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Four pillars support lasting growth in restaurants


Whether it’s opening new units in existing territories or bringing brands to new regions, restaurant franchisors and franchisees are experiencing a hot market.

On the macro-economic level, the recent Bank of America Merrill Lynch 2015 CFO Outlook Pulse survey showed 72 percent of middle-market CFOs across the country report their mid-year revenues are either on target or exceeding 2015 projections. Further, 84 percent of CFOs say their companies are driving earnings through domestic expansion, while 27 percent are driving growth through international expansion.

Growing brands should keep in mind the following four elements of the most successful concepts that have grown over long stretches of time.

Profitability: Does each single restaurant unit make money at the store level?

Franchisors and franchisees must determine whether the individual units are profitable and over what time frame a new unit reaches sustainable profitability. With a simple but satisfying product, clear mission, customer responsiveness and modest capital expenditures, profitability can be achieved over time.

However, the best concepts (and operators) are those that bring units up to speed within 12 to 18 months of opening and generate return on investment in the mid-30 percentile range or above.

For example, Chipotle has generally had among the highest and consistent ROIs of almost any concept today, given strong average unit volumes against modest capital expenditures per restaurant. In Chipotle’s case, they are generally at or above 50 percent returns. These are unlevered returns, so if a growth concept can use a little debt that even further enhances the return on equity.

Consistency: As you open more units, do they perform similarly in terms of sales and profits?

Brands must also evaluate and execute strategies that enable new units to generate similar levels of sales and profitability, so the concept can run uniformly across the system as it builds out. Consumers seek out the comfort that a consistently operated franchised concept provides, even as they do appreciate regional flavors or uniqueness.

This is where a concept such as Panera Bread has historically exceeded investor expectations. With innovative menu offerings, use of digital technology and clearly defined simple strategies, the chain experiences consistent operating results.

Panera Bread annually discloses the unit level sales for restaurants built in a single year, which allows investors to see the sales levels for these new units. This prevents issues, such as new geographies or cannibalization of new concepts, from dragging down the returns of newer units.

Replicability: Can new units be opened easily and at an increasing pace in new and existing regions?

Successfully implementing a concept over and over again in new geographies has been a challenge for some of the newer public concepts. Consider that both Noodles & Co. and Potbelly openly discussed struggles in Washington, D.C., and New York City. These markets proved challenging given high rents and competition.

Some successful expansions include In N Out’s move into Texas and Chick-fil-A’s growth into the Northeast. While both franchisors are considered somewhat regional names, both have succeeded outside their core market. 

Culture: What is the essence of why employees love working there and how to preserve despite growth?

Finally, culture is a critical part of the equation. New concepts such as Raising Cane’s spend a lot of time and financial resources to maintain culture across their growing business. For instance, founder Ron Graves spends time personally with new store managers to spread the culture.

A franchise that can maintain the same culture that led to the single unit’s success across new units is more likely to find the motivated employees and satisfied customers.

At the same time, when expanding into new markets, businesses must be mindful of the different cultures that come with new territory.

Maintaining concept consistency while understanding and catering to different customers in each market will keep franchise branches thriving.

If a franchise is able to master each of these four concepts—profitability, consistency, replicability and culture—they will ultimately achieve a highly sustainable rate of growth, and that sustainability is what the market ultimately pays for long-term.

Cristin O’Hara (cristin.m.o'hara@baml.com) is managing director and head of the restaurant group, and Roger Matthews (roger.matthews@baml.com) is managing director for restaurant investment banking at Bank of American Merrill Lynch.

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