So Here's The Thing: Spring Cleaning Part 1

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Okay, friends, welcome to this week’s edition of So Here’s the Thing with my friend, Jack Monson. Hey. We’re here this week to talk to you about all things spring cleaning. Spring is in the air, we are officially now in March. And the topic is things that we need to spring clean in the restaurant and franchise industry.

Yeah, the alternative topic for this episode was, pick up on aisle seven, because there’s just so much junk.

Clean up on aisle seven, clean up on aisle seven. That’s what we say every time my son spills something.

Yeah, and it’s true, the floor is messy in the restaurant and franchise business right now. There’s just a lot of junk, a lot of things spilled. And it feels like a lot of things are getting piled on to other things without clearing out the first things, right? And I know we’re going to talk a lot about AI and AI apps and the problems that people just keep buying more services and buying more software and buying more apps and using more stuff on top of the stuff. So that’s why we wanted to talk a little cleaning today.

It’s time for our Spring Cleaning Episode Part 1. This is definitely going to be a two-parter, right? Okay.

Yeah, at least.

At least. Okay. So number one thing that I think we need to clean up our act on is a franchisee focus. And I say this on the heels of absolute, terrible store level profitability now for two years straight. And this is even after surviving COVID, right? And so I think we have gotten away to your point. I think so much has been heaped on brands at a brand level. There’s been too much to deal with. Marketing is just probably the best example, but not to go into that now, that the focus on the unit level profitability, what is good for our operating partners, i.e. our franchisees, and what can we do to support them right now? Where are the breaks we can cut? What are the initiatives we can work on? Where can we listen to them and hear their feedback? I am always going to be a proponent of a franchise, the first kind of approach to growth. However, it really makes me sad to see that the last few years, we’ve had very few brands that I can point to who have done a very good job of this.

Yeah, I think with a few exceptions, that’s something that almost every big restaurant brand has just fallen apart on. And now we’re seeing the consequences. It feels like half of the big brands out there are closing stores, and then there’s a whole other group that another franchisee is buying up everybody else, right? That happened twice this week with Freddy’s and Sonic, and I think there was a third one too, where a franchisee is buying up like 75 locations. And I think that’s a good thing, because it’s obviously someone who knows how to make money at the local level. So maybe those stores will all perform well, and the business will grow and everything. So that’s good, but boy, we look at some other examples. Papa John’s, Pizza Hut. You see a trend here where it’s like, okay, we’re gonna close 300 stores. 300 stores. I mean, that’s a lot.

Okay. So yes, but let me give the corollary. So there has not, in my opinion, been enough of a pruning back of store count on some of these big brands since before COVID. And what you would have thought would have been store closures related to COVID, I think got delayed because of many different factors, like support from the brand maybe, you know, for the franchisers who were doing it right, right? Federal or state relief, right? I think that there’s essentially what’s going on right now is the market has shifted, consumer demand has shifted, and whether it’s the franchisor getting rid of or divesting or refranchising company stores or closing them and turning them into franchises is always an option. But if they’re not performing, they just need to go. And then you’ve got these franchisees who have a mixed portfolio that on a histogram probably has some outlier great performers and some lower performers, but that bottom quartile is sinking the ship. And so their option is to close those units or sell the whole package is distressed. And so I think we’re seeing a couple of things here. One is franchise selling to other franchisees is never a bad thing, in my opinion. It’s better to sell it to a current operator than to some random person you don’t know, or to close them, or sell them even sometimes to a corporate’s parent. Like it’s not a good play.

Like I said, sell them to someone who knows how to operate.

What they’re doing, yes. But I’m not seeing a ton of deals where it’s like, oh, that operator just really screwed that up. I’m seeing these deals where they are a phenomenal operator. They’ve always been in the top 10 percent, but the portfolio weight has gotten kind of messed up, or changes in the demographic have happened, or maybe their market got more heavily pushed towards delivery and they’re just not set up for that with their real estate portfolio. So it’s the unfortunate pruning that needs to happen as a consequence of a lot of compressed changes in the industry, whether it’s around people, operations, unit level economics, doesn’t matter. So yeah.

And maybe it’s late pruning, right? Like I talked about Papa John’s closing 300 stores, and you can’t tell me that those 300 have been performing well for the past couple of years, right? I don’t think they suddenly just dropped off in December of last year. They probably should have done some pruning a year ago, two years ago, three years ago, but they didn’t.

Yeah. Well, from a corporate parent perspective, not a good look in the last two years.

And that’s why they didn’t do it right.

Absolutely compressed profitability in the bottom line is severely impacted. The last thing they want to be doing is shutting store count. When let’s be honest, that’s what private equity looks for. Like big owners look for things like store count, look for year over year growth or at least flat on total revenue, which most of these brands can do in their sleep, right? Just with population growth. I hate that I’m saying that, but it’s true, right? Like, so you can sit on duds in your portfolio for a given amount of time. But I think we’re starting to see that correction now. So we’re seeing it in, as you mentioned, franchisees buying other franchisees. We’re seeing corporate store divestments where the company stores that have been part of the crown jewel are now like dead weight, and they’re trying to flip them into franchises so that a franchisee can then take the reins, operate them more effectively, or trim them and take the hit, right? So I think all of this, to circle back to the point, is you need to have some kind of recalibration in the market, of what locations are working and which ones aren’t, and that’s what we’re seeing right now. We’re just seeing it kind of creatively because the deals are just responding to what the market is available, right? Like, what’s available in the market is not a lot of private, like private equity, not a lot of lending, right? And so as a result, I think we’re getting these kind of creative backroom deals that may be cashless, that may be equity swaps and may be franchisees joining together. And I think we’ll see more of that this year.

Absolutely. Yeah, there’s going to be way more of that. I’m going to take a sidebar. What you’re feeling on on a big franchise system that still has a ton of company owned stores. Are you a fan of that? Not a fan of that?

Not a fan. I think there’s a point in the company’s trajectory of growth where it does not make sense to be an operator anymore because the ROI from an investor point of view is better on the franchise royalty for that unit than on the cash flow at the bottom. And so that’s that parent child thing.

I know my kid could do it better than me.

Like well, if you’ve raised them right, the answer is yes. Exactly.

That’s a great analogy. Yeah.

If you are a good franchise or then there should be better return for you in those units as franchise as opposed to company. Now, there is an argument for having a certain amount of core company stores for R&D, for testing, for control of a certain core market. But most importantly, for that cash flow that then funds the SG&A or the overhead of the parent co. Now, when the franchise system gets big enough, then the royalty should in theory cover almost all of that overhead. But it takes a significant number of units to get there. And I’m talking like 100, 200 or more. It obviously depends on the concept. But most people don’t think through that. But you need to cover a $5 million expense on running a corporate parent. You need a lot of royalty rate to cover that. A lot.

I had this conversation last week at the International Franchise Association. I had the opportunity to interview Ricky Richardson, who’s the CEO of one of my favorite concepts, Eggs Up Grill. I love this concept. Great food, great position. And they have over 100 stores. They have one corporate owned store. And I said, oh, so you have a laboratory. And he’s like, exactly. They are in the franchise business. They are not in the eggs business. And I love that thought of, like you said, setting those stores up to succeed and let them succeed.

There should be no difference. Like if you are that good at running a system that you developed and you have perfected it in your company stores and they are the gold standard, then there should be no problem re-franchising.

Yeah. Too many brands have like, you know, 10 corporate stores and I call them 10 distractions from their main business. So I know-

That is so inefficient. I think that might be my most like biggest pet peeve is like either have a significant number of company stores that materially produce that need a team to run them and have them geographically concentrated or have one. Like don’t sit in this in between of like five to 15 company stores. Like do one or do 20 to 30 and make it count, right?

Yeah. I’ll drop another name. The late great Fred DeLuca of Subway Fame once said, are you in the sandwich business or are you in the franchising business? Pick one, you know, and I love that. I know we’re way off track here from our spring cleaning.

We’ll get back to it.

We’ll get back to it. No, this is good. I know you wanted to talk about labor and workforce as well.

Well, I’m going to, yeah, I just want to quickly touch on this and we can expand on it next time. Okay. Tagging in to the franchisee first kind of resetting our orientation to what is it going to take for someone to want to buy this franchise to be profitable in it and want to keep growing with us. And really digging down into the unit level economics and not just giving it lip service. Like, yeah, we’re going to shave a few points off here on supply chain and put it back to your profit. No, I’m talking about a revision of labor schedules and labor modeling, a revision of menu engineering and pricing that goes with it and giving those tools to the franchisees and investing in core technologies, you know, training, etc. And a reboot of how those main contributors to profitability are being addressed in the system capital S. So do not think at this point that your franchisees are going to have the sophistication tools, resources and research needed to reboot that themselves, nor are they permitted to in the case of some labor models. Right. That’s what you’re there for, right? Exactly. That’s the franchisor’s job. So I want everyone to take away from this, that if you are going to go franchisee first and re-center on your franchisees, it’s no longer about marketing dollars. This is about how to reset the system for success in today’s environment. And on that note, I think that there is a need for reinvestment in how we franchise these things, right? Like what the unit level economics look like under actual pressure. There is our timer. We’re totally at time.

Okay, we’re at time. All right, let’s pick up on this on part two, which will be next week right here. Thanks so much. We will talk to you all soon.

Thanks, guys.