Fred DeLuca, the legendary founder of Subway and visionary for the franchise business model, died last Monday at the age of 67 after a battle with leukemia.
DeLuca founded Subway when he was only 17 years old and built it into the biggest restaurant company in the world by number of locations. Subway celebrated its 50th anniversary last month, shortly after DeLuca transitioned company leadership to his sister, Suzanne Greco, who was named president.
In the January/February 1998 issue of QSR—the publication’s third overall—DeLuca sat down with then-editor Lea Davis Paul to discuss the sandwich chain’s innovative growth strategy. At the time, Subway had 13,000 locations globally; today, it has more than 44,000. The interview offered a close-up look at the inner workings of Subway’s franchise system, which has been credited with the brand’s phenomenal growth.
The Q&A with DeLuca, below, is presented without edits to showcase Subway’s brand position and strategy at the time of the interview, which was conducted in late 1997.
These days, many of the real growth opportunities in this industry seem to be going to the established multiunit operators. Could you do today what you did as a 17-year-old?
I didn’t approach it with a whole lot of strategy. My thought was to open up a few stores and make some money to pay my way through college. It wasn’t anything like what you see today, the global company with 13,000 stores.
But I think someone could start out today in the same way I did. All I did was open a small store that worked in a given neighborhood, develop some systems, and draw up a plan for expansion that eventually evolved into franchising. That process can very much work today.
When you decided to franchise your young business, did you know what you were getting into?
I didn’t give it enough thought, didn’t even think about it being easy or hard. And the expansion plans weren’t that enormous. When we started, we set a goal of 32 stores in 10 years. After eight years, we had 16 company-owned stores. The question was, How can we get to our goal? We saw Kentucky Fried Chicken growing in our area at that time and knew they were franchised, so I thought maybe we’d franchise to help us get to the goal of 32. We weren’t thinking worldwide or country-wide or even statewide. We were thinking a few people would join us as franchisees and essentially run stores they owned. The thought process wasn’t much more complicated than that. Once we got that foundation down—some franchise owners who could make a living for themselves in the local neighborhood—it enabled us to move out from our home base.
How did those early experiences shape the franchising model you use today?
I think our early operations experience shaped the franchising. Ours were small stores with low investments, simple operations, no cooking, and strong control systems. Those foundations made the stores work, and that’s what enabled us to do the early franchising—it shaped what we taught our new franchisees. The next phase, as we started getting a little larger, was codifying the system. Then we had to develop skills to expand to other markets.
Early on, we came up with a program we call development agents. We kind of invented the program; a lot of companies do something similar now. The basic idea is that if we’re going to have locations far from headquarters, how do we provide local assistance to people? We thought the right approach was to locate someone there who would have a higher level of responsibility and work with people on the local level. The development agent does what is most successfully done in the field; meanwhile, at headquarters, we do what is most successfully done in the central location. That structure has been very helpful and helped us grow in the United States and Canada.
What about when you began international expansion?
We developed a new kind of structure with a small but very critical addition. As we started to go to different countries, the distance wasn’t the factor so much as the cultural differences—new laws, different ways of getting food products. It wasn’t easy for our first franchisees to establish themselves, and there was a lack of understanding at headquarters about the local needs and practicalities. So we added a new kind of employee internationally. They go out and work with the development people, international franchisees, and local markets and act as a go-between for headquarters and the location. They translate requests and get reconciliation.
That structure has helped us open a lot of doors internationally. Two years ago, we might have been in 20 or 25 countries; today, we’re in 62. We’ve planted new seeds in a lot of places, in a pattern similar to our growth in the United States during our franchise expansion days.
Subway has enjoyed phenomenal growth.
Yes, we only crossed the 1,000-store mark in 1987 and today we’ve got 13,000, so we’ve added 12,000 stores in the past decade. It’s been quite rapid growth, fueled by existing franchisees. People sometimes ask me how we could add so many stores, and the answer is because every year 60 percent of our growth comes through existing franchisees. Nowadays, it’s probably as high as 75 or 80 percent.
You’ve named McDonald’s as a role model for growth. What might you want to do differently, in view of their recent challenges?
I think the best thing McDonald’s has done for us is that they’ve gone in new markets and trained people to be regular users of branded food in chain restaurants. That’s opened the door for other chain restaurants like Subway to come in with a different offering. In terms of McDonald’s recent difficulties, I think you have to break out the international and domestic markets. Internationally, I think they’re making a lot of progress; it’s here that they’ve had some difficulties with same-store sales.
But I don’t think these same-store sales have as much to do with growth as they do with changing consumer attributes and the resulting consumer ratings for their food. Today, people are more conscious of nutrition, and I will trace that to a specific event. I saw it happening when they began putting nutrition labels on cans that you and I can read and understand. That now is translating to what people eat outside their homes. Intuitively, they know the kinds of foods served at McDonald’s are not consonant with the nutrition they like to eat, and I think that is creating some difficulty for the chain. There are also quality issues. Over the past couple of years, Burger King has made a lot of market-share gains. The nutrition in their food is probably similar. But I think that Burger King gets a higher attribute rating for many of their products, and their marketing has fueled that. I suspect that McDonald’s will find a solution, and I don’t pretend to have the solution, either.
How do you pass your ambitions for growth on to your franchisees?
I think a franchisee who joins our company with one store naturally thinks about growing the business, building sales, and profit and worth. And if they’re successful, then their thoughts turn to opening a second store, and so on. There’s not a need to pass ambition down so much as there’s a need to make sure there’s an opportunity for franchisees to express their ambitions to grow—meaning if someone is ready to grow with another store, allowing them to do it and facilitating the process. But, there does need to be some restraint. If you allow everybody to grow as fast as they would like, some people will get ahead of themselves, financially or managerially. You don’t have to teach them about growing—they come to the party with that. It’s a matter of helping them along.
At what point could a chain be growing too fast? How did you know when to apply the brakes?
Around 1982, I thought about what the optimum growth rate could be and worked backwards from there. At that time, we had grown to about 200 stores—well beyond our initial goal of 32—and the question was, Just how big can we grow in a country this size? Back then, I was certain that 5,000 stores could be built, but I thought it was possible to reach 10,000. Then the question became, What is the optimum growth rate? It seemed a suitable target would be to add about 1,000 stores each year. That would provide enough velocity to build out the country in a fairly good time frame, and at that time nobody had ever built 1,000 stores per year. In fact, I don’t know if anybody’s done it besides us. McDonald’s might have done it recently. Then the question was how to do it in a way that wouldn’t drain us of resources or capacity. In our case, what we needed in place was facilitators—people who could help the franchisees meet objectives. That meant staffing up in five or six functional areas at headquarters in development groups. We also needed adequate field support to provide the help franchisees needed, so we built up our development agents and office staff.
When was the chain’s growth rate ever a strain?
I can pinpoint one time very clearly: 1987 was a strain for us. The prior year, we had built 400 stores, which was within our capacity, but the following year, we probably had demand to build more than 1,000 stores, but we actually only added about 800. But, that 800 was twice as much as the prior year. That was a strain because we were geared up to build 400–500 but the explosion in demand came and we found ourselves running behind in many of the timetables we like to maintain—bringing people through training fast enough, getting their leases negotiated, developing floor plans, handling equipment orders.
How did you deal with the strain?
Well… [laughing] Basically the solution was pretty straightforward. We had to get more capacity; in this case, we needed people capacity. We hired and trained people who could assist in each of the defined functions: franchise sales group, lease negotiation team, store design group, training group (classroom and in-store), construction assistants, and the equipment leasing group. We just had to really staff up.
In 1987, we did 800 stores, and in 1988 we opened more than 1,000 stores. At that time, I made the judgment that we were going at about the correct pace. The speed felt very comfortable, and there wasn’t any need to go past it. We were on track to reach our goal. Another chain handling a different concept might decide that it’s better to go more slowly. Our operations are extremely simple compared to other foodservice operations, and because of that we have some advantages in developing more quickly.
As it’s expanded, Subway has had its share of territorial complains from franchisees.
Any company that has just a few stores won’t have concerns registered. Franchisees in small chains say, “Let’s build more stores so that we can get famous.” At the other end of the spectrum, the thought process is, “Gee, we have a lot of stores. Is putting more in the wisest thing to do?” There’s the philosophical discussion of “What’s the right number of stores?” And then there’s the specific discussion: “Hey, that franchisee wants to build a store close to mine. I don’t think that’s a good idea.” So while the general discussion goes on forever at a generally low level, the specific stores are what causes anxiety with people.
We’ve developed a site review procedure. Although we are not required to do this in our agreement, we feel the right thing to do is to notify nearby franchisees every time we’re going to negotiate a lease. We send a letter to the four closest franchisees saying we’re proposing opening a store in this location and asking if they have any objections to it. If they have no objections, the store goes through. If they do have objections, we have a review procedure where we interview customers and do field work to estimate the immediate impact on an existing store. If it looks like the initial impact will be high, then we don’t go forward with the store.
What do you consider a significant impact?
If a new store opens and an existing store goes down in sales less than 5 percent during the first week of operations in the new store, that’s not significant because historically we’ve seen that new stores train new customer bases who go on to shop at existing area stores when they travel. But if we see something that is over 10 percent, either in our initial studies or in reality, that is considered quite significant. That’s a large amount to build back up from. New customers are developed and sales do tend to come back [to existing stores], but it’s harder to move from that [10 percent] point. We try to space the stores in such a way that each new store will have a minimal effect on existing stores.
We have a backup plan, too. Because of traffic patterns or the way a community is developing, we could have an initial impact on existing stores that nobody saw coming. Our marketing fund acts as a backup for stores that experience an unexpected downturn when a new store opens. That franchisee applies and gets a three-month marketing budget. If the store hasn’t bounced back, the franchisee can get an extension, and keep getting extensions. We devised that in cooperation with the SFOAC, our Subway Franchise Operators Advisory Council.
How did the council come about?
As we were growing, there were a lot of questions and issues coming up from franchisees. We needed a mechanism so that people could talk among themselves and issues could be brought to the forefront and worked on by management. So about six years ago, we brought in a couple of college professors who had been involved in franchisee organizations. They gave some guidance on ways to put an advisory council together. Our particular method was kind of interesting—we formulated our council through lottery. We divided the Subway world into five territories and said whoever would like to be on the advisory council, put your name in the hat. We got a great turnout in each hat. The council was selected by pulling names, and it’s worked out very, very well. A couple of years later, the national advisory council saw fit to devise regional advisory councils.
Let’s look ahead now. What market trends are you participating for 1998?
Of course, people are eating out more often, and we’re seeing that influence the growth in the number of restaurants. There’s a concern for healthier lifestyles and eating. You’ve probably noticed the low-fat message in our advertising.
Will that continue through 1998?
Yes. We have an interesting situation. We have had to do so little to change our products [to fit the low-fat context] that it’s really not even noticeable. We’ve always had this menu, and we found that when we verbalized the low-fat message to our consumers, we saw a good uptick in our sales. We’re sort of gaining back position in consumers’ minds, and we believe there’s really not another chain that could credibly present that message, or uphold that image. It’s pretty tough for the Burger Kings out there to try to talk about having low-fat meals—even if they went and introduced a line of low-fat products, people would not see that as what they really offer. Another of our competitors is Taco Bell, and they had a low-fat menu [that didn’t do well].
It’s interesting… We discussed this before we started sending the low-fat message to the consumer. The conventional wisdom in the industry was that this doesn’t work. I think the conventional wisdom is right—that it doesn’t work for most situations. But in our case, we already had that image of fresh food because of the way our service is designed—fresh bread, fresh vegetables, fresh assembly at the counter right in front of you. In our consumer research, we were thought of very highly for quality of food and ingredients, so our message of healthiness was credible to the consumer.
What trends won’t you be responding to?
There are a few trends that we’re probably not going to respond to, at least in the short term. I suspect we’ll continue to see an increasing amount of food brought back to the home for consumption, either taken out to finish preparing at home or home delivery. But, the economics of our business doesn’t allow us to offer delivery service on a wide scale. So we’ll just pass on that. We do delivery in a few, very limited markets, but our stores don’t work well with delivery. If you think about a Subway store, they’re pretty small, and they’re designed to run with just one person during slow periods. As soon as you put delivery in, you need a second person.
How much will Subway continue to invest in cobranding?
We’re dealing with cobranding in two forms. First, there’s locating a food operation inside another retailer, which has really made a lot of progress in the United States in the past five years. We’re right in there, doing more and more of that. The other kind of cobranding is with two brands under one roof. We’re doing more of that and researching more opportunities, but we still have a lot of work to do. I think we can expect to see more of that from, for instance, Baskin-Robbins and Dunkin’ Donuts, especially now that they’ve acquired Togo’s. We are making alliances with different companies. Right now, we’re installing a bunch of TCBYs in Subway stores. Our approach will continue to be making alliances with companies that it makes sense to partner with, to fill out dayparts or even with competitors for lunch.
That’s interesting, the idea of pairing up with a daypart competitor.
We’ve got a couple of outlets with Taco Bell, and they work very well for us. Dunkin’ Donuts and TCBY are working well as alliances, too. It’s something we’re going to be doing more of.
You’ll also see us responding to trends in facility size. The average quick-service facility size has been growing smaller for years, as drive-thru business becomes bigger. When you look at cobranding, stores within stores, the average size is declining. We’re already on the low end of the scale with facility size, but over time I think our facility size will decrease also. That doesn’t necessarily mean we’re going to rent smaller spaces, but the type of configuration will yield a lower average store size. Say we go into a c-store, that’s much smaller than the regular store. Of, if we put two brands under one roof, there will be a smaller area per brand.
It’s striking how well suited Subway is—in ways you probably never anticipated—to respond to today’s trends.
It’s true. Sometimes, as they say, you just suddenly wind up in the right place, without any planning. To some extend, we’re the beneficiaries of having the right configuration for trends that came upon us. All told, I think we’ve been pretty fortunate.