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    Fork in the Road

  • It’s an age-old question: Should your brand grow through franchised or company-owned units? For many, the answer isn’t so black and white.

    Penn Station East Coast Subs
    Penn Station chose the franchise route to scale, but other brands prefer the control afforded by company-owned units.

    Operations ran pretty smoothly when Jeff Osterfeld opened his first Penn Station East Coast Subs in 1985 in downtown Cincinnati, Ohio.

    Things got a little dicey after the company founder had opened three stores. He learned that if he was at one store, it would be fine—the food would come out quickly and correctly, the restrooms remained clean—but the other two stores would backslide.

    Osterfeld’s predicament 30 years ago helped shape what executives at Penn Station now call an “ownership mentality.” At the time, Osterfeld needed employees who would feel and act like owners, willing to do whatever it took to succeed.

    That’s why Penn Station began franchising back then, and it’s why the brand still leans heavily on franchised operations; only one of its 295 locations is company-owned. And the brand goes further with the “ownership mentality,” requiring a managing owner to oversee each location and tying each general manager’s pay to profits and performance evaluations.

    “We’re a true believer in the franchise model,” says Penn Station president Craig Dunaway. “I think that ownership model is so engrained in who we are. I think it’s probably why a homeowner takes better care of their home than an apartment renter. We want an owner as close to the counter as possible.”

    In the age-old debate over whether to expand through franchised or company-owned stores, Penn Station is firmly in the franchise camp.

    Although franchising may seem like just a faster and cheaper way to grow, Dunaway says, franchisees with their own capital on the line also care more about the product and profits than a company-hired manager. He adds that the brand is picky about which franchisees it lets in the system.

    “I think it’s a higher bar [than other brands]. And we hear that from prospective candidates,” Dunaway says. “We feel like we kind of know better after 30 years. Ultimately what we’re selling is profitability and return on investment.”

    Franchising, long a popular method of accelerating growth in the quick-service market, shows no signs of slowing down. Up-and-coming brands are increasingly using franchisees to push up unit counts and quickly bring their brands to regional, national, and international audiences, experts say.

    In recent years, even legacy brands like Burger King, McDonald’s, and Wendy’s have made headlines for massive refranchising efforts.

    Among the top 500 chain restaurants, 76.4 percent of 2014 unit growth came from franchisees, according to Technomic. The share of franchise growth was up more than 2 percent compared with 2009.

    But Technomic’s research also showed that heavily franchised brands underperformed compared with company-owned stores in 2014. The 225 majority-franchised chains studied posted a lower-than-average sales increase of 3.2 percent in 2014; the 44 completely franchised brands recorded a collective decrease of 1.6 percent.

    Conditions were much better for companies that operated more than half of their own locations, which counted a 5.6 percent collective increase in 2014 sales—higher than the average 4 percent increase for the top 500 as a whole.

    The group of 183 chains that included no franchisees posted the highest sales gains in 2014, at 6.2 percent.

    Technomic content manager Mark Brandau says data flies in the face of the conventional wisdom that says franchisees are just better at operating restaurants than large corporations. Nevertheless, he does concede that there are plenty of advantages to franchising.

    “I think what I bristle at, and what the data don’t necessarily confirm, is this notion that a franchisee is always going to automatically outperform a company-owned unit manager, all things being equal,”
    Brandau says.

    That’s one reason several brands are opting against the franchise model. Modmarket, a 13-unit, Colorado-based, health-minded fast casual, is fueling its growth in-house. Save for a single airport franchisee, which was required by the Denver International Airport, all of Modmarket’s stores are corporate-owned and operated.

    Cofounder and co-CEO Anthony Pigliacampo says he plans to keep it that way. The farm-to-table chain aims to become a national brand with eight new stores planned for 2015 and as many as a dozen in 2016.

    Pigliacampo says franchising can be a smart, convenient financial tool to accelerate growth. If Modmarket were a simple sandwich concept, he says, franchising might make sense.