Monday, May 21, 2018
Business

The dark side of your $5 Footlong: Fast-food chains say it could bankrupt them

A Subway sandwich is far more than the sum of its fillings, franchisee Keith Miller says.

Those ingredients cost roughly $2. Then he pays labor. Electricity. Gas. Royalties. Credit card transaction fees. Rent.

All told, Miller, who owns three Subway franchises in Northern California, says it costs him well over $4 to produce one of Subway’s foot-long subs. And that is why, when the chain announced plans to drop the price of the sandwich to $4.99 starting this month, he and hundreds of Subway’s other 10,000 U.S. franchisees sent a strongly worded letter warning that the promotion could force some stores to close.

"The numbers don’t work for us," said Miller, who also chairs an industry group, the Coalition of Franchisee Associations. "Ten years ago, they might have worked, but now they don’t, in my opinion."

As fast-food chains across the country have slashed menu prices to revive flagging sales, a growing rift has emerged between some name-brand corporations and the local operators who run their outlets.

For years, the retail industry has been shaken by giant companies that have been able to keep prices low, wooing consumers but squeezing suppliers and smaller competitors. But in the restaurant business, the push to keep prices low has pitted corporate headquarters against individual outlet owners — all operating under the same brand.

Corporations need to grow systemwide revenue to please board members and shareholders. But small-scale franchisees, who face rising costs and increased local competition, are far more concerned with store-level profits.

In addition to Subway’s plans to relaunch the $5 Footlong, McDonald’s is reviving a version of its Dollar Menu and Taco Bell has promised to expand its selection of discount items, as have Wendy’s and Jack in the Box.

"This is an inherent financial conflict between franchisees and franchisers," said J. Michael Dady, a lawyer at the Minneapolis firm Dady & Gardner who represents franchisees in conflicts with their corporate parents. "And some have handled it much better than others have."

To date, the uprising at Subway has been the most visible.

In late November, franchisees began circulating a petition that asked Subway to withdraw the foot-long deal, which they said would hurt their businesses.

Under the franchise system, chain restaurants such as Subway coordinate menus, product sourcing, store design and strategy across all locations. Local operators pay the chain to belong to that system. They also manage the day-to-day business of their stores — rent, labor, ingredients, utilities, maintenance and equipment — and draw their paychecks from whatever is left.

Discounts can cut dangerously deep into those margins, the petition says.

The document has been signed by nearly 900 people from 39 states who claim to own Subway franchises. Like Miller’s, many are small or family-run entities that operate only a handful of locations.

In a statement, Subway said that the petition does not represent the views of the majority its franchisees and that the promotion is optional. Business owners who opt out, however, may face disgruntled customers.

In a separate presentation to franchisees, Subway said the promotion was intended to help them stanch several years of falling traffic.

But many franchisees say that corporate attempts to grow sales have added to a growing list of challenges.

Miller said that when he bought his first Subway 28 years ago, his margins could swell as high as 18 percent. But since then, he said, competition has grown far more fierce and costs have risen dramatically for labor, utilities and rent.

In California, where the minimum wage rose to $11 per hour on Jan. 1, Miller’s labor costs are up 50 percent from 10 years ago, he said. The cost of a full-price sub has risen only 20 percent.

Meanwhile, the restaurant market has grown more crowded. Between 2009 and 2014, the United States added nearly 18,000 fast-food restaurants, according to the Agriculture Department — growing at more than twice the rate of the population over the same period and continuing a decades-long trend.

To make matters worse, it’s not just quick-service restaurants competing for consumers’ dining dollars anymore. Fast-casual restaurants such as Panera, delivery services such as GrubHub and meal kits such as Blue Apron have all muscled their way into the market, as have grocery and convenience stores.

Despite the feedback from some franchisees, analysts say the discounting push is not likely to end. Chains have no other choice in this ultracompetitive environment, said Malcolm Knapp, the founder and president of an eponymous market-research firm based in New York. Many, he added, have succeeded in devising tiered value menus that also work well for local owners.

"The reality in fast food now is that you need a value menu to survive," Knapp said. "If you could live without it, would you? Sure. But the business shows you can’t."

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