WHAT'S NEW?
by Callum Floyd

What’s happening in the franchise world and where’s it all headed? As per usual the menu includes growth, and that’s exciting. Stimulatating too is the emergence of previously non-franchised sectors, interesting acquisitions and alliances, and new multi-unit franchisees. But today’s environment also provides many challenges. Some markets are changing rapidly, competition intensifies in many sectors, technology continues to proffer new opportunities and threats, and disputes continue to emerge. Chain management gets tougher.

Changing Markets
Yesterdays successful product/service offering and marketing campaign won’t necessarily work today, as many leading franchise systems have found. Perhaps nowhere is that exemplified more clearly than the fast-food sector where a need for change has been driven by three key trends.

The first is the threat of lawsuits. So far two high profile US lawsuits have been waged at the fast food industry’s tallest poppy, McDonalds Corp – claiming they didn’t warn customers its food could be fattening. All have so far been thrown out, and the United States’ GOP controlled house voted to ban class action suits blaming fast food. But industry insiders are concerned that should any future suits be successful many chains would be bankrupted and leading economies could be dramatically effected (the US fast food sector employs almost 12 million people). Many chains have made fundamental changes in order reduce their exposure, including changing menus dramatically, improving nutritional disclosure, and promoting healthier lifestyles in their advertisements.

The second is a consumer led trend toward healthier lifestyles. Despite the recent legal attention most leading fast food chains had already begun responding to a general change in customer tastes, based on a desire to lead healthier lifestyles. No operation has perhaps responded to this challenge as strongly as McDonald’s. McDonald’s introduced fruit, a huge range of salads, wraps and other low fat options to their menu. Encouragingly, this strategy was credited with increasing sales in a number of markets, not least Australia – which bounced back from a loss to post a healthy profit last year. Thus, the move to a healthier menu can be a profitable one. Other chains have also followed suit. Wendy's tested milk and fruit with its Kids Meals, and Burger King introduced low-fat baguette styled chicken sandwiches. Applebee’s introduced a Weight Watchers menu in all its restaurants throughout the US. Sandwich chains, such as Subway, are clearly capitalising on the trend toward more healthy living. The chain has surpassed McDonalds’s for the number of restaurants in the United States. Interestingly, Subway are reported to have said the health benefits of eating Subway sandwiches are one reason for its growth.

Fad or not, Dr Atkin’s and related low carbohydrate, high protein diets provide the third trend influencing the fast food sector. Demand for low-carb products is strong, and that demand, has had a twofold affect on the franchise community. First, restaurants, and fast food operators, have rushed low-carb options onto their menus. In the US, Subway recently introduced two low-carb wrap sandwiches. Burger King joined the train by offering bunless Whopper hamburgers, and, Hardee’s and Carl’s Jr feature burgers wrapped in lettuce. The big challenge for most chains is wrestling with what to offer as a low-carb substitute to the existing product range.

Chains featuring products and items difficult to adapt to low carb diet have found going particularly tough. In an example the fast growing US donut sensation, Krispy Kreme, was forced to downgrade their profit forecasts. And blame was levelled directly at the low-carb craze. Scott Livengood, CEO of Krispy Kreme stated:

“Our current guidance assumes a continuation of the low-carb phenomenon that is affecting the industry. Needless to say, we are disappointed that external forces have caused us to revise our first quarter and fiscal 2005 earnings guidance.”

The second low-carb effect on the franchise community comes in the form of whole new franchised concepts (explained next)

New Franchise Concepts
Franchising’s growth throughout the world has been amazing. And perhaps one of the most startlingly features, is the rate at which new industries continue to adopt the franchised organisational form. New franchise concepts are appearing all the time. The low-carb craze noted above has spurned a new class of franchise. Indeed, increased demand not only pulled low-carb products onto restaurant menus and supermarket shelves, it also spurned whole new specialty retail concepts that now offer franchise opportunities. Examples include McSlim’s Low Carb Market, TLC (Totally Low Carb) Stores and Cactus Low Carb Superstore.

The development of the Internet has also led to the establishment of many franchised concepts. The latest concept piggybacks eBay (www.ebay.com), the Internet auction phenomenon. The concepts are termed drop-off stores. Customers simply stop by the store to drop off items they want to sell, and the stores take care of the rest, including photographing items, writing descriptive copy, and listing the items on eBay. They also hold the inventory, answer any questions, process payments, and arrangement shipments to successful bidders. Four companies so far offering eBay drop-off franchise opportunities include iSold It, QuikDrop, e-Powersellers and AuctionDrop. Others such as AuctionWagon are bound to follow. Perhaps we’ll see an NZ version for www.trademe.co.nz!

Globally, there is also an increased prevalence of mobile service based franchise concepts. Indeed, while location-based retailers and restaurants were largely responsible for franchising’s early growth and popularity, it is the service-based sectors that are showing real growth in new concepts.

The mobile service-based sector is attractive to potential franchisees because of the relatively low set-up costs and on-going overheads. Examples of existing service-based business types include lawn mowing, gardening, home and commercial cleaning, home maintenance, painting, mortgage broking and PC repairs, child development, personal training, business services and consultancy, mortgage broking and car detailing. But there are many others, and continued growth is inevitable. Many non-franchised business continue to investigate and adopt the franchised organisational form.

The Effect of Increased Competition
While franchising continues to enter new industries, many sectors are not so new to the arrangement – and, in fact, exhibit increasingly high levels of competition. One example again includes the fast food sector, where some companies have been operating since the 1950’s and 60’s. Another example includes mobile and/or home-based service type businesses, where low-set up costs and minimal barriers to entry provide fertile ground for new competitors. Increased density in the lawn mowing and cleaning sectors illustrate this point. The Franchise New Zealand directory, alone, lists eight franchise offering lawn mowing and 12 offering cleaning franchises.

Nothing focuses attention on operations like intense rivalry. Intense rivalry pressures price, market share and profit margins. In response to increased competitive activity, smart franchisors differentiate themselves from the competition, and focus on unit-level productivity and profitability.

· Differentiation
Smart companies are seeking to differentiate themselves from competitors in order to create a point of difference, build closer [and more meaningful] relationships with existing and potential customers, and build barriers to entry.

Numerous examples are evident in the highly competitive fast food sector. McDonald’s recent initiatives include promoting a greater quality in a further attempt to differentiate itself from others. Interestingly, the emphasis on quality monitoring has reputedly led more US franchisees to leave the system in the past twelve months than had exited in the previous five years. The quest for quality is obviously a serious one.

McDonald’s also sought to distinguish itself by introducing a range of healthy products and the new “I’m Lovin’ it” jingle. In the US, McDonald’s health focus involves new Go Active Happy Meals for adults that include salad, bottled water, a pedometer and advice to walk more. Other health initiatives include new low-fat dressing, more salads, and more nutritional information. So far the healthy initiatives have stood have stood the company in good stead.

McDonald’s has also worked hard changing and testing a new image before rolling it out throughout the group. For example, McDonald’s publicly available revitalization plan explained how experiences in New Zealand and France proved a fresh, sophisticated environment could generate increases in sales and profits.

In another revitalization attempt, Burger King reportedly has a pipeline of 30 new products now being explored.

McDonald’s and other chains, like Starbucks and Schlotzky’s have also sought to differentiate themselves by rolling out Wifi access (wireless Internet service) in many restaurants. In another technical couched effort Papa John’s, a US pizza giant, launched a “Pizza and Entertainment” promotion that provides customers with a perishable DVD movie (DVD’s become inactive 48 hours after removal from packaging) free with pizza.

· Producitivity and Profitability
A number of global chains have been battling with profitability, including Burger King, Marks & Spencers and Papa Johns. For Papa Johns, in the US, a depressed pizza market, record cheese prices, expensive petrol, heated competition and soaring insurance costs have all sliced into profits – which they can ill-afford given the difficulties and debt exposure faced by some of their franchisees.

But not surprisingly, it is again McDonald’s who is spearheading changes relating to productivity and profitability. McDonald’s is working with suppliers to identify potential production and sourcing efficiencies. They are also expanding testing and use of labour saving equipment, and streamlining processes. For example, many of their US restaurants are changing from standard beverage dispensing machines to automated ones that drop and fill the right-size drink cups as sales are keyed into registers. Other McDonald’s examples include use of new machines to automatically filter and change cooking oil, thereby freeing labor, and, self-order kiosks.

7-Eleven, the global convenience store chain, is also seeking to improve both unit productivity and improvement through standardization. Specifically, 7-Eleven is seeking to obtain economies of scale in purchasing and marketing by requiring store owners to order 85 percent of 7-Eleven recommended products.

In another example, Blockbuster Inc, the video rental company, is seeking savings to reduce supply costs by establishing a centralised procurement division. The procurement function will allow the company to consolidate purchasing of equipment, office supplies and other products, and centralise distribution and shipping of US bound items.

Starbucks recently tested removing their trademark comfortable seating in some UK cafés ina an attempt to increase throughput and turnover.

Clearly, no holds are barred in the current environment. When it comes to seeking performance improvements, the most minor features, tasks and processes offer potential for efficiencies and cost savings.

Technology
Franchised chains also face challenges through advancements in technology. Advancing hardware, software, networking, connectivity and transmission capabilities continue to offer new opportunities, and threats to franchisors and their networks of franchisees and company-owned operations.

New Internet and email advancements have provided an added and effective new medium for internal communication, as well as an important marketing opportunity. On the flipside, however, the Internet has also spawned new competitors, like Amazon.com the Internet retailer, to compete with many retail and service-based bricks and mortar operations - often with lower overheads. Other technological advancements, like automated stock management systems, customer relationship management tools, global positioning systems and digital closed circuit television variously provide franchised operations with opportunities for improved efficiencies, security, and increased revenues - but also require effort and expertise for successful implementation throughout franchised chains.

Acquisitions, Alliances & Co-Branding
A range of co-operative activity dots the franchise landscape, globally and locally. Two separate donut chains have recently landed co-operative deals with discount retail giant Wal-Mart. Krispy Kreme’s enables them to sell doughnuts at selected Wal-Mart store. Dunkin’ Donuts’, by comparison, sees them implementing actual stores within Wal-Mart stores. In another store-within-store deal, Cosi Inc (fashionable sandwich chain) stores are to be located and tested in 10 Macy’s department stores. If the test is successful, Cosi Inc could be rolled out into more than 250 Macy’s stores. From Macy’s perspective, it is hoped that hungry customers will eat at Cosi Inc then continue shopping – rather than exiting to eat in a mall food court.

The aforementioned alliances involved different but complimentary concepts, were it is expected both will generate sales for the other. Some other new alliances by contrast involve both similar companies and concepts. In one startling inter company example, Back Yard Burgers entered an agreement with Yum! Brands. The agreement granted Yum! the right to its trademarks for establishing and operating up to 10 multi-brand outlets involving Taco Bell, Pizza Hut and/or KFC. In all, nine outlets were established partnering Back Yard Burgers and Taco Bell under the one roof. The alliance was not successful and further inter company co-branded outlets will not be established.

But both Yum! and Allied Domecq continue, however, with intra-company co-branding strategies involving their own respective brands. Yum! controls KFC, Pizza Hut, Taco Bell, Long John Silver's and A&W All-American Food Restaurants, while Allied Domecq controls Dunkin’ Donuts, Baskin-Robbins and Togo’s stores. Both restaurant groups apparently expect to generate rapid growth by offering two brands and more choice in one restaurant.

A number of high-profile acquisitions have also occurred recently. Last year Yum! added the Pasta Bravo chain to it’s stable, after successfully testing the concept in a multi-brand format with Pizza Hut.

Wendy’s was also on the expansion-by-acquisition trail earlier this year, after gaining a majority holding in Café Express. Wendy’s has been expanding its restaurant portfolio for sometime. Other chains in Wendy’s group include Tim Hortons and Baja Fresh Mexican Grill. Wendy’s has also secured a minority stake in Pasta Pomodoro, a small chain of California-based Italian restaurants.

Last month Blockbuster video acquired Rhino Video Games to expand the video rental chain’s presence in the growing console games and games trading market. Clearly, Blockbuster is looking to alternative concepts for continued growth. The US purchase of Rhino followed the acquisition of Gamestation in the United Kingdom.

Multi-Unit Franchising
Some research studies note an increased prevalence of multi-unit franchising in aging franchise systems, and countries – as their franchising experience grows. At an anecdotal level, this is certainly evident in New Zealand, with more experienced franchisees from mature companies taking over under performing neighbours and/or purchasing rights to additional territories.

In the US, particularly in the Quick Service Restaurant (QSR) sector, multi-unit forms such as sequential franchising (which involves single-unit franchisees gaining rights to a second and then sometimes further units based on performance) and area development (where rights to multiple units is granted from the outset) are becoming especially prevalent. These forms are adopted, increasingly, to facilitate more rapid development and reduce the number of individual franchisees. Oftentimes, scale economies are also achievable and beneficial at the franchisee level – particularly when certain concepts (e.g., restaurants) are densely located.

Interestingly, advertisements in the US frequently require prospective franchisees to show the financial and managerial capacity to establish at least 3-5 units, but sometimes whole or even multiple states. And recently, certain desirable franchise concepts, like Krispy Kreme (the donut sensation), demand franchisees provide evidence of expanding another concept within the area. Moreover, they want proof new franchisees have done it before.

A final multi-unit trend involves the increased prevalence of multi-concept, multi-unit franchisees. From a franchisee’s perspective this provides advantages such as risk diversification, and more growth than would otherwise be achievable involving a single concept in one concentrated geographic area.

When Disputes Occur
Franchising is no stranger to disagreements, due to natural tension surrounding the interdependent franchisor-franchisee relationship. But sometimes disputes escalate and erupt to levels that damage brands.

Two recent high profile franchisor-franchisee disputes involve the global convenience store retailer, 7-Eleven, and, the global parcel freight giant UPS (United Parcel Service).

7-Eleven encountered stiff opposition from franchisees (including being sued a coalition of certain franchisees) when they attempted to introduce the minimum purchase requirement (intended for reducing purchasing and marketing costs). The agreement has been in negotiation with franchisees for the last two years. Key franchisee concerns include reducing freedom in placing orders, and generally reducing franchisee decision–making ability. Most franchisees have now signed up to the initiative. But a large group of franchisees have not, and are not expected to signup until September.

The second high profile dispute followed the UPS (United Parcel Service) company’s 2001 acquisition of Mail Boxes Etc, the provider of office supplies and business services to consumers and small businesses, in 2001. Last year UPS convinced 90% of Mail Boxes Etc franchisees to rebrand and adopt a revised ‘UPS Store’ format. From the remainder, a national alliance of around 200 franchisees filed lawsuits against the Mail Boxes Etc franchisor and UPS, claiming use of high pressure tactics and questionable sales tactics relating to the rebranding process. The rebel franchisee group also claims the revised format is not suited to many locations.

In another example, International Dairy Queen (IDQ) gained high profile resistance for their DQ Grill & Chill concept, introduced about two years ago. A group of franchise owners protested publicly, claiming the initiative requires more investment than some rural and small town Dairy Queen franchise owners can afford.

Growth and New Markets
Many franchise systems continue to grow and/or seek growth at an alarming rate. Some franchise systems are remarkable in that they have many times more units in development than they do in actual existence. In one such US example, HCX Salons, has 40 hair salons established, but 225 in development. In another, Camille’s Sidewalk Café, has 32 established, but more than 500 in development.

Regarding this country, Harcourt’s, New Zealand’s largest real estate chain, is growing rapidly in Australia. Meanwhile, Subway, the global sandwich chain is growing rapidly throughout New Zealand. One wonders when Subway will surpass McDonald’s in unit numbers here, like it did in the US.

While many chains are seeking growth domestically or familiar overseas markets, an increasing number of chains are seeking growth in less traditional markets. Notable examples include the culturally dissimilar markets like the Middle East, and parts of Asia – like China.

A number of companies are looking for strong growth in Middle Eastern countries. Wellknown franchises, including The Athlete’s Foot, Subway, Baskin Robbins, Benetton, Hertz and Domino’s Pizza are all expanding rapidly in the region. New Zealand’s own Pumpkin Patch also recently signed agreements to open stores in the area.

Many big names are also entering, or have entered, China – all no doubt attempting to tap the country’s population of 1.3 billion, and growing middle class that could top 200 million by 2009.

But while the long-term rewards for China expansion are appealing, operating can be extraordinarily difficult. Imitation is rife and defending trademarks can be challenging. Starbucks is currently suing a rival Shanghai chain whose name in Chinese is almost identical to its own. And many other chains fear prospective franchisees will copy their systems and formats.

While chains like KFC (1000+ Chinese outlets) and McDonald’s forge ahead in China, some are pulling back. Notably, Blockbuster Inc is exiting Hong Kong, which it had intended to be a launching point for China. Plans for growth in China have also been abandoned due to high levels of video, DVD and CD piracy and bootlegging.

To the Future
The ‘only constant is change’ adage continues to prevail in the sphere of franchising. Adaptation today, more than ever, is absolutely vital.

Tasks associated with franchise system management continue to increase in complexity. A combined inward/outward focus is clearly requisite to successful management. It is vital to understand what makes your operations tick. And it is equally important to understand your environment, and the threats and opportunities it provides. Franchise strategists will continue to have more options to evaluate and at least some will require specialist skills.

The requirement for adaptation will also only increase. What worked yesterday mightn’t today, and a legendary history and name like McDonald’s simply won’t be enough to get you through.

In certain sectors some quite radical reinvention may be necessary. And as illustrated above, this later point can provide particular challenge to chain managers. Especially since the franchise concept, for all its virtues, is not well suited to rapid and fundamental changes in direction which are not well communicated to and understood by franchisees.

This article first appeared in Franchise New Zealand Magazine

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