a pressure test. If your franchisees aren’t gobbling up the resales, or at least interested in it, there’s a problem. You know, you’re not gonna validate very well if your current franchisees don’t wanna grab those resales that are coming up, especially if they’re in, you know, an adjacent territory or something like that. If those guys aren’t buying those, there’s definitely a problem. So I love that from a validation standpoint that if your franchisees are first in line, things are going well, and they’re doing well.

That’s a good point, but I will also tell you, I think there’s less of an appetite for sometimes the one-off deals, right? Like, and it takes a bit of vision to go in and see how you can put together a resale package that works for you and your current territory, footprint, portfolio, et cetera. And so there are reasons, let me just say this, that resales may sit dormant for a minute that have nothing to do with whether or not it’s a good deal. There are so many, can I just say this? I know this is like a third point I want to make. There are so many incredible deals out there right now. If you are an investor with cash who understands turnaround and operations, like if you just do a 360 around you and you’re willing to get your hands a little dirty and absorb that risk because you have confidence in your ability to turn around, it’s a veritable like smorgasbord out there for you. Just take your pick. I think I’m seeing a lot of that right now too, a lot.

Are you seeing groups come in and gobbling up all of the resales from a brand, or are they being more strategic or should I say surgical, and getting a couple here and a couple there and like that, or are they sort of putting it all together to try to get more from one brand?

I think most of the deals I’m seeing, the sophisticated operators are saying, I want X number of brands in my portfolio. These are the day part segments and types of things I’m going after, and they’re knocking on the door of the franchisor and saying, I’m interested, like I’m a prospect.

Yeah.

What do you have? What do you got, right? And I think these deals are not necessarily always publicly listed. They’re traded in kind of who you know, in kind of back rooms, and sometimes that’s the way it should be done. It’s not appropriate to have them publicly listed, especially like example, like company store units, you’re flipping to franchise or what have you. There’s reasons that you wouldn’t necessarily be bold about, you know, your intention to flip units to franchise or to sell. And they could have things to do with corporate structure that have nothing to do with market conditions, right? They’re just shifting in a different direction. They have different like big brand strategies that have nothing to do with the health of the offering itself, you know?

So we’ve got to wrap now, but let’s make a note to put a pin in it, as we like to say.

I want to talk about FDDs next time.

We want to talk about FDDs. And I do want to get into some more discussion on using AI to find those great opportunities. So I will see you in one week, my friend.

Bye, friends.