Global Economics

Subway Franchisees Unhappy in Germany


Struggling to keep their businesses afloat, the sandwich chain's German franchise owners blame high fees and the indiscriminate sale of licenses

The US sandwich chain Subway has ambitious plans for expansion in Germany. But its German franchise owners are unhappy with their side of the bargain. Many are struggling to keep their businesses afloat.

Sonja Birkel thought she knew exactly what she was getting into. After all, she and her partner David Mauk had spent years working as district managers for McDonald's -- a position that gave them ample opportunity to familiarize themselves with all the tricks of the fast food trade.

Birkel and Mauk thought they could use their know-how to start their own business -- as franchisees for Subway, the US sandwich chain. Full of hope, they scraped together their savings, took out a loan for €184,000 ($243,000) and opened a new fast food outlet in the town of Michelfeld in the German state of Baden-Württemberg.

In the beginning, everything went better than they could possibly have hoped. The Subway system, which allows customers to select their own bread and fillings for their sandwich, was a big hit with customers. The two new entrepreneurs made as much as €16,000 a week.

But after three months, turnover began to decline, eventually averaging out at about €6,000 a week. What with the costs of rent, electricity, personnel, interest and advertising, combined with high prices for tuna, chicken and bread and the fees charged by Subway, in the end nothing was left over for Birkel and Mauk.

"We didn't earn a single cent even though we ourselves often stood behind the counter for as long as 12 hours a day," Birkel complains.

After 15 months, bankruptcy was unavoidable -- and the restaurant in Michelfeld was sold for just €20,000. "We lost everything we had spent years working for," Birkel concludes bleakly.

Is their story just an unfortunate one-off, a regrettable accident in Subway's global kingdom? Apparently not -- at least not in Germany, where 295 licensees are now running 418 restaurants with a total annual turnover of €106 million ($140 million). "A conservative estimate would be that 30 percent of the Subway franchisees in Germany are just scraping by at the subsistence level," says Bernd Fassbender, president of the Franchisee Association Germany (DNFV).

"Frustration among the franchisees is growing day by day," says a restaurant owner in the Rhineland. Their discontent has developed to the point where many of his colleagues are refusing to pay the contractually fixed fees to the company headquarters. Others are preparing a class action suit against Subway.

Even Marco Wild, Subway's top representative in Germany, admits there are problems. "Our profitability isn't yet where it should be," he says.

And yet most franchisees were full of enthusiasm when they started out in what is still a booming economic sector -- the franchise business. Germany already has about 870 systems whereby people who want to set up their own business can use a tried-and-tested brand and business model in exchange for a monthly fee. Generally speaking, franchisees are responsible for how business is conducted in their branch, while the franchisor takes care of advertising, book-keeping and supplies.

DISAPPOINTING PROFITS

Subway is considered an especially attractive brand, since getting started as a franchisee doesn't require a large investment -- unlike, for example, McDonald's franchisees, who have to provide at least €500,000 of their own capital.

And so the sandwich kingdom -- founded by Frederick DeLuca with a single sandwich stand in Bridgeport, Connecticut in 1965 -- is expanding rapidly. During the past 10 years alone, the number of Subway outlets has more than doubled. Over 27,000 fast food restaurants already bear the yellow and green logo worldwide and boast a combined annual turnover of about €10 billion.

DeLuca and his colleagues have ambitious plans for Germany, which got its first ever Subway outlet in 1999, in Berlin. They want 1,500 Subway restaurants to open there by 2010 -- which would mean Subway replacing its arch-rival McDonald's as the number one fast food chain in Germany, just as it has already done in the United States.

But the 16 so-called development agents (DAs) responsible for advancing DeLuca's sandwich offensive in various regions of Germany are having difficulties meeting the target that has been set for them. Turnover isn't rising as quickly as the number of restaurants, and expansion has even halted in some places. In the city of Aachen, for example, only two of the orginal four Subway restaurants are still in business.

Inside sources indicate that DeLuca's original goal has been postponed, so that the plan is now for 1,500 Subway restaurants in Germany by 2011, one year later than originally intended. The local franchisees' complaints are getting louder, and the word has begun to spread among would-be entrepreneurs that a Subway license can easily turn out to be a one-way ticket to downward social mobility.

Subway's management found out just how strong the discontent among its franchisees is in Leipzig last November, at the group's first national meeting in Germany. A respected institute for market research presented the results of an extensive objective survey of Subway's franchisees. "The result was devastating," says Sven Romberg, who runs several Subway restaurants in the Ruhr region. "It was like a slap in the face."

The franchisees' objections begin with the English-language franchise contract, which makes a New York City court responsible for arbitration in cases of litigation. On a day-to-day level, the lack of territorial protection for franchisees is more annoying. The DAs are not paid a salary. Instead, they profit from the sale of licenses and receive a percentage of the monthly franchise fees -- regardless of whether the franchisee makes a profit or a loss. The system puts the DAs under strong pressure to constantly open new outlets -- and they apparently do so without any strategic rhyme or reason. "It's pure cannibalism," one franchisee complains.

The selection procedure for new franchisees is also controversial. Unlike McDonalds, where new franchisees go through a one-and-a-half-year training program, the DAs hand out licenses after a two-week course. They are happy to give them "to anyone who can read and write," complains Romberg, who is also the chairman of the National Franchisee Board Germany (NFBG), an association founded by German Subway franchisees to represent their interests.

HUNGRY FOR HELP

New franchisees have to pay an initial fee of $10,000 for the right to use the Subway franchise. Subway then pockets 8 percent of their gross turnover, with an additional 4.5 percent going to the company for advertising costs. The fees paid to the sandwich chain are higher than those paid in other systems, raising questions among store owners. "Many Subway franchisees are asking themselves what they get in return for the fees," says Fassbender.

And eight years after the company first ventured into the German market, there is still no proper Subway headquarters in Germany to provide franchisees with advice, practical help, analysis and information. Subway representative Marco Wild employs just seven people in his office in Cologne.

Issues of quality control are only being tackled now, following massive pressure from the ranks of the franchisees, with some suppliers being changed. Last year, several Subway restaurants repeatedly received meat that had been found to be of inferior quality by public testing institutes. One report by the Oldenburg Food Institute stated that, "This kind of product cannot be classified as 'ham.'"

"Subway has to invest more money in its company structure in order to boost its expansion," insists Romberg. But that's precisely the problem. DeLuca isn't willing to spend much money on his ambitious plans. He wants Subway's expansion to be financed almost exclusively by the franchisees.

The national groups even have to painstakingly pool their money to finance their advertising campaigns. It took several years before they had enough funds to pay for television ads. Now the time has finally come: Some €6 million will go into the first German TV ad campaign in mid-April, which will last 14 weeks. "That will provide a massive boost," says Wild confidently.


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