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THE GREAT FAST FOOD CHALLENGE

by Dr Callum Floyd
 

Franchising continues to permeate an increasing number of countries and business sectors. Yet while previously non-franchised business types continue to adopt franchising, some industries are not so new to the form. Case in point: The fast food sector. In fact, the fast food industry is probably responsible for today's proliferation of franchising. Were it not for the likes of McDonald's explosive growth, from the 1950s onwards, franchising might never have gained the profile it commands today.

The fast food sector is a dynamic industry featuring a high density of franchising. It is also one of the most challenging sectors to operate in, due to an ever-increasing number of operations competing for the same dollar. Intense rivalry exists between concepts. Indeed, such is the challenge within the sector that Ray Kroc, the man who franchised McDonald's, once stated, "If you see a competitor drowning, you stick a hose down their throat."

Competing and defending market share within the fast food market has always been a challenging task. Operating within the current environment is even more demanding. The sector has been rocked by a number of trends requiring rapid and fundamental action. We explore three inter-related trends influencing the sector, namely the advent of lawsuits blaming fast food, a general trend toward healthier eating and the new low-carb craze. We also touch on the effect of increased competition before exploring how incumbent franchise systems are adapting to their changing environment.


THE PROBLEMS
The Threat of Law Suits

Obesity has reached epidemic levels in the world, and almost two-thirds of Americans are overweight or obese. Perhaps opportunistically, two high profile lawsuits have so far been waged at the fast food industry's tallest poppy, McDonalds Corp - claiming they didn't warn customers its food could be fattening. All have so far been thrown out, and the United States' GOP controlled house voted to ban class action suits blaming fast food. But industry insiders [naturally] remain concerned by these recent actions (which are similar to those waged against the tobacco industry) claiming if successful they could bankrupt several fast food chains, and leading economies could be dramatically affected (the US fast food sector employs almost 12 million people). The response by some players has been massive. Operations have changed menus dramatically, nutritional disclosure has improved, and advertisements promoting healthier lifestyles have increased.

Move to Healthier Lifestyles
Despite the recent legal attention most leading fast food chains had already begun responding to a general change in customer tastes, based on a desire to lead healthier lifestyles. No operation has perhaps responded to this challenge as strongly as McDonald's. McDonald's introduced fruit, a huge range of salads, wraps and other low fat options to their menu. Encouragingly, this strategy was credited with increasing sales in a number of markets, not least Australia - which bounced back from a loss to post a healthy profit last year. Thus, the move to a healthier menu can be a profitable one.

Other chains have also followed suit. Wendy's tested milk and fruit with its Kids Meals, and Burger King introduced low-fat baguette styled chicken sandwiches. Applebee's introduced a Weight Watchers menu in all its restaurants throughout the US. Sandwich chains, such as Subway, are clearly capitalising on the trend toward more healthy living. The chain has surpassed McDonalds's for the number of restaurants in the United States. Interestingly, Subway are reported to have said the health benefits of eating Subway sandwiches are one reason for its growth.

Low Carb Craze
Fad or not, Dr Atkin's and related low carbohydrate, high protein diets have rocked restaurant operations throughout the world. Perhaps nowhere has this diet been more prevalent than the United States, where recent reports suggest one in four Americans trying the diet, and more than 10 percent adhering to it at this point in time. Demand for low-carb products is strong, and increasing. In turn, that increased demand, has had a twofold affect on the franchise community. First, restaurants, and fast food operators, have rushed low-carb options onto their menus (clearly, alienating such a large proportion of consumers is not an option). Subway recently introduced two low-carb wrap sandwiches. Burger King joined the train by offering bunless Whopper hamburgers, and, Hardee's and Carl's Jr feature burgers wrapped in lettuce. Low-carb options also hit the breakfast menu at Holiday Inns.

The big challenge for most chains is wrestling with what to offer as a low-carb substitute to the existing product range.

Some franchised operations have not weathered the low-carb storm well. Krispy Kreme, the US donut sensation, was recently forced to publicly downgrade their profit forecasts. Blame was leveled directly at the low-carb craze. Scott Livengood, CEO of Krispy Kreme stated:

"Our current guidance assumes a continuation of the low-carb phenomenon that is affecting the industry. Needless to say, we are disappointed that external forces have caused us to revise our first quarter and fiscal 2005 earnings guidance."

The second low-carb effect on the franchise community comes in the form of whole new franchised concepts. Increased demand has not only pulled low-carb products onto restaurant menus and supermarket shelves. Whole new specialty retail concepts, such as McSlim's Low Carb Market, TLC (Totally Low Carb) Stores and Cactus Low Carb Superstore have been developed and now offer franchise opportunities.

Increased Competition
While the fastfood sector has long been regarded as competitive, the level of rivalry only intensifies. Numerous chains are expanding: multi-unit development deals are being inked left, right, and center. Brands like Subway, Krispy Kreme, Camille's Sidewalk Café, Cosi Inc, Whataburger, Papa Murphy's, Moes Southwest Grills and Bob's Big Boy are all on the expansion trail. Meanwhile, a number of incumbant chains and/or their franchisees are struggling to return positive results on existing operations. One well-known example is Burger King where one high profile multi-unit franchisee went bankrupt, and improved sales and profits are vital in turning other franchisees and the franchisor operation around.


THE ANSWERS
The above trends raise a number of challenges for chain management. The following excerpt from a recent Burger King press release reflects the initiatives undertaken by many leading operations in the fast food industry:

"Emphasis is on Return to Core Consumers, Commitment to Quality, Innovation and Differentiation and Unwavering Dedication to be 'Brilliant With the Basics."

Indeed, the various challenges of adapting to an ever-changing market place and environment, and increased competitiveness, are broadly being addressed by initiatives relating to (1) marketing differentiation, and (2), improvements in store level productivity and profitability.

Differentiation & New Marketing Initiatives
A number of chains have responded to the current environment by attempting to differentiate themselves from competitors, whilst at the same time making themselves more attractive to existing and new customers. No chain in the fast food sector has outperformed McDonald's in this regard. McDonald's sought to distinguish itself by introducing a range of products, a new focus on store quality, and the new "I'm Lovin' it" jingle. McDonald's new health focus involves new Go Active Happy Meals for adults that include salad, bottled water, a pedometer and advice to walk more. Other health initiatives include new low-fat dressing, more salads, and more nutritional information. So far the healthy initiatives have stood have stood the company in good stead.

McDonald's has also worked hard changing and testing a new image before rolling it out throughout the group. For example, McDonald's publicly available revitalization plan explained how experiences in New Zealand and France proved a fresh, sophisticated environment could generate increases in sales and profits. According to a recent press release, Burger King reportedly has a pipeline of 30 new products now being explored.

McDonald's and a range of other chains, like Starbucks and Schlotzky's have also sought to differentiate themselves by rolling out Wifi access (wireless Internet service) in many restaurants.

Another technology-based differentiation example include Papa John's "Pizza and Entertainment" promotion giving customers a perishable DVD movie (DVD's become inactive 48 hours after removal from packaging) free with pizza.

Unit Productivity & Profitability
The late Jim Cantalupo, past McDonald's CEO, recently outlined their shift in strategy and focus: "[p]reviously, we emphasized adding new restaurants. Today, our emphasis is on building sales at existing restaurants."

Nothing focuses attention on operations like intense rivalry. Intense rivalry pressures both market share and profit margins. As a consequence, increased competitive activity requires chain operators seek opportunities for improving both unit productivity and profitability. Numerous chains are exploring and implementing initiatives intended to improve both aspects. Burger King and Papa John's are both focusing on doing the basics well, with some franchisees struggling to service loans.

McDonald's is working with suppliers to identify potential production and sourcing efficiencies. Importantly, McDonald's is also expanding testing and use of labor saving equipment, and streamlining processes. For example, many of their US restaurants are changing from standard beverage dispensing machines to automated ones that drop and fill the right-size drink cups as sales are keyed into registers. Another example includes use of new machines to automatically filter and change cooking oil, thereby freeing labor. Self-order kiosks provide another.

7-Eleven, in a related sector, is also seeking to improve both unit productivity and improvement through standardization. Specifically, 7-Eleven is are seeking to obtain economies of scale in purchasing and marketing by requiring store owners to order 85 percent of 7-Eleven recommended products.


THE IMPLEMENTATION CHALLENGE
While there may be compelling reasons for change, implementing new initiatives is a challenging task. What sells in one market market may not in another, and new initiatives typically don't come without expense or risk to existing franchisees. Add to this the famous failure of some misguided franchisor suggestions (like Ray Kroc's Hulaburger), and franchisees have a right to initial scepticism.

And here-in lies the sticking point stemming the roll-out of many new initiatives intended for system-wide benefit. Whereas managers of company-owned chains can demand store-level operators implement new ideas, franchising proffers a very different dynamic and environment for affecting change. While managers of company-owned stores can be told to change, franchisees must be sold on change. Franchisees must be convinced the benefits outweigh the costs.

The recent experiences of 7-Eleven exemplify adaptation challenges inherent in franchising. 7-Eleven encountered extradinary opposition to their minimum purchase requirement (intended for reducing purchasing and marketing costs). The agreement has been in negotiation with franchisees for the last two years. Key franchisee concerns include reducing freedom in placing orders, and generally reducing franchisee decision-making ability.

In another example, International Dairy Queen (IDQ) gained high profile resistance for their DQ Grill & Chill concept, introduced about two years ago. A group of franchise owners protested publically, claiming the initiative requires more investment than some rural and small town Dairy Queen franchise owners can afford.

Clearly, franchisors need to work very closely with franchisees on new initiatives. As noted in Jeffrey Bradach's book, Franchise Organizations, which explores restaurant chain management, affecting systemwide adaptation is a complex and challenging task. Successful adaptation requires not only an understanding of organizational change, but also an understanding of franchisor-franchisee relationship dynamics.



This article was written in May 2004.
 
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Dr Callum Floyd is owner and editor of both Franchise-Chat (www.franchise-chat.com) and Franchise Wire (www.franchisewire.com). He has a Masters and PhD researching franchising, and is Co-Owner of Franchize Consultants (www.franchize.co.nz), New Zealandís leading and award winning franchise development company.

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