Another year has come to an end. And thus far it has been a busy year for the franchise industry. We have seen numerous new concepts opt for the franchise business model as their growth engine, enter the market, and a few others lose traction. So, what’s hot in the sector? Here is a quick look at some of the key trends in the franchise industry over 2018 and the impact they will create in 2019:
- Restaurant franchises increased their focus on off-premise options: An increasing number of franchise restaurant brands were quick to latch on to rise of on-demand delivery and catering trends. For instance, sales increases from off-premise avenues also prompted Schlotzsky’s to include more options to ease to-go and pick up facilities as a part of its overall brand refresh last year; while Firehouse Subs replaced some of their table and chairs at all systemwide locations with shelves where delivery orders can be stacked. The number of food delivery app downloads is up 380% compared with three years ago.
Prediction for 2019: Operators are going to take a thoughtful, strategic approach to delivery. Now that the off-premise model has been proven, we can expect the next year to be one where partnerships with third-party companies get more collaborative in the face of increased competition. Some operators might even look at bringing some of the operations in-house after careful consideration.
- Rise of “public-to-private” deals among publicly traded franchisors: The number of “public-to-private” deals, where a private equity group buys a listed company, hit 152, up from 94 in 2016. Among the big franchises to take this route included Bojangles’, Sonic Drive-In, Jamba Juice, Buffalo Wild Wings. The impact of large public-to-private deals can be seen on the FRANdex, an index for publicly traded franchise companies developed by FRANdata. In Q2-2018, M&A activity and stock splits largely led the index to underperform both the S&P 500 and Russell 2000.
Prediction for 2019: The trend is not expected to slow down any time soon, as more and more publicly traded franchise restaurant concepts continue to be impacted by economic and consumer changes. Bain has identified 72 potential listed targets in the US alone that represent a “rich hunting ground”.
- Franchisors focus on flexible space options to reduce overheads: The high rate of closures at traditional anchor businesses like Sears and Toys R Us forced franchisors to come up with innovative ways to disassociate their topline from being anchored to malls. One such strategic innovation that is evident off late is the focus on spin-offs and offshoot concepts, that focus on smaller real estate options. Satellite locations, kiosks and smaller store alternatives are just a few of the ideas franchise groups. Companies like Denny’s, The Cheesecake Factory, etc. have all adopted this strategy to cut occupancy overheads particularly in the current economic climate where there is more pressure to reduce operating costs.
Prediction for 2019: Expect franchisors to focus more on franchisee profitability and creating more innovative approaches to reduce their operating costs. We can expect franchisors to begin initiatives to simultaneously drive new customer growth, increase average ticket, increase customer frequency, and extend the lifetime value of the customer as well as create and perfect recurring revenue models for franchisees.
- Franchisees chose alternative capital sources of financing: While institutional lenders are picking up their role as the most active player in the market with a small business loan approval rating of close to 65%, these banks are primarily seen to be more inclined towards large, multi-billion corporate loans as their small business lending rating has remained largely flat in the last year. According to a recent report by fin tech research firm Medici, small business loan approval rates at alternative lenders were 55%-60%, while those at large banks were 23%-27%. Having said that, SBA guaranteed lending also remains an important part of the overall franchise lending by specializing in small and startup borrowers.
Prediction for 2019: Brands will aim to create exclusive strategic lending relationships with banks, fleet leasing companies, and other financial institutions to gain access to start up and expansion capital, securing liquidity for their system.
- Franchisor chose “going global” over “staying local”: 39% of units for the largest 200 restaurant franchisors in the U.S. are now international and over the past three years, 74% of these franchisor’s collective unit growth came from outside of the U.S.  A growing number of franchisors expanded their presence internationally in 2018. For instance, Pizza Hut signed a strategic deal to target at least 1,300 new stores in Latin America; while Orangetheory Fitness opened nearly 150 new units in international markets like Japan, Hong Kong, and Germany. Home healthcare franchises like brands Right at Home, Comfort Keepers, Brightstar Care, and Home Instead also increased their global reach by taking advantage of ageing demographics in places like Europe and Australia.
Prediction for 2019: It is evident that the globalization of American franchises is a movement that is not going to slow down any time soon. If anything, it will only gain momentum. More specifically, this growth is expected in countries with large emerging markets, such as India, Australia, The Middle East and China, who house over half of the world’s population but only a quarter of its gross domestic product. This could mean significant opportunities for franchising, as there has been a growing trend for U.S. brands seeking growth overseas.
- Franchise sales outstripped unit openings: There were 67 franchise brands with signed agreements for more than 100 unopened units, representing close to 16,000 unopened franchise locations. This was partly to overly aggressive franchise salespeople combined with weaker than expected franchisees’ returns. Another issue that led to such high number of unopened locations is directly related to site selection; while demand for traditional A+ endcap locations in premium developments far exceeds supply, availability of attractive second-generation sites has tapered off since 2008.
Prediction for 2019: Lenders and private equity are expected to look more closely at unopened units counts as a lead indicator and predictor of a franchisor’s sustainability. We can expect pricing multiples to be discounted by private equity buyers in 2019 resulting in lower valuations as these unopened territories/businesses are not being monetized by the franchisor.
- Consolidation among franchisees due to rise in PE ownership: Private equity investor interest was not limited to franchisors in 2018, they also showed a high attraction for franchisee businesses. For instance, CapitalSpring financed an acquisition of 38 Panera Bread cafes for Manna Development Group, a franchisee with more than 135 franchised locations across six states; while Bandon Holdings, one of the biggest franchisees in the Anytime Fitness system, received a majority investment from the private equity firm Fireman Capital Partners to help fuel its future growth. This rise in popularity of franchisees/owner-operators in the private equity circles led to consolidations among many franchise systems.
Prediction for 2019: Given the number of consolidations among franchisee base that has taken place in 2018, the next year would be the one for franchisors to evaluate the complexities involved in managing a franchisee base that is increasingly been acquired and owned by private equity investors. It is expected to be a year in which an increasing number of franchisors will try to understand the level of optimal balance required among franchisors in a market that is increasingly becoming attractive for private equity investments.