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The Problems Franchisees Face with Conglomerate Franchisors

Posted by: Nick Leiber on July 24, 2009

BusinessWeek’s SmallBiz team is introducing two new guest bloggers today. Don Sniegowski, who wrote the post below, is the founding editor of the daily franchise news site BlueMauMau. (Watch this video for his explanation for the unusual name.) He will be blogging about developments that impact franchise buyers and veteran franchise owner-operators. Our other new guest blogger is attorney Jonathan I. Ezor, who will be blogging about Internet business law. Check out his post from earlier today.

donsniegowski.jpgFranchise conglomerates accumulate franchising chains for all sorts of reasons and in many ways. Conglomerates that own multiple franchise systems and brands, may buy various brands within their own niche, such as when restaurant franchisor Raving Brands adds other eatery brands.

Conglomerates may also have diversified franchise systems, such as troubled NexCen Brands, which oversees varied retailing chains from The Athlete’s Foot to Maggie Moo’s ice cream shops. But in 2008, before the fall of the Dow and the economy, conglomerate franchising firms were increasingly making the news–like the announcement of insolvency issues at NexCen, the bankruptcy of Metromedia Restaurant Group (parent to Bennigan’s and Ponderosa Steakhouse brands), and even the acquisition of Wendy’s by Triarc.

Some experts have warned that small business investors should be wary of buying franchises in conglomerate franchising firms. Why? In a world where businesses sharply compete, think of the old maxim, “Jack of all trades, master of none.” Consider my previous post:

Darren Tristano, executive vice president for Technomic Inc., a restaurant and vendor consultancy and research firm that tracks the 500 largest restaurant chains, thinks there has been a surge of franchise conglomerates over the past few years. Tristano states, “If you go back about 10 years, there was a trend by the major chains to really go after different non-competitive brands within their portfolio. This occurred within full service and limited service [restaurant brands].”

Tristano says that franchisors saw having multiple brands as a benefit to franchisees. “If you look at McDonald’s, they acquired Boston Market, Donato’s Pizza and Chipotle. What they were trying to do,” he continues, “was give their franchisees an opportunity to own other restaurants within their area without being competitive with the McDonald’s brand.”

But where conglomerates were once buying companies, they are now trimming down.

Bruce Schaeffer is president of Franchise Valuations Ltd. His activities in providing valuations, expert testimony and opinions about the “fair price” of franchise companies have put him in a position to follow the finance, accounting and tax aspects of franchising and the economy for 30 years. He observes, “the small boom in franchise conglomerate mergers and acquisition of franchise brands became a bust in 2008.”

“All of the low-hanging fruit of good deals in available franchise opportunities was picked two to four years ago because the cheap money financing of 2006 and 2007 is but a memory, gone with the wind,” Schaeffer declares.

Technomic’s Tristano also thinks the future of these franchise conglomerates is shifting away from multi-brands. He observes, “Over the course of time, we’ve seen Wendy’s move in that direction with Tim Horton’s, Baha Fresh, Café Express, Pasta Bravo. But nothing has really come about and they have divested from that.”

“Take a look at a Kahala, Raving Brands or even Yum!,” Tristano says. “Yum! has indicated that they are going to move away from their co-branding. They want to strengthen their brand without being the dual- or tri-branded units.”

Scott Haner, vice president of franchise development for Yum! Brands, affirms this: “It is true that we do not have as many [brand] combinations as in the past. We have found the ones that work best with our customers and we are aggressively expanding them.”

Other conglomerates are also trimming down on the number of brands that they carry while trying to focus on what works.

“When you look at Raving Brands, they had a great concept to stay within fast casual and offer lots of different things,” says Tristano. “They’ve since sold off Mama Fu’s. They’ve sold Moe’s. They are now working on smaller concepts. So they’ve gone from a company that wanted to achieve a billion dollars in sales to a company that creates brands and sells them. Franchisors can make money doing that. But they’ve shifted.”

With the fall of the economy, will franchise owner-operators see more conglomerates selling off their brands to be more focused and competitive? That is to be expected.

When funding was abundant and cheap, franchise conglomerates grew large by funding acquisitions and growth through debt. But what happens when the heavy debt load must now be paid off and these firms cannot easily roll over their debt in today’s harsh economic environment? Although not exactly a conglomerate, Dunkin Brands, holding company to Dunkin’ Donuts and Baskin Robbins ice cream shops, has such a heavy debt-load problem. The New York Post this morning reports that the next year is key to seeing if Dunkin’ can pay off its colossal debt that comes due in the next two years.

Dunkin’ Donuts, bought in an expensive leveraged buyout in 2006, borrowed $1.5 billion through a market securitization handled by Lehman Brothers that was designed to push expansion far beyond its base in the Northeast. The debt comes due in 2011. Dunkin’ can extend repayment up to two years if it meets certain thresholds, including a set number of new-store openings. At the end of 2008, Dunkin’ Donuts had 8,835 franchised stores, and while Dunkin’ continues to tout its planned expansion, the private-equity owners have told their investors that they are breaking even on the investment since they bought it three years ago.

If there is a local entrepreneur thinking that changing branded franchise chains in a conglomerate’s portfolio is something for Wall Street and won’t affect their day-to-day Main Street shop investment, they should think again. In a franchise system, a franchisor has huge discretion over the franchise operations. The new franchisor can make a difference in not only the strategic direction of all units in the chain but also in the daily operational requirements and profitability of a franchised shop. Of course, in the worst case scenario, think of the chaos that Bennigan’s franchise owners faced when it was suddenly announced that their franchisor would cease to exist. Hint: Local customers assumed that their neighborhood franchises had also shuttered their doors. And suppliers to the franchises stopped shipping supplies to them.

But that’s a meaty discussion that should be tabled for another day.

Don Sniegowski is the founder and editor of Blue MauMau, a daily business news site for franchise buyers and owner-operators. Previously, he led global field operations and franchise development for a quick-print franchising firm. Sniegowski also helped lead global publishing efforts for trade publisher Global Sources Media and led Asia-Pacific retail and operations for Franklin Covey.

Reader Comments

Ray Borradale

July 27, 2009 2:18 PM

One concern for franchisees to a conglomerate when their particular brand is sold off is that they are not afforded the opportunity to perform any level of due diligence on the incoming franchisor. Even if they were it would have no influence on the transfer.

While we have seen new franchisors enhance the performance of a network to the benefit of all parties there are numerous examples where exactly the opposite has occurred.

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What's it like to run your own company today? Entrepreneurs face multiple hurdles new and old, from raising capital and managing employees to keeping up with technology and competing in a global marketplace. In this blog, the Small Business channel's John Tozzi and Nick Leiber discuss the news, trends, and ideas that matter to small business owners. Follow them on Twitter @newentrepreneur.

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