As the pandemic era nears its waning chapters, franchising has held steady. In fact, you could argue market conditions threw weight behind one of the sector’s historic growth vehicles.
The franchising field expanded at a 3.2 percent compound annual growth rate from 2015–2021, according to financial services company Rabobank. The share of franchising as a portion of foodservice sales in the U.S. scaled about 4 percent, per year, through that window. The top 10 franchising restaurants’ market share lifted from 19 percent in 2012 to 28.4 percent by 2021. That compared to an 11 percent decline for non-franchised restaurants, based on Rabobank estimates. Per Euromonitor, as of 2021, franchises accounted for some 40 percent of domestic foodservice sales.
During the pandemic, franchises grew their market share nearly 10 percent, Rabobank data showed. And it’s just beginning. McDonald’s franchisees, for instance, which make up 95 percent of its U.S system, experienced average growth of $125,000 per restaurant last year. That put operators over $500,000, a 50 percent hike in the past three years.
Financial reporting from franchisees, industrywide, indicated stronger-than-normal cash operations, up 28 percent in 2021 versus the five-year average. Franchisees grew absolute sales from $213 billion in 2019 to $238 billion last year.
The why behind the sector’s resiliency traces back to decades of selling points. But it also owes to what’s changed.
“Great quick-service restaurant franchise deals stem from mutual trust, attraction to a dynamic and growing brand and above all, the fundamental financial metrics of the business,” says Robin Gagnon, CEO and cofounder of We Sell Restaurants. “Rapidly increasing costs to launch and operate require that franchisees join forces with those who offer the greatest opportunity to leverage their capital and grow their operation.”
“For those reasons, AUV has never been more critical since sales can play a key part in delivering on profitability,” she adds. “Low-volume operations that a few years ago may have been worth a second look will slide as occupancy, interest rates, and buildout costs spiral to new norms.”
This has been clear at the top. Yum! Brands and Restaurant Brands International turned in significant growth in 2021. The Pizza Hut, KFC, Habit Burger, and Taco Bell owner debuted a net of 1,259 restaurants in Q4, pushing its year-end total to 3,057 net new openings—the most in its history, and, according to CEO David Gibbs, the most ever achieved by a restaurant group. Burger King, Popeyes, Firehouse Subs, and Tim Hortons’ parent achieved net growth of 4.5 percent, finishing the calendar with 29,456 restaurants compared to 27,025 in the year-ago period.
Inspire Brands, which directs Dunkin’, Arby’s, Buffalo Wild Wings, Rusty Taco, Sonic Drive-In, Jimmy John’s, and Baskin-Robbins, opened more than 1,400 units in 2021, including over 500 U.S. franchise-led stores and 800 locations outside the country.
Alex Oswiecinski, cofounder and CEO of Prospect Direct, says you can’t get around hard numbers. Brands with a solid ROI are going to attract operators, especially amid rocky conditions. “In a time when other assets like stocks are very volatile, folks are looking at where they can put capital that has a reliable, proven track record of returning cashflow in the near- to-medium term,” he says. “I believe the trend will continue where brands that have proof of existing franchisees making money by meeting the needs of today’s consumer will have a leg up over brands that are more aspirational, or oriented around hitting trends that are further out.”
According to the International Franchise Association’s 2022 outlook, franchise establishments in the quick-service industry increased by 2.6 percent last year. It expects the figure to clock in at 2.1 percent in 2022 for a total of 192,426 businesses. The important note was 2020 saw quick- and full-service franchise venues decline 6.7 and 6.5 percent, respectively. Both bounced back to the tune of 2.6 and 3.3 percent growth. Come 2023, they’ll nearly be on par with where the field stood pre-COVID.
Oswiecinski says his company has observed interest “about the same” for franchising as a whole pre- versus post-pandemic. “But it has polarized the winners and losers,” he says.
“The pandemic changed habits by teaching people that they could procure goods and services without leaving their homes,” Oswiecinski says. “Even after restrictions were lifted, these habits of expecting convenience remained. Brands that focused on technology or adapted to bring their service directly to the consumer, either physically or digitally, are winning.”
Gagnon agrees. “Franchisors that stand out are investing in technology on multiple fronts. This includes the customer service dimension where loyalty apps keep customers returning, measuring their distance to the door to prep food that’s hot when they arrive for pickup and allow for kiosk ordering, improved drive lanes, and more,” she says.
Franchise brands continue to leverage tech to reduce footprints (even to the point of cutting the dining room out altogether), while increasing speed of operations to reduce start-up costs, Gagnon notes. “They [also] are using tech to enhance marketing efforts, geo-targeting the consumer, even using artificial intelligence for order-taking to improve profitability as the labor model is re-evaluated within the category,” she says.
“An age-old principle is more relevant than ever today—a great franchise deal is awarded, not sold,” says Graham Chapman, EVP of account services at 919 Marketing.
COVID solidified quick service as a category nimble enough to take the technological leap, while also delivering on a support model for franchisees. It’s a dynamic that helped build loyalty and goodwill from operators as investments paid off and they kept the doors open during one of the most chaotic periods on record. As noted, once the landscape shifted, hosts of quick-serves were able to retain sales or even gain market share.
It’s going to reshape the base. “Technology fees as part of the franchise agreement within the sector is a topic to be watching as we head into 2023,” Gagnon says. “Shockingly few brands collect these fees as part of their FDD, but this will be a must-have for the future. The evolution of technology is going to require constant reinvestment to stay competitive in the marketplace. Companies that collect technology fees on an ongoing basis won’t need to put plans on hold to improve the customer experience while they search for funding to innovate.”
Stan Friedman, a 30-year franchise executive, veteran franchisor, and president of FRM Solutions, says leading bands are standing out due to adjustments and forward thinking just like what Gagnon mentioned. In other terms, whether brands met post-COVID requirements and cascaded those learnings down to operators, is a question prospective franchisees now seek out.
“More frictionless transactions and fewer touchpoints means online ordering and eliminating the need for someone to physically answer phones to take orders,” he says. “It’s a win for the operator in terms of labor, a win for the consumer—not needing to touch money, sign a credit card receipt, etc.”
Friedman believes the pandemic sped changes already coming. “And those who are really winning today,” he says, “are the brands that had the foresight to embrace these technological advances, prior to COVID, as opposed to making mad dashes toward less efficient solutions by virtue of necessity just to stay in the game.”
Graham Chapman, EVP of account services at 919 Marketing, refers to today’s leaders as franchise concepts “built for the modern-day customer.”
“These brands are usually led by forward thinking innovators who are ahead of the curve, especially from a marketing perspective,” he says, referencing product placements in popular Netflix shows and influencer campaigns.
“Of course, any brands that were early adopters of drive-thru models with a service-minded touch, i.e. Chick-fil-A’s new drive-thru model [express lanes], and have found creative ways to make Olo/delivery apps work without destroying margins are in a great spot,” Chapman adds. “However, an age-old principle is more relevant than ever today—a great franchise deal is awarded, not sold. Franchisors thrive only when they are growing sustainably and awarding locations and territories to qualified candidates who fit the brand and its culture.”
The makeup of franchising
There should be plenty of movement as the market resets. Among the top 50 quick-serves in 2020, the total number of franchised units fell 2 percent. However, franchisors’ share of unit ownership lifted from 13 to 15 percent. Meaning, operators stepped in at times to take back sagging operations. Those units could be flipped. Yum! said it anticipates $100 million in refranchising proceeds this year alone. High multiples and eager buyers led to significant amounts of deal activity during COVID. Private equity was aggressive. Wendy’s and Taco Bell franchisee Delight Restaurant Group reported a 92.2 percent growth in sales, primarily through acquisitions of units. Flynn Restaurant Group had $3.7 billion in revenue in 2021 after it completed a $552.6 million purchase of 937 Pizza Hut and 194 Wendy’s stores from bankrupt operator NPC International.
What’s next? Rabobank believes deals of this nature led to a shakeout of sorts for U.S. franchisees, “which is expected to result in greater consolidation of the landscape.” The company credited the uptick in deal activity to a confluence of challenges; higher returns, buyers’ cash levels, and recent growth trends.
Valuations in 2023/2024 are unlikely to be as attractive. Margins are tightening due to rising prices, instability in commodity complexes is increasing, and the cost of capital is climbing.
“I would say the economy is on everyone’s mind at the moment, specifically inflation and the government’s next moves,” Oswiecinski says. “This directly affects franchising with regarding to tightened lending, access to and cost of capital for prospective franchisees. This means brands that have the majority of their new franchisees using SBA loans may need to temper development expectations. Brands that have a product/services tied to essential human needs will fare better.”
The same goes for brands that are more inflation-resistant, or higher-margin business models with a smaller portion of the P&L tied up in labor and real estate expenses, he says—concepts differentiated enough in the market to have pricing power.
“Outside of labor challenges, the biggest topic to monitor has to be the economy in general,” Chapman reiterates. “Will the economy just endure a short dip or is a crash on the horizon? How do international conflicts/trade battles impact supply chain/distribution? If the economy does, indeed, crash will that actually be a good thing for quick-serves offering cheaper food, and often the comfort food options many folks turn to in an economic depression?”
As usual, setbacks will present opportunity for some and final straws for others, and that’s especially true of an entrepreneurial world like franchising. “Overall, though, as we saw in the last recession and during other periods of volatility, some people will use these external circumstances as an excuse to not make a change, while for others it will be an inflection point that prompts them to take the leap into something they’ve been wanting, but putting off, like franchise/business ownership,” Oswiecinski says.
Something else to consider is the landscape itself. In 2020, independent locations declined by 8 percent, according to The NPD Group (28,399 closures). But per NPD’s Fall 2021 ReCount restaurant census, which totals restaurants opened as of September 30, 2021, the independent field expanded by 1 percent, or 2,893 units, last year.
Independent locations grew in seven of the nine Census regions, NPD said, and large areas like Los Angeles, Dallas-Fort Worth, and Seattle-Tacoma.
Simply, independents are reemerging as a competitor, although they’re likely to trail for some time due to debt load and other realities difficult to address without collective scale.
“But even as dine-in returns, other channels aren’t going to vanish. While dining rooms are back, curbside and off-premises is not going anywhere,” Friedman says. “So brands that accommodate these incremental opportunities for transactions are win/win. Smaller footprints, fewer SKUs are also winning combinations, as supply chain and labor issues continue to linger.”
You can say the same about drive-thru, even if the angle has changed. “COVID made drive-thru an exponentially stronger competitive advantage,” Chapman says. “Drive-thru quick-serves could limit close proximity and face-to-face interaction, reduce/eliminate dining room service—therefore, limiting staffing needs—avoid complete reliance on delivery apps that can cripple margins, etc.”
“This created even more demand and interest in the quick-service category, especially for those with drive-thru models as sales exploded,” he continues. “It will be interesting to see if drive-thru concepts maintain their momentum in a post-COVID world where more and more folks are working from home.”
Labor isn’t a topic losing ground, either. Quick-service franchises boasted a workforce of 3,880,612 in 2019. The 2022 projection was 3,810,044, according to IFA. Full-service: 1,116,894 in 2019 and 1,096,149 estimated for 2022. “Franchisors who are taking direct action and sharing the burden of raising wages and the ‘Great Resignation’ are the ones that stand out,” Chapman says. “Some brands have introduced robot servers and other new ideas to streamline service and cut labor costs. Others have doubled down on showing their people how much they care to improve hiring and retention, like offering entry-level employees actual career paths and possible future ownership opportunities and hosting systemwide surveys to reward devoted franchisees with great stories by paying for education/certifications or subsidizing housing costs.”
As consumers begin to dine at full-service brands again, Rabobank expects franchising valuations to suffer. In the U.S., unit economics will remain strong relative to competitors, the company noted, but perhaps not quite as robust as we’ve seen over the last five years. So 2022 could be a year for some franchisees to exit as well.
Meanwhile, Rabobank sees significant franchise whitespace overseas as restaurants seek joint development deals. Between 2016 and 2021, units in the rest of the world grew to twice the number of those in North America.
“For franchisors in the U.S., more focus will need to be put into maintaining share, margins, and smart growth than absolute growth,” Rabobank said. “This will be done through innovation, tech advancements, and optimizing existing tools to allow operators to be more effective and to keep up with the increasingly capricious consumer. This may include the deployment of ghost kitchens, host kitchens, and smart limited-time-offering management.”
And just as COVID allowed franchisors to prove their mettle, the industry in 2023 and beyond will reflect the strength both ways. “Relationships are more important post-COVID than ever before,” Friedman says. “Relationships not just with consumers, but between franchisor and franchisees; franchisees and their teams, managers, and customers. And let’s not forget suppliers. Trust is not an entitlement and it takes intentionality to earn it and keep it.”