The chips are down for Chipotle, but not for long

February 11, 2016

by Todd Wasserman

In 2013, Chipotle released a haunting animated video featuring a scarecrow that observes the horrors of automated farming. Set to Fiona Apple’s rendition of “Pure Imagination,” the ad went on to win CAA Marketing a Grand Prix at Cannes the following year.

Before the Cannes judges weighed in, though, Funny or Die did with a damning parody changing the tune to “Pure Manipulation” and offering a cynical analysis of Chipotle’s marketing. “We can say what we want. In our world of pure imagination,” went the lyrics. “Just pretend we’re your friends. It’s what we want you to believe.”

Funny or Die’s blistering critique did little to hurt Chipotle’s appeal. Instead, several incidents of food-borne illnesses over the past few months have exposed the chasm between the chain’s brand promise and the realities of running a large-scale restaurant operation. It’s safe to say, at least, that Chipotle won’t be trumpeting its “food with integrity” mantra for a while or criticizing rivals for their factory farming practices.

Because of its healthy financials and sheer size — the company’s market cap is around $14 billion — few expect Chipotle to go the way of Chi-Chi’s, another Mexican chain that closed its doors in 2004 after it unknowingly perpetuated a hepatitis A outbreak that killed four people.

That prognosis for Chipotle, however, assumes that the worst of the crisis is over. Going forward, Chipotle will source more of its food from major suppliers, mooting a prime differentiator from other fast-food chains. The company is also planning to launch a new branding and PR campaign to woo back its Millennial base. Already, a burrito giveaway designed to appease customers after the chain closed its doors briefly Monday for companywide safety meeting has overshadowed concerns about food-borne illnesses, at least on social media. (Reps from Chipotle and agency GSD&M could not be reached for comment.)  Experts predict that Chipotle will likely end up in the clear.

The damage so far
Almost 500 people have gotten sick from Chipotle food since last June, 20 of whom were ill enough to be hospitalized. One such customer, Chris Collins of Portland, Ore., experienced bloody stools and excruciating pain after ingesting E. coli 026 from one of Chipotle’s chicken bowls. At one point, his doctors feared kidney failure. Though that never came to pass, Collins was still weak and “emotionally shaky” in December, according to a cover story in Bloomberg Businessweek.

Such stories have hurt Chipotle’s bottom line and brand image. In early February, the chain said sales at established restaurants fell by a third in January. That news followed a 15% drop in the fourth quarter of 2015. At this writing, the company’s stock price was down about 42% from its 52-week high.

On the brand side, Chipotle’s image has gone from positive to negative. YouGov’s BrandIndex, which surveys 5,000 consumers online every day, rates brands on a buzz score that ranges from -100 to +100, with zero being a neutral position. For most of 2015, Chipotle’s buzz score was around +10, but in January, that sunk to -29 and was at -27 at this writing.

“Chipotle has been playing catch up on this crisis from the start,” says Ted Marzilli, CEO of BrandIndex. “The brand was slow to respond to the initial incident. [It has] just not been able to get out ahead of this crisis, and fairly or unfairly, is paying the price in both public perception and decreased sales.”

The six-month rule
Despite the challenges though, few people see this as a fatal blow to the chain. In a research note to clients, Wells Fargo analyst Jeff Farmer cited previous incidents of food-borne illnesses at other national chains to demonstrate same-store sale declines can be cut in half six months after the incidents occur (assuming that there are no more incidents). Farmer added that same-store sales of such affected companies can also rise 12-15 months after the incident.

In an interview with Campaign, Darren Tristano, president of Technomic, food industry consultancy, cited the same rule. “Our research indicates that in six months, most consumers forget about these food-poisoning issues that come up,” he said.

The Blue Bell Effect
In Chipotle’s case, that’s a pretty safe bet. Jonathan Bernstein, a crisis PR expert, says that Chipotle has built up so much good will with its branding efforts that it can withstand this major PR setback. He compared Chipotle to Blue Bell, the ice cream brand that is so beloved by its fans that many were able to overlook a recent outbreak of listeria linked to the brand.

“Customers’ loyalty to a brand can make a huge difference in overcoming even food illness-related crises and people really stuck with Blue Bell a long time after many would have done the same — given a choice of other ice creams,” he said. “With Chipotle, they created such good will before these problems that although that’s been eroded, it’s not terminal at this point.”

Rebeca Arbona, executive director at Interbrand, unconsciously echoing Funny or Die’s critique, noted that brand loyalty is based on a relationship that mimics real friendship. “You have many impressions and interactions,” she said. “That works in your brain like knowing a person. If you know a person really well and you like them, you’re going to forgive them a lot.” Arbona said that she was surprised, for instance, that Toyota not only weathered its 2009-2010 slew of recalls — issues that were linked to the deaths of some consumers — but has nearly doubled its brand value since then.

That said, Tristano said that it’s likely that some customers will never return to Chipotle. Most will though. “Younger customers will return,” he said. “They tend to be more trusting and more brand loyal. If we look at this, it is clearly a setback for a brand that has had nothing but success in the industry.” The fact that this happened to a brand whose credo is “food with integrity” is ironic, Tristano said, but won’t prompt the masses to label it hypocritical.

Fixing the brand
As Marzilli noted, Chipotle didn’t deal with the crisis effectively at first. Though the company closed 43 restaurants in the Northwest after the E. coli outbreak that affected Chris Collins became public, some 234 customers and employees contracted norovirus at a Simi Valley, Calif., location in August. That same month, some 64 people in Minnesota fell ill from salmonella-tainted tomatoes.

It wasn’t until Dec. 10 that Chipotle CEO and founder Steve Ells appeared on the “Today” show to apologize to customers who had gotten sick from eating at the chain. On the operations side, Chipotle hiredMansour Samadpour, head of IEH Laboratories & Consulting Group in Seattle, to overhaul the company’s food safety efforts. Among the changes: More food will be prepared at commissaries, rather than on site, undercutting Chipotle’s “food with integrity” mantra since often the food won’t be local and fresh. Food will also be given high-resolution DNA-based tests, a measure that will weed out smaller suppliers who can’t afford that expense. On the PR side, Arbona said closing all the stores for a few hours was a good move. “It was a symbolic act,” she said. “They were hitting reset.”

Allen Adamson, a branding consultant, said that Chipotle will have to ditch its previous brand communication, which struck a lighthearted tone and presented a somewhat holier-than-thou image related to food quality. “You want to see the CEO on screen talking about what they’re doing, not an actor saying ‘Trust us,’ ” Adamson said.

Bernstein said Chipotle should focus on transparency, training its personnel in the new food safety protocol and setting realistic expectations “that they’ll do their best to prevent illness, but particularly with norovirus, it’s not always possible.”

What might be fatal, aside from more outbreaks, is any communication that smacks of arrogance. As we’ve seen in recent years, consumers will overlook safety issues, even ones that result in deaths, as long as the company doesn’t talk down to them. As a counter example, Arthur Andersen, the financial consultant, was drummed out of existence after it got caught up in the Enron scandal in 2002. While that was a huge blow, execs at the company exacerbated the damage by behaving arrogantly during a Justice Department grilling. “They got tried in the court of public opinion,” Bernstein said.

Chipotle is unlikely to make the same mistake. “Ultimately it comes down to humility,” Bernstein said. “If they can express sufficient humility, people will forgive them.”


The Problem That’s Tearing Restaurants Apart

September 4, 2015

2015-09-02_1259Roberto A. Ferdman,
Copyright 2015, South Florida Sun-Sentinel. All Rights Reserved.

All across the country, restaurants are struggling to fill their kitchens. It’s happening on the East Coast in New York City and in the Midwest in Chicago; it’s happening out West, too, in Los Angeles, San Francisco and Seattle. Good cooks, who were once in excess supply, are suddenly a lot tougher to find.

The truth is that despite what is shown on the Food Network or other cooking shows, being a cook is grueling work that’s not for the faint of heart. The slowdown in immigration over the past five years has also made it harder for kitchens to find staff because the industry is deeply reliant on immigrant labor.

But there’s another problem that’s been bubbling up for decades: Many of the people who work the kitchen have been getting shortchanged — especially when compared to the wait staff serving customers.

“The back-of-house staff are typically underpaid compared to the front of the house,” said Darren Tristano, executive vice president of Technomic, a restaurant industry research firm. “It’s a really big issue.”

On paper at least, cooks in this country are paid more than waiters. The median pay for cooks is about $10 an hour, according to the Bureau of Labor Statistics. For waiters, it’s roughly $9 an hour. But those numbers don’t tell the whole story — because waiters are paid tips and kitchen workers are not. And tips completely skew the comparison.

The government’s estimate for how much waiters make includes a bit of guesswork about how much they earn from tips, since tips are often paid in cash, and things paid in cash tend to slip through the cracks. The Atlantic wrote about the issue earlier this year: “The IRS estimates that as much as 40 percent of tips go unreported. It’s hard to track for an obvious reason: Everyone likes giving and getting tips in cash. Nationally this adds up to as much as $11 billion in unreported (and untaxed) income.”

Waiters, in other words, are probably making a lot more money than Bureau of Labor Statistics data make it seem. PayScale, which tracks salaries through crowdsourcing, estimates that in cities like Miami, Boston and San Francisco, waiters can expect to make $13 an hour in tips alone, on average. Elsewhere, tips can add well over $10 an hour to servers’ salaries.

Waiters working in big cities understand this. But so do cooks, and they aren’t happy about it.

“The fact that servers are making so much money in tips is certainly a reference point that causes cooks to be dissatisfied with their pay,” said Michael Lynn, a Cornell University professor and one of the country’s foremost experts on tipping. “That is absolutely true. It’s the way it is.”

Waiters aren’t paid like everyone else. Unlike cooks, who are subject to the federal minimum wage, servers are instead compensated based on the assumption that they are going to earn some extra money on the side.

Restaurants are required to pay their wait staff what is known as the tipped-minimum wage, which is $2.13 per hour.

The understanding is that tips will make up for the difference between the tipped and regular pay floor. But even when the tips don’t make up that difference, waiters still make no less than the federal minimum wage because restaurants are legally required to pay the rest.

The truth, however, is that that rarely happens. The average base pay for waiters is $4.90, according to PayScale. What they make in tips is earned on top of that, and tips alone more often than not amount to a good deal more than the $7.25 federal minimum wage.

“It can be a very high-paying job,” said Tristano. “Especially considering that many entry-level cooks earn at or near the minimum wage.”

Kitchen workers aren’t allowed to share tips. Early on, it was common practice for restaurateurs to pool together tips and then split them among their entire staff. It was also common for tips to disappear en route to the employees, likely into the pockets of management.

Realizing the need for regulation, the government intervened, creating a set of rules known as the Fair Labor Standards Act, which stipulates, among other things, that, if tips are pooled, they can only be distributed among workers who “customarily and regularly receive tips.”

Cooks do not qualify. Neither do dishwashers or janitors.

“You can force a waiter to share a tip with a busboy or bartender but not with someone in the kitchen staff,” said Lynn. “It’s illegal to split tips with the cooks.”

Part of the reason for the measure was to ensure that there was no room for defrauding the public. If people think they’re tipping the waiter but aren’t, there’s a lack of transparency. But mostly, Lynn said, it was a hasty response to the outgrowth of firms plucking tips away from servers.

“It was a less than optimal solution,” he said. “It was patchwork. The problem is that it doesn’t really benefit the people working the back of house.”

Tristano agrees. “It’s not working for cooks,” he said. “It’s not working for them at all, and that’s never really been addressed.”

The number of chefs and restaurateurs who are concerned about the current system is growing. Last year, a panel that included celebrity chef Michael Chiarello and Shake Shack founder Danny Meyer discussed how the tipping system is creating pay inequality within restaurants. In 2013, New York Times restaurant critic Pete Wells wrote a passionate takedown of tipping.

“The restaurant business can be seen as a class struggle between the groomed, pressed, articulate charmers working in the dining room and the blistered, stained and profane grunts in the kitchen,” Wells wrote.

Many restaurants have responded by breaking from the traditional tipping system. Some have gotten rid of tips altogether. For instance, Sushi Yasuda in New York City added this note to its credit card slip a couple years ago: “Sushi Yasuda’s service staff are fully compensated by their salary. Therefore gratuities are not accepted.” Many others have simply added a flat service charge.

Dunkin’ Donuts Slams New York Regulators Over Wage Increase

July 28, 2015


Juliana LabiancaFreeman Klopott

Dunkin’ Brands Group Inc., the owner of Dunkin’ Donuts, upbraided New York regulators over a plan to boost fast-food wages to $15 an hour, a move the company said could lead to price increases.

A wage board formed by Governor Andrew Cuomo arrived at the decision without involvement from the restaurant industry, Dunkin’ Chief Executive Officer Nigel Travis said on a conference call Thursday.

“We’re deeply disappointed that the governor chose to skirt the legislative process by appointing a wage board, which did not even include a representative from our industry,” he said. “Our franchisees, and in fact other company’s franchisees, were denied the chance to fairly express their concerns.”

The board recommended on Wednesday that the minimum wage for fast-food workers be raised to $15 by 2018 in New York City and three years later in the rest of the state. Cuomo has indicated that his labor commissioner, who has final say, will follow the board’s advice, though adjustments may be possible. The increase, which will be phased in annually, applies to fast-food chains with 30 or more locations.

Dunkin’ is contemplating ways to adjust to the pay increase, Travis said. One option is boosting prices, he said.

Unfair Attention?

Travis complained that the fast-food industry was singled out by regulators, a concern echoed by McDonald’s Corp. Chief Financial Officer Kevin Ozan during a conference call Thursday. McDonald’s wants minimum-wage increases to “deal with all industries similarly,” he said. Ozan didn’t discuss New York City’s wage hike specifically.

Picking on fast food alone will put those businesses at a competitive disadvantage, said Randy Mastro, an attorney hired by a group of New York franchisees. The proposal, he said, targets business owners who are “already struggling to survive on low margins and cannot afford this 66 percent increase in labor costs for their entry-level workers.”

Restaurant companies have come under increasing pressure to boost pay over the past year. Large chains have a corporate social responsibility to pay a fair wage, said Darren Tristano, executive vice president at research firm Technomic Inc.

“If you’re a chain, it may feel like you’re being targeted, that it’s making it harder to be successful,” he said. “But it’s the right thing to do.”

In response to Dunkin’ complaints, Cuomo spokeswoman Dani Lever referred to comments the governor made at a rally in New York City. At the event, he said higher wages are needed for workers to live a decent life.

“You cannot live and support a family on $18,000 a year in the state of New York,” Cuomo said. “That’s why we have to raise the minimum wage.”

Immigrants to Get Wage Boost from Job Mobility Under Obama Plan

December 10, 2014

Copyright 2014 Daily HeraldiVfER3CaVAIA

President Barack Obama’s decision to lift the economic ceiling on almost half the nation’s 11.4 million undocumented immigrants will give those workers a chance at higher pay and better jobs.

That means it will also raise costs for businesses that rely on off-the-books labor.

Dishwashers will become waiters, and day laborers will move to full-time work on farms, forcing employers to pay higher wages for new workers. A 1986 immigration law covering 2 million people pushed up pay by 15 percent in the first six years for those workers.

Those are some of the effects of the president’s plan to protect about 5 million people from deportation.

“We’re going to see these people do better in the job market,” said Sherrie Kossoudji, an associate professor at the University of Michigan in Ann Arbor. “They’re going to be more mobile.”

On the higher end of the economic scale, workers with specialized technical expertise will have more freedom to change employers. And their spouses — often highly skilled themselves — will be allowed to work, too.

The consequences for the broader economy will be slight. The order has the potential to boost U.S. output by between 0.4 percent and 0.9 percent over the next 10 years, according to a report from the White House Council of Economic Advisers.

In contrast, the sweeping, bipartisan immigration legislation passed by the U.S. Senate last year would raise the gross domestic product by 3.3 percent by 2023, according to the Congressional Budget Office. That bill failed to advance in the Republican-controlled House.

Wage Pressures

Obama’s plan, which he outlined this week, will defer for three years the deportation of those who came to the country as children, as well as the parents of children who are citizens or legal permanent residents.

As a result of the order, the agricultural industry, which relies heavily on immigrant labor, could face rising wage pressures. Once workers are documented, they won’t stay in seasonal work for long, said Baldemar Velasquez, president and founder of the Farm Labor Organizing Committee of the AFL-CIO.

“How are you going to replace the people you’re losing?” Velasquez said. “Farmers will still be looking for workers to harvest their short-term crops.”

Restaurant Workers

An estimated 18 percent of undocumented workers — about 1.5 million — are employed in low-paying restaurant and hospitality jobs, according to the Migration Policy Institute, a Washington-based research group. Another 1.3 million work in construction and 723,000 in retail.

For restaurants, Obama’s action will make it easier for those employing undocumented workers to follow the law, said Darren Tristano, an analyst at Technomic Inc., a research firm in Chicago.

“It will help the operators who are not compliant, who are running the risk of being closed or fined,” Tristano said. “It should take some of the complexity and pressure out of a business that is hugely labor oriented.”

One of the smaller groups aided by Obama’s directive may see the biggest gains: Some 40,000 foreign students who earn graduate degrees to get jobs in technology industries will be allowed to work in the U.S. for up to 29 months.

These students, who have degrees in science, technology, engineering and math, would have a significant effect on productivity and innovation, said Giovanni Peri, an economist at the University of California at Davis.

“It involves few people, but very crucial people,” said Peri, whose research shows that undocumented labor complements, rather than competes with, U.S. workers. “Those workers will go beyond the effect of matching the right person to the right job and increasing efficiency. They’ll create innovation.”

Good Start

For employers, the steps are a good start toward addressing the shortage of skilled workers, said Emily Lam, vice president of federal issues for the Silicon Valley Leadership Group, a San Jose, California, trade association. Still, the effect is limited because it’s only a temporary fix, she said.

Another large impact might result from a provision that expands opportunities for skilled immigrants and their spouses. Workers with specialized technical expertise would have more freedom to change employers. Their spouses would also be allowed to work.

Settled Debate

While Obama’s order has sparked a clash with Republicans over its legality, the economic debate over easing immigration laws is largely settled: Decades of research shows the economy benefits from greater worker mobility.

The 1986 amnesty law signed by President Ronald Reagan raised wages and boosted the economy. Almost 2 million undocumented immigrants living in the U.S. were given legal status, as were about a million seasonal workers.

By 1992, real hourly wages for those workers had risen an average of 15.1 percent as they moved out of low-status, low- paying jobs, according to a Department of Labor survey. Wages continued to rise, according to a 2012 study by the Economic Policy Institute in Washington, even as the nation entered a recession that lasted from July 1990 to March 1991.

Obama’s plan is even less controversial from an economic viewpoint because it mostly applies to people already working in the U.S. For them, the move brings opportunity.

“It’s quite a small effect in the aggregate,” Peri said. “There’s no harm done to the American worker and a big gain for the immigrants who can take these opportunities. That’s the big picture.”

Cumbersome Process

Peri was one of those immigrants, moving to the U.S. from Italy to study in 1993. He earned a doctorate degree and landed an H-1B visa, which are set aside for highly skilled people. The system made it almost impossible for him to get his green card granting permission to live and work in the U.S.

“It was so long and cumbersome I had to marry an American,” he said with a laugh. Now he’s a citizen raising three children. “I’ve invested in the U.S.”

For undocumented workers, moving up the economic ladder can be difficult, if not impossible. The economy creates and destroys millions of jobs a month, and that churn is one key to raising wages. Companies hired more than 5 million employees in September, according to Labor Department data, and almost 2.8 million people voluntarily quit their jobs, the most since April 2008.

The threat of deportation typically discourages workers from switching jobs, even within an off-the-books economy. Many don’t consider more visible jobs with their current employers to reduce the risk of detection, cutting off the easiest route to better wages, Kossoudji said.

With the danger of deportation at least temporarily lifted, “it releases them from having to be in the back of the restaurant,” she said.

Starbucks Petition Urges Lawmakers to Wake Up, End Shutdown

October 25, 2013

Screen-Shot-2013-10-11-at-10.03.31-AMStarbucks on Friday kicked off a petition drive to mobilize its customers and other businesses in hopes of ending the federal government shutdown.

“Please join us in doing what you—and your companies—can to give the American people the voice they currently lack, and are desperately crying out for,” Starbucks CEO Howard Schultz wrote in a letter posted on the company’s website. “And in the process, you can help to restore faith and trust in our government through your civil words and deeds.”

By mid-morning Friday, more than 200,000 people had signed on, Schultz said during an appearance on CNBC’s “Squawk on the Street.”

Within the past 48 hours, Schultz has spoken with more than half of the CEOs of companies listed on the Dow 30, he said. They all were consistently disgusted with the situation, he added.

“I’m saying enough is enough,” Schultz said.

The petition comes as Americans’ frustration with Washington politicians is high. A new NBC News/Wall Street Journal poll found that 60 percent of Americans would opt to throw out every member of Congress at once if possible.

The Starbucks petition states: “To our leaders in Washington, D.C., now’s the time to come together to: 1. Reopen our government to serve the people. 2. Pay our debts on time to avoid another financial crisis. 3. Pass a bipartisan and comprehensive long-term budget deal by the end of the year.”

Starbucks is urging like-minded individuals to sign the petition online or to bring it into a Starbucks. They can also sign up for email or text updates, share them on social media and download a badge for their social sites. By Friday morning, the Starbucks post on Facebook had more than 70,000 likes.

Earlier this week, the Seattle-based coffee chain started with a soft-sell campaign, urging customers to “pay it forward” by buying a coffee for another customer. Starting Friday, the company added to those efforts by stocking its stores with petitions, asking politicians to wake up to the people’s wishes.

“I think Starbucks has a lot of guts to be the first ones to get involved,” said John McCourt, a graduate student at New York University, who is documenting his quest to visit every one of the coffee chain’s outlets in Manhattan. On Friday morning, he had already signed the petition and bought coffee for another person at an Upper East Side Starbucks.

“I think the petition is an evolution of the pay-it-forward. The pay-it-forward was asking people to be nicer to each other, to be more civil to each other. Three days later, nothing happened, so now we have the petition,” McCourt said.

Although mixing politics with business can have negative repercussions for some companies, this campaign is right in line with Starbucks brand and identity, said Darren Tristano, the executive vice president at Technomic, a food industry research and consulting firm.

“It really fits in with the Starbucks philosophy. They’ve always done things with a strong corporate responsibility,” Tristano told CNBC.

Schultz has weighed in on high-profile political issues before, including a plea for Starbucks customers to leave their guns at home and a 2011 call for people to stop making political contributions until lawmakers reached a deal on the U.S. debt and spending.

“In my mind it’s also a promotion for the brand,” Tristano said. “I think what it’s showing is this brand cares enough to help other people. Why can’t the government work harder to help out citizens?”

Pointed Complaints at Quiznos

May 30, 2013

More Franchisees Take Aim at the Denver-Based Sandwich Chain, Claiming Corporate Greed is Shortchanging – and Closing – Stores

Quiznos’ long-standing friction with disgruntled franchisees has surfaced again in a new round of lawsuits.*Since December, 10 suits have been filed in Denver District Court, alleging that the Denver- based sandwich chain has treated its restaurant owners unfairly.*The claims are similar to those in a long history of related legal actions — that the company has taken actions to increase corporate profits at the expense of franchisees who are struggling to break even.*Analysts say the new legal disputes signify more problems for a chain already beset by declining sales, store closures and stiff competition in the sub-sandwich sector.*The latest lawsuits come three years after Quiznos agreed to a $95 million settlement with 6,900 class-action franchisees who said the company overcharged them for supplies and failed to provide adequate marketing support.

In the new round of lawsuits, store owners claim Quiznos continues to overcharge by forcing them to buy food at marked-up prices from a Quiznos-affiliated supplier.

“The hidden mark-ups, which are the keystone of Quiznos’ scheme, have generated massive profits for Quiznos while simultaneously driving its franchisees to financial ruin,” one of the lawsuits says. Most of the suits contain similar or identical language.

The lawsuits allege that Quiznos management increased the use of coupons for free and discounted food — costs that are absorbed by restaurant owners — in order to make the franchisees buy more food at marked-up prices from Quiznos’ supply affiliate.

Denver attorney Jeffrey Cohen, representing the franchisees, said he would offer no additional comment.

Quiznos issued a brief statement and said it would not comment further.

The statement reads: “We believe that these lawsuits are completely without merit. Quiznos management team will not allow these lawsuits to distract us from our mission. We remain committed to delivering a premium product and experience to our guests, and helping our franchise owners grow their sales and profits.”

Named as defendants in the suits are a number of Quiznos corporate entities, including its franchising arm; the supply affiliate; the company’s majority owner, investment fund Avenue Capital Group; and former owners Richard E. and Richard F. Schaden.

Franchisee John Portrera of Petoskey, Mich., a longtime critic of Quiznos’ management, said he shut down his restaurant Dec. 31 after 4 1/2 years because of mounting losses and resulting personal turmoil, including a divorce.

“What they’re doing is criminal,” he said. “I lost my savings. I lost my wife. I cashed in my life insurance policy. I lost everything, but now I’m so happy just to be out of it.”

Portrera said that even though his restaurant was rated highly by Quiznos in categories such as customer satisfaction and cleanliness, he lost about $400,000, including his initial investment and operating losses.

Disputes between franchise companies and their franchisees are relatively common, but few have the persistence and animosity as Quiznos’.

For example, Burger King restaurant owners sued the parent company in 2009, arguing that they were losing money by being forced to sell some menu items for $1. The suit was settled 17 months later, with both sides saying they would collaborate on future pricing decisions.

Analysts say Quiznos’ friction with franchisees has created a debilitating spiral of store closures and declining revenue.

“The sales decline and the heavy couponing have really made it tough for franchisees to make a profit,” said Jonathan Maze, an analyst and writer for Franchise Times magazine. “Quiznos charges a lot of money (to franchisees) for its food.”

University of Denver finance professor Mac Clouse said some restaurant chains with franchise supply agreements use their buying power to acquire food at low prices, and then pass the savings on to franchisees.

Yet the lawsuits claim that Quiznos has taken the opposite approach — using economies of scale to negotiate low prices for bulk-food purchases, then reselling the food at higher prices to restaurant owners.

Quiznos is privately owned and is not required to report financial results to the Securities and Exchange Commission. However, some of its performance metrics can be found in franchise disclosure documents that the company is required to file in some states.

The documents show that Quiznos collected much more money from selling food and supplies to franchisees than it took in from royalties based on sandwich sales.

The supply company, American Food Distributors LLC, which Quiznos describes as an “affiliate,” had 2011 revenue of $225.3 million. Quiznos’ franchise operation, QFA Royalties, collected 2011 royalties and fees of $73 million from franchisees.

The disclosure documents show that the chain’s number of stores fell from 4,381 in 2009 to 2,834 in 2011, a decline of 35 percent over two years. At the peak in 2006, there were more than 5,000 outlets.

Total revenue for QFA Royalties has plunged 41 percent in two years, from $123 million in 2009 to $73 million in 2011. Net income declined by a similar margin in that period, from $47.7 million to $28.4 million.

“Quiznos has struggled, primarily because they’re in an intensely competitive market,” said Darren Tristano, executive vice president of food-service analysis firm Technomic.

“It’s always been a difficult relationship between the parent company and the franchisees,” he said. “It seemed as though they had gotten past that (with past settlements), but now they’re battling again.”

KFC Growth Seen Slowing as Indonesia Limits Franchisees

May 13, 2013

i59E2rCg2bVEYum! Brands Inc. (YUM), owner of the KFC and Pizza Hut dining chains, and other fast-food companies may be forced to slow store growth in Indonesia, the world’s fourth- most populous nation, because of government rules to protect small businesses.

As US revenue drops, Yum is focusing on growing overseas, particularly in China and Southeast Asia. A plan taking effect in the next five years to limit restaurant franchise holders to operating 250 outlets in Indonesia, where fast-food sales rose 15 percent in 2011, may crimp openings for Yum and other US food chains as well as encourage similar restrictions in other nations.

“It’s going to probably slow things down a bit,” said Darren Tristano, executive vice president at Chicago-based restaurant researcher Technomic Inc. “This is going to be a bump in the road” for Yum, which already has 700 locations in Indonesia, he said.

Indonesian Trade minister Gita Wirjawan earlier this month announced the rule, which has certain exceptions, in a bid to protect small- and medium-size businesses. KFC, which sells wraps, spaghetti and chicken porridge in Indonesia, is the top US fast-food chain in the Asian nation with about 32 percent of the market, according to Bloomberg Rankings data from July.

Customers eat fried chicken with rice at fast-food restaurant Kentucky Fried Chicken in Jakarta. KFC, which sells wraps, spaghetti and chicken porridge in Indonesia, is the top US fast-food chain in the Asian nation with about 32 percent of the market, according to Bloomberg Rankings data from July. (Getty)

The rule “doesn’t impact Yum’s growth plans,” Virginia Ferguson, a company spokeswoman, said in an e-mail. “Our local franchisee will continue to work with authorities on the guidelines.”

Yum Expansion

Yum’s saturation of two or three stores per million people in Indonesia can expand to that of the US, where it has 50 to 60 eateries per million people, Muktesh Pant, chief executive officer of Yum International, said at an investor conference in December.

There is “no fundamental reason why Indonesia will not get there,” he said. In Indonesia, where gross domestic product growth is outpacing that of Brazil, Russia and India, Yum has said it can grow 43 percent to 1,000 stores by 2015.

“Indonesia is a very attractive market because of the extremely fast-growing middle class with discretionary income,” Bill Edwards, CEO of Irvine, California-based Edwards Global Services Inc., which advises retailers and restaurants, including Denny’s Corp. (DENN), in opening stores overseas.

While Yum says its growth won’t be affected by the rule, it’s harder to keep the brand and food quality consistent with different and smaller store owners, Edwards said.

“What if one operator does a bad job?” he said. More franchisees will require more supervision from the parent company, he said.

Yum, based in Louisville, Kentucky, has dropped 1.4 percent this year, while the Standard & Poor’s 500 Restaurants Index has gained 4.5 percent.

‘Still Evaluating’

The regulation affects companies such as PT Fastfood Indonesia, which operates more than 400 KFC restaurants in Indonesia. The rule applies to all food-mart franchisers and franchisees, including public companies, Wirjawan said.

“We are still evaluating and calculating the potential impact of the new rule,” Justinus D. Juwono, director of PT Fastfood, said in a telephone interview. “We haven’t changed or revised our investment plan or target yet. But, we’ll closely look into it, when we get our evaluation and calculation done in two or three weeks.”

Companies in Indonesia are allowed to operate 250 outlets either by selling partnership stakes or agreeing to open them in certain remote locations to be determined later, Wirjawan said at a press briefing in Jakarta on February 15. They will have five years to comply, he said.

Indonesia Population

Indonesia is the fourth-most populous country in the world with about 248.6 million people, according to a July estimate from the US Central Intelligence Agency World Factbook. China is the biggest country by population, followed by India and then the US, with 313.8 million people, the data show. Indonesia’s economic growth was about 6 percent in 2012. The nation had the world’s largest Muslim population as of 2010, according to the Pew Forum on Religion & Public Life.

Fast-food sales in Indonesia climbed 15 percent to $1.54 billion in 2011, compared with an increase of 9.6 percent globally and 3.6 percent in the US, according to data from Euromonitor International.

Dunkin’ Brands Group Inc. (DNKN), owner of the Dunkin’ Donuts and Baskin-Robbins dining chains, has about 600 stores in Indonesia, all of which are franchised. The company has been remodelling its Baskin-Robbins ice cream stores there.

“We are currently reviewing the regulation, and it is too early to determine possible impact,” Michelle King, a spokeswoman for Canton, Massachusetts-based Dunkin’ said in an e-mail. “We remain committed to the market.”

Me Too

McDonald’s Corp. (MCD), the world’s largest restaurant chain by sales, has about 130 stores in Indonesia, all of which are franchised. Becca Hary, a spokeswoman for the Oak Brook, Illinois-based company, declined to comment on the rule.

Indonesia may be the first of nations to impose restrictions on retail operators as other markets take on a “me-too” approach, Edwards said.

“This is one of the things we’re worried about in the franchise community,” he said. “This may set a precedent for other countries – the ‘me too’ does happen.”

Peru, Bastion of Fast Food

January 21, 2013

LIMA — There are more North American fast-food restaurants in China than any other emerging market, which isn’t much of a shocker. The surprise is the country with the greatest concentration of the eateries: Peru.

Considering that it’s a nation so well-known for its cuisine that it exports its own restaurants to other countries, it’s interesting to note that hungry Peruvians in populated areas have to travel, on average, just 1.1km to find a fast-food joint, according to data compiled by Bloomberg.

This is all good news for fast-food companies, which are increasingly counting on Latin America for growth after thriving in China.

“We’re starting to see the emergence of Brazil and South America being a hotbed for US restaurant franchises to go and open up,” said Darren Tristano, Executive Vice-President at food industry consultant Technomic Inc. “Now that Asia has already started, I think South America is really going to be where the growth is.”

The first American chain opened in Peru in 1981 and the result is evident. KFC and Burger King are doing a brisk trade, as is Bembos, Peru’s biggest burger chain.

Peru is finally reaping gains from free-market policies adopted in the 1990s. Peruvians now spend more time shopping and eating at a growing number of malls and new shopping districts, increasing demand for fast food. That market grew 15 per cent last year, according to data from the Peruvian Chamber of Franchises.

KFC, McDonald’s and Burger King first moved into Peru in the 1980s and 1990s, and have since branched out beyond Lima to the other thriving cities. Today, US chains have 60 per cent of the market.

“Foreign brands have much more experience and they have a structure and operating capacity that brands in Peru haven’t been able to develop,” said Diego Herrera, President of the Lima-based chamber. “They’re brands that have studied their marketing, their customers, their processes almost to perfection. They come here and advance very quickly, filling gaps at a sort of pace that Peruvian businesses can’t match.”

Local entrepreneurs are also tapping into foreign interest in Peruvian cuisine to develop new fast-food concepts. Peruvian outlets increased sales by 26 per cent last year, compared with 15 per cent for foreign brands, according to the chamber. The restaurant industry as a whole grew 9.4 per cent last year, according to the statistics agency.

“The market is going to become more favourable for Peruvian brands, as long as they are sustained by a solid corporate structure,” Herrera said. “This is only the beginning.” BLOOMBERG

Fast-Food Companies Find a Market for Growth in Peru

January 21, 2013

KFC, McDonald’s and others are looking to Latin America for future expansion.

There are more U.S. fast-food restaurants in China than in any other emerging market, which isn’t much of a shocker. The surprise is the country with the greatest concentration of the eateries: Peru.

Hungry residents of Peru’s populated areas have to travel, on average, just two-thirds of a mile to find a U.S. fast-food joint, according to data compiled by Bloomberg. This is all good news for fast food companies, which are increasingly counting on Latin America for growth after thriving in China.

“We’re starting to see the emergence of Brazil and South America being a hotbed for American restaurant franchises to go and open up,” said Darren Tristano, executive vice president at food industry consultant Technomic Inc. “South America is kind of becoming the next window. Now that Asia has already started, I think South America is really going to be where the growth is.”

The first U.S. chain opened in Peru in 1981, and the result is evident. Eight fast food counters line the walls of the Jockey Plaza mall in Lima — half of them Peruvian brands and the other half U.S.

Yum! Brands Inc.’s Kentucky Fried Chicken, the largest U.S. fast-food chain in Peru, and Burger King are doing a brisk trade, as is Bembos, Peru’s biggest burger chain.

After three decades blighted by dictatorships, terrorism and hyperinflation, Peru is reaping gains from free-market policies adopted in the 1990s that fueled the fastest economic growth in Latin America in the past decade. Economic stability is spurring a consumer boom that has gathered steam during the past decade.

Peruvians now spend more time shopping and eating at a growing number of malls and new shopping districts, increasing demand for fast food. That market grew 15 percent last year, according to data from the Peruvian Chamber of Franchises.

U.S. chains such as KFC, McDonald’s Corp. and Burger King Worldwide Inc. moved into Peru in the 1980s and 1990s and have since branched out beyond its capital, Lima.

U.S. chains have cemented their domination in the past decade and today have 60 percent of the market. McDonald’s and Burger King led the expansion in sales last year, followed by Bembos. In more developed markets such as Brazil and Mexico, local brands account for 92 percent and 70 percent of sales, respectively, according to the chamber.

“Foreign brands have much more experience, and they have a structure and operating capacity that brands in Peru haven’t been able to develop,” said Diego Herrera, president of the Lima-based chamber. “They’re brands that have studied their marketing, their customers, their processes almost to perfection. They come here and advance very quickly, filling gaps at a sort of pace that Peruvian businesses can’t match.”

Biggest Franchise Trends for 2013

January 10, 2013

gaining-tractionFranchising has changed dramatically over the last five years. There are more multi-unit and area developers, more high-tech ways to optimize sales and leaner and meaner corporations honed by the recession. At the same time, franchising remains subject to the challenges it has always faced: the fads, the bubbles and the whims of public taste. We can’t say for sure how the next year in franchising will shake out, but here are our picks for the trends that will have the biggest impact.

Area Bombardment

When the economy headed south, franchisors did, too–and east and west and north. A soft franchising market in the U.S. sent many franchisors overseas, and the lesson they learned is that area development is the way to go. Instead of searching out dozens or even hundreds of mom-and-pop franchisees, many American concepts are partnering with a deep-pocketed overseas developer who can navigate the culture and open and operate numerous units at once.

It’s a lesson many franchisors have brought home, and after several years of increasing growth, area development is settling in as the new normal. According to research firm Frandata, more than 50 percent of franchises are held by multiple-unit owners, and many of them act as area developers, building out entire metro areas, counties or even states.

“Franchisors are realizing the advantage of dealing with area developers,” says Bret Lowell, a partner at the Reston, Va., office of business law firm DLA Piper and author of Multiple-Unit Franchising: The Key to Rapid System Growth. “When they open their second, third and fourth units, the franchisor doesn’t have to go through the sales process and doesn’t have to deal with six people opening six different units. There are economies of scale and added efficiency with area developers.”

Other economic factors have also driven area development in franchising. Banks are more likely to lend to franchisees with successful track records, and franchisors reduce risk by letting proven operators open stores, rather than rolling the dice with a newbie. Lowell believes that even as lending continues to unfreeze and the economy improves, franchises will still favor area developers and multi-unit operators. “I think the economy and efficiencies will cause it to remain,” he says. “My sense is, franchisors like to have that multiple-unit arrow in their quiver. In many cases, it’s a good option.”

Mark Siebert, CEO of Homewood, Ill.-based franchise developer iFranchise Group, also sees a rosy future for area developers. “There is still a lot of real estate available, and landlords are still aggressive on pricing,” he says. “Franchisors targeting area developers are going to continue to do well in this economy.”

Refranchising Rambles On

Refranchising–in which a company sells its corporate-owned stores to franchisees–is often taken by the marketplace as a sign that a business is in distress. But if that’s the case, then franchising must be in a free fall. In recent years, Arby’s began divesting itself of corporate units, while Burger King, Pizza Hut, KFC, ampm and dozens of other high-profile franchises launched refranchising efforts. In the last year, Taco Bell announced plans to refranchise 400 units.

Kevin Burke–managing partner of Los Angeles-based Trinity Capital Management, which has financed billions of dollars in refranchising deals over the last two decades–says the trend should be interpreted not as weakness but as vitality. “In the beginning, a lot of refranchising was about franchisors trying to pay down debt, but now it’s a strategic move,” he explains. “A franchisor’s skill set is very different from the disciplines needed for a franchisee to run store operations. They want to have a lineup of executives who are well-versed in policing brand standards, working on products and promotions and overall strategy. They don’t need to be running the stores themselves. From a strategic point of view, companies are saying, ‘We want to stick to our knitting and what we’re good at.'”

There are economic incentives for getting out of running company stores as well. Collecting royalties is much easier than actually selling mufflers or sandwiches, and securities analysts are more enthusiastic about royalty streams than store revenue. At the same time, as units begin to age, franchisors question the logic of investing $500,000 or $1 million in a remodeling effort when they can sell the location off to a franchisee who will foot the bill and still pay royalties for the next decade. “A lot of things can go wrong between sales and the bottom line,” Burke says. “Franchisors have realized that collecting royalties is the purest play.”

Fast Food Gets Healthy (Really)

Remember the McLean burger? The Burger King Baguette? The Frescata sandwiches from Wendy’s? The fast-food road is littered with failed bids to get Americans to eat healthfully from the drive-thru window.

It once seemed like an exercise in futility, but after throwing slimmed-down burgers and other dietary monstrosities at the wall for the last two decades, franchises are finally creating healthful fast food that sticks. Case in point: The introduction of a low-cal turkey burger last year at sibling chains Hardee’s and Carl’s Jr. may have been one of the franchise’s most popular product launches ever. Meanwhile, Burger King’s Garden Fresh salads and chicken wraps spearheaded that company’s largest menu expansion. At McDonald’s, consumers seem stuck on oatmeal, and the chain has slimmed down its Happy Meal, as well as added calorie counts to its drive-thru menu boards–a move now required, per healthcare legislation, of restaurant chains with 20 or more outlets.

So have the fast-food chains finally gotten the menu right, or have Americans finally awakened to their button-popping waistlines? According to Darren Tristano, executive vice president of the Chicago-based restaurant research firm Technomic, the answer is a little of both. “Yes, they’ve found appealing flavors,” he says, “but consumers are also interested in taking control of their diets.”

It also seems that the big franchises are interested in getting ahead of concepts like Energy Kitchen and Evos, which are luring health-conscious consumers with bison burgers and air-baked French fries. Even fast-casual burrito and burger joints are often seen as smarter choices than the traditional fast-food options. But the big guys seem most concerned about LYFE Kitchen, a Palo-Alto, Calif.-based concept run by former McDonald’s bigwigs, which is recruiting franchisees and reportedly may build up to 250 units over the next five years.

Digital Aids

For most of its existence, franchising has been a strange combination of intuition and research. Franchisors have to know instinctively which candidates will do well in their system, and they use traffic patterns and local income levels to choose real estate–though in the end it’s been primarily a gut decision. But more and more are seeing the advantages of digital-age data collecting, and services that aid franchisors in site selection, franchisee selection and customer retention are becoming must-haves.

Site Analytics and other services, which use hard data and detailed traffic patterns to help franchisors decide where to place their stores, were used by just a handful of franchises a few years ago. Today companies are clamoring for these services. Google and Facebook recently launched features designed specifically to help franchisors and franchisees collaborate on social media branding and promotions, both of which will see wider adaption in the coming year.

Even something as simple as digital menu boards, which franchises resisted for the better part of a decade, will see wide deployment as companies realize the opportunities they present, such as the ability to add happy-hour offerings, hold one-day promotions or disseminate personalized messaging. Meanwhile, the Franchise Business Index (launched by the International Franchise Association) is tracking monthly growth of the sector and providing insights into the direction it’s headed–a strong symbol of how far and how quickly franchising has moved into the information age.

Bursting Bubbles?

How much is too much? For certain franchising food trends that have proliferated at a rapid rate–and will likely continue to do so in the coming year–the saturation point may be approaching.

Frozen-yogurt franchises like Red Mango, Pinkberry, Menchie’s, Yogurtland, 16 Handles and dozens of regional players are almost as thick as Starbucks–but without the caffeine-addicted customers and with limited winter appeal. Because they’re cheap to open, frozen-yogurt franchises are multiplying like locusts.

“The problem with frozen yogurt is that it’s location-driven and largely undifferentiated,” says iFranchise Group’s Siebert. “It has low barriers to entry and a lot of players. I’m not sure if it has totally run its course, but we’re rapidly coming to the point where winners will be sorted out from losers.”

James Sinclair–founder of OnSite Consulting, a Los Angeles-based hospitality consultancy that analyzes the restaurant industry–says he and his colleagues have determined that a fro-yo store can be opened for about $20,000. “Granted, it would be a horrible store,” he admits. “The point is, I think we’re reaching the down-slide of the cycle. It’s been just as much driven by property owners. These stores open quickly and don’t take any significant modifications, so landlords have encouraged these places to open in the down economy. Everywhere you go you see three yogurt stores on any given corner. And there’ve been tremendous closures.”

Another franchising craze, quick-serve “better burgers,” also seems close to saturation. Five Guys opened more than 1,000 franchises in less than five years; other companies in the category include Smashburger, The Counter and BurgerFi.

“I think the whole burger concept is reflective of the marketplace and the fact that people were craving somewhere in the middle,” Sinclair says. “They don’t want to have a long, drawn-out meal with table service, but they don’t want a cheap environment, either. That’s what sprouted this whole burger thing.”

“The American appetite for burgers seems almost endless,” says Technomic’s Tristano, pointing out that so-called better burgers aren’t necessarily cannibalizing sales from fast-food joints, but are going head-to-head with fast-casual concepts like Chipotle and Noodles & Company, a market segment in which there seems to be plenty of room for growth. Still, the CEOs of better-burger franchises are getting nervous about market saturation, with almost all of them giving recent interviews explaining why their concept will survive the coming “shakeout.”

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