Judging from the performance of Potbelly Corporation’s (NASDAQ:PBPB) IPO on Friday, the franchise remains a popular investment concept in Wall Street. The company operates and franchises Sandwich Works shops in the US.
But as is the case with other investment, not every franchise is successful. And even among successful franchise chains, some fare better than others. McDonald’s (NYSE:MCD) and Yum Brands (NYSE:YUM), for instance, have fared much better (in terms of equity performance) than Wendy’s (NASDAQ:WEN).
What makes the difference? Five factors:
1.The Right Business Model: The way the chain enhances customer value vis-à-vis the competition. Franchise pioneer McDonald’s, for instance, delivers customers a quick, convenient and inexpensive meal, vis-à-vis traditional restaurants. KFC offers the same meal attributes but with a different menu—focusing on chicken rather than hamburgers—though both chains broadened their menu portfolio overtime, adjusting it to the local tastes.
Dunkin Donuts offers coffee and donuts (and in recent years ice-cream) to go at convenient locations.
2. Scale: The Cost savings associated with a larger production scale of a standardized menu–the bigger the production scale, the lower the cost per menu. With 33,510 units around the world, for instance, McDonald’s has a scale advantage over Wendy’s, which has 9,792 stores.
|Company||Rank||Worldwide Sales ($M)||Domestic Units||InternationalUnits||TotalTOT -2.9%Units|
|KFC (Yum Brands)||3||21,300||4,780||12,621||17,401|
|Pizza Hut (Yum Brands)||6||12,626||7,600||6,147||13,747|
|Dunkin’ Donuts (Dunkin Brands)||18||6,004||6,792||3,020||9,792|
Source: 2012 Franchise Times: Top 200 Franchise Systems
The scale advantage is reflected in the operating margins of the two companies. McDonald’s enjoys a hefty 30.12 percent operating margin, versus 7.38 percent of Wendy’s.
|Company||OperatingMargins (%)||Return on Assets (%)||Qtrly Revenue Growth (yoy)||Qtrly Earnings Growth (yoy)|
Source: Yahoo YHOO +0%.Finance.com
3. Scope: The cost savings associated with the offering for sale of different products by a single corporation rather than by different corporations. McDonald’s and Panera Bread, for instance, offer a variety of products for sale (McDonald’s has added Mccaffe in many locations), vis-a-vis Wendy’s and Dunkin Brands. That can explain the higher return on assets.
4. Location: The benefits associated with occupying primary location sites for franchise stores. In fact, location can support and re-enforce all these advantages. As an older franchise McDonald’s, for instance, had the opportunity to pick best locations. This further explains both the hefty operating margins and the high return on assets.
5. Market Saturation: The degree of market penetration. The lower the degree of penetration, the higher the room for the company to grow by opening new stores. Potbelly and Panera Bread, for instance, have more room to grow, vis-à-vis McDonald’s and Yum Brands.
The bottom line: Successful franchise chains begin with the right business model, and proceed with the amassing of the right scale and scope in the right locations, until they reach optimum market saturation.
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