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Why so many restaurant chains fall over the edge—an analysis


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Five franchised restaurant chains have filed for bankruptcy protection since December, most recently Sbarro. Our veteran restaurant reporter takes a look at the reasons behind the trend that no one wants to follow, and offers some guidance on how to avoid it. 

Chain restaurants sure seem to be in trouble these days, at least by one measure: bankruptcies. Five franchised restaurant chains, and six overall, have requested federal debt protection since December, and others could follow as brutal wintertime sales push concepts walking a financial tightrope over the edge.

The bankruptcy trend has affected brands in all sectors and service styles, and includes a pair of big concepts once thought to be among the most enviable in the restaurant industry, Sbarro and Quiznos. Others include the mall-based chain Hot Dog On A Stick, the sports bar owner Fox & Hound Restaurant Group (which also owns Champps) and, most recently, the Italian chain Johnny Carino’s. 

The reasons for the filings are as numerous as the chains themselves, from sales problems to debt problems or even simple disputes with vendors. But we can come up with several lessons from the bankruptcies, especially when we compare them with the restaurant industry’s other big trend at the moment: initial public offerings.

Consumers are picky

Post-recessionary dining trends are catching up with some of the industry’s weaker concepts. Consumers are fickle to begin with, but they’re also dining out less: According to NPD Group, consumers ate out 20 percent of the time last year. In 2008 they ate out 22.6 percent of the time. 

Thanks to social media and websites like Yelp, consumers have ratings systems to judge restaurants and discover new concepts or local chains. Big chains like Burger King, Wendy’s and Applebee’s have been investing millions into remodels and technology changes. This leaves behind concepts that can’t do these things. 

The result? Every one of these chains in bankruptcy court have suffered sales losses that contributed to their downfall. Meanwhile, fast-casual chain Zoe’s, which went public in April, had same-store sales growth of 6.8 percent in 2013, after double-digit same-store sales growth each of the previous two years. 

“Competition is fierce,” said Adam Friedman, a partner in in the bankruptcy group of law firm Olshan Frome Wolosky, which represented Fox & Hound Restaurant Group in its filing. “There are many concepts and chains, and new chains, competing for the same customers. The competition is occurring at the time when consumers have less money to spend. This seems to be benefitting new chains, or the concepts that have been able to reinvest and keep their menus and concepts new and current.”

Franchisee selection counts

For years, Quiznos was THE hot concept in the restaurant industry, making it one of the fastest-growing chains in the country in the early part of the 2000s. The company’s executives now blame that fast growth for much of its problems, saying Quiznos sold franchises to anybody who would buy them, and then did little to help determine where their units should go.

The company’s business model also didn’t support profitability. Operators were required to buy food from its distribution arm, American Food Distributors, which charged higher prices for food and paper products. The chain’s sales fell yearly, with unit volumes falling from a high of $436,000 to less than $300,000 at the time of the bankruptcy filing. As a result, thousands of stores closed, taking the chain from a peak of nearly 5,000 to 2,100 today, including international stores.

Contrast that with Popeyes Louisiana Kitchen, which has focused on growing top line sales and improving profitability for its franchisees. Unit volumes grew from $1.2 million in 2008 to $1.6 million last year. 

The lesson: The best concepts make sure they attract strong franchisees, and then give them a profitable business. The operators are happier. They don’t cut corners, and they make investments that fuel sales even further.

Debt kills

Quiznos could have fixed its business model and invested in the business and its operators, except for the $875 million in debt that the company borrowed in a 2006 leveraged buyout. The company could have eliminated that debt two years ago, but instead left $600 million in debt following a restructuring. That just delayed the inevitable.

Similarly, Sbarro had $400 million in debt in 2011, but it filed for bankruptcy protection, and then emerged from that bankruptcy with $130 million left on the books. The company badly missed earnings targets established in its reorganization plan—it projected $31 million in EBITDA last year, or earnings before interest, taxes, depreciation and amortization, but finished with just $4 million. 

Falling sales combined with too much leverage is an ugly combination. Leaving too much debt on the books, especially after a bankruptcy, leaves a company with little room for error, making it unable to make the big changes and investments necessary in a revitalization project.

Internet kills, too

Both Sbarro and Carlsbad, California-based Hot Dog On A Stick are mall-based concepts in an era when people are simply not shopping as much as they used to. According to the research firm ShopperTrak, foot traffic at retail centers declined 14.6 percent during the recent holiday season—but total sales actually grew, by 2.6 percent.

To be sure, retail traffic isn’t the only problem. Sbarro’s business model, for example, is also outdated. The company premakes its pizzas and then reheats them for speed of service, while consumers increasingly want freshly made products.

But in the end, fewer shoppers means fewer eaters. Both chains blamed declining retail traffic for their problems. But as the number of shoppers declines, the result could affect other restaurants that have built their businesses on nearby retail traffic. 

Nobody is safe

In the 1980s, finding an open seat in a Champps, now owned by Fox & Hound, was like getting a winning lottery ticket. In the 1990s, Sbarro was one of the most profitable restaurant businesses in the country, luring lots of investors and cash. 

But fickle consumers found the next best thing. The chains were bought and sold, got loaded up with debt, and then began making sacrifices to make profits. The chains’ quality took a hit, and then sales fell further, ultimately leading to their current state. 

It’s a lesson for all of those high-flying concepts with big sales and huge profits: Be wary of the mistakes that put these other chains into bankruptcy court. Because today’s hot concept could be tomorrow’s has-been. 

 

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