Franchisors, Developers Pursue the Perfect Match

When it comes to evaluating a potential area developer, don't marry for money, say franchisors. With money as a given, look for that indefinable "fit" and you're golden for the long haul.

When it comes to evaluating a potential franchisor for a multiple unit deal, verify the numbers, say franchisees. If they're good, see how you get along with the "family" you're about to join. If all goes well, you'll be working closely and making money for decades to come.

When it comes to marrying for love or for money, in the franchise business it had better be both. Unlike real-life marriages, where someone will get rich eventually, even if both parties are miserable, in franchising you'll get neither. Money does not buy success in franchising, even if you outlive or outlast your "spouse."

"You can have the greatest partner, but the unit economics have to work," says Rocco Fiorentino, a Krispy Kreme area developer with a deal for 27 units in the Philadelphia area and western Pennsylvania. "The relationship is important from an operator perspective; brand affinity and unit economics are important from an investor perspective."

Assuming the unit economics work, there are the intangibles, the "click" that happens (or doesn't) when people meet. "It's one of those things," says Darin Harris, VP of franchise development for Captains D's Seafood. "If you or I are looking for employment and go into an interview, there are questions we ask about each other and our background, our objectives and long-term goals. You immediately see where there's a marriage or where there's not."

Looking for Mr. GoodDeal

Several of the operators interviewed for this story had cashed out of successful multi-unit operations-bagels, burgers, tacos-and were in the "flirting" phase, shopping for the right deal but sitting pretty enough to be patient and negotiate on their terms.

"We originally were looking at several different markets," says Clarence A. Mitchell III, who in 1998 was majority owner of 15 Taco Bell franchises in Charlotte. In 2001 he sold his holdings and started looking for another restaurant concept. Mitchell, who has spent nearly 30 years in the restaurant industry, began as an 18-year-old employee and worked his way up.

Along with his three operating partners in Serve Holdings, Mitchell soon found Captain D's an attractive potential partner, but they didn't tie the knot until 18 months after their initial meeting. They closed the deal on Nov. 3, 2003, agreeing to buy 20 corporate locations in the Memphis and Jackson, TN areas, and to build 15 more in the next 5 years. The territory includes sites in Arkansas and Missouri.

"When we first sat down with Captain D's, we zeroed in on this market as the ideal location for this organization," says Mitchell. It was a large deal, and they needed to be certain it was the right area and the right market at the right time.

"We have a buy-and-build strategy," says Mitchell. "As we started looking for the next move for our company, we wanted to be sure there was an acquisition opportunity big enough to be a springboard for growth."

With the other deals they considered, the necessary elements did not fall into place. Some franchisors didn't have enough restaurants they were willing to sell, or the ones they did want to sell were not generating the cash flow they wanted. "We buy cash flow," says Mitchell. Some offers were simply in the wrong part of the country.

"We're extremely happy with the results thus far," says Mitchell, who will remodel the 20 stores with Captain D's new prototype. "From a pricing standpoint we feel that we got an excellent opportunity. We have a lot of upside left in the market from a growth standpoint with the existing locations. And from a developer's standpoint it's not oversaturated."

Another reason is that Captain D's is not another burger chain. "It's a niche concept, where there's limited competition for the product. When I ride down the street I don't see a lot of competition," says Mitchell.

"They're able to go into a market where they may have other restaurants of their own, but no additional territory they can develop," says Captain D's Harris. "They can build out a brand that's not competitive with their brand. That's something we see a lot." This also gives area developers a way to retain valuable employees by providing them with a new opportunity for growth within the organization.

Four Is Enough

Michael McCracken also began early in the restaurant industry, starting with burger chains in high school in the late ' '60s and moving continually upward. By 1995, after 20 years as a Hardee's franchisee, he owned 31 restaurants and knew it was time to get out. "I saw the crash coming for hamburger chains, especially Hardee's, and sold out on top," he says.

When a bidding war for the units ensued between two Burger King franchisees, McCracken took the best offer to Hardee's corporate in July 1995, which matched the offer plus $1 million. Time to retire at 43? Couldn't do it. Too Type A, he says.

After shopping around, he climbed aboard the Krispy Kreme bandwagon and spent two years with the company, working at a franchise and going to school. But when it came time to award the franchise for central Illinois, he was offered a corporate job in Winston-Salem instead. He declined.

"It's a great company. I love 'em, but they made a decision to go with one of their best operators. I have no regrets. They made the right decision," he says. It was time for the free agent to begin his search anew.

"I looked at 50 different franchises. I looked at every franchise there was," he says. Some of the concepts that caught his eye included Zyng Noodlery, Bear Rock Cafe, Atlanta Bread Company, and Jason's Deli. "I wanted to be in the restaurant business, and I knew I could run anything."

In late 2002, during the Christmas holidays, his wife found Camille's Sidewalk Cafe on the Internet. "It was in an article on the top 50 franchises. She looked at every one of them and thought this made sense," he recalls. They traveled down to Tulsa a month later, met with the founders, David and Camille Rutkauskas, and decided to go with the concept.

"They gave me a one-store deal. It turns out I'm going to build four stores for them. That's all I want, to run those four very, very well. I've done the 30 stores across Illinois. Now I want to do four great stores." He has one open already in Peoria, which is Camille's top performer. Two more were scheduled to open in January 2004, one in downtown Peoria and one in the southern suburb of Pekin.

Why Do Area Developers Fall in Love? The reasons Fiorentino chose Krispy Kreme, Mitchell signed with Captain D's, and McCracken opted for Camille's differ for each developer-as they do for the other developers FranchiseUPDATE surveyed, and for the franchisors who signed them. The predominant reasons can be boiled down to two: 1) money, and 2) people. Both parties see a great opportunity to make money together, and to do it by developing a long-term relationship with like-minded people.

But it's the nuances, the variations, the individual chemistry and corporate culture, along with the vagaries of the marketplace (think Mad Cow) that makes life interesting in the franchise lane. We've sorted out the "wish list" of what franchisors want from multi-unit developers, and what those developers seek in a franchisor into handy, bite-size bullets (see table). Now let's see what the players have to say.

Money Makes the World Go Round

"Being a banker at heart, we looked at the numbers, the financials," says David Ostrowe, president and CEO of Ostrowe & Associates in Oklahoma City, discussing his purchase of four Captain D's company stores in October 2002. The biggest appeal, says Ostrowe, was the undersaturated, underperforming market. "We knew we could turn this market around fast."

Ostrowe remodeled all four stores in 9 months to reflect the new look of Captain D's. He also ran 26 weeks of TV last year, in a market where Captain D's previously had zero TV exposure. "Our commitment financially to this market has been tremendous, and the sales have paid off," he says.

As a franchisor of the four former company stores, Captain D's has earned more money in royalties than they earned in net profit when they owned the market themselves, says Ostrowe. "Both parties are making money now. Both parties have to win."

"When you have a concept with great unit economics, you want as many as you can have. Krispy Kreme has allowed me the opportunity to build units within 3 states," says Fiorentino. He signed a development agreement for 16 locations in the Philadelphia market, which includes the state of Delaware, and southern and central New Jersey. Later, he signed a second agreement for 10 more stores in western Pennsylvania and purchased one more for a total of 27.

Beyond the great unit economics, other factors that drew Fiorentino to Krispy Kreme include the company being one of the most vertically integrated companies he's ever seen (they not only manufacture their own mixes and fillings, but their own doughnut-making equipment from raw steel). He also is clearly taken with "the showcase in every one of our stores we've built. It's the theater that gives the guest the experience, the magic moment. We have the opportunity to provide a world-class product and a guest experience second to none."

Krispy Kreme also provides Fiorentino with a 2-in-1 method for increasing his profits. Using his existing equipment, he can make doughnuts to sell wholesale to stores in his territory, separate from his retail operation, with minimal additional cost.

The dual retail/wholesale opportunity was a strong plus for McCracken as he evaluated Camille's. "When I went down to Tulsa, I liked the operation. I felt we could make money. I liked the ease of the operation, especially the catering operation where you can make a thousand dollars worth of food to go out the door by 11 a.m., using your own kitchen with no extra equipment. It's very similar to what I was doing with Krispy Kreme, the idea of having two businesses in one."

For McCracken, everything just worked. "Camille's fit me, or I fit Camille's, however you want to say it. It just made sense."

But Don't Follow the Money!

"Don't just franchise to people who have money. Money is easy to find," says Captain D's Harris. "What's not easy is to find is people who are dedicated. You pay a royalty for two reasons. One is because you put a brand name on your building that immediately attracts customers. Second, is you're investing in a brand that has a system, and you're investing into that system because you want to follow that system."

Harris recalls a potential area developer who was very, very financially secure. "It had been a long time since I saw a portfolio like this gentleman had. In our initial interview we started talking and he said, 'Y'know, I'd really like to put an aquarium into the restaurant, serve some different desserts or seafood.' But that's not what our brand is about," Harris says.

"My point is that it's not just about having money, it's about having a cultural fit, people who are interested in growing the brand and how the system operates. They're getting into a franchise because they want to use the system and see the value in not having to create that system."

In their UFOC, Captain D's details its financials all the way down to the unit level P&L in Item 19. Harris estimates only about 30% of franchisors disclose so fully. "It's our approach, our culture. We want people to know about us as much as they can. They all want to know how much money they can make, and we can't as franchise sales executives talk about that," he says.

"Our job is to give them as much information about the investment opportunity as we can, and let them spend time on questions that are more important than 'How much money can I make?' Here are the numbers. Talk to the franchisees and verify them. Now let's spend some time talking about what makes a 20-year relationship work."

Niches and Barriers

If you're going to invest your money and your time in a concept, wouldn't it be nice if there were some small level of security, at least in the form of keeping the competition at bay?

"One thing people like about our system is that there are high barriers to entry," says Harris. "People just can't open up a seafood store and compete." The average unit volume for a Captain D's is $900,000, and it takes an equivalent investment to buy one.

"The barriers to entry for another company to knock us off are significant," says Fiorentino. "I don't say it's impossible, but there are significant barriers." He calls Krispy Kreme an "absolute brand," referring to the company's ability to control the product from raw ingredients to manufacturing equipment to the magical experience within the stores. "It gives us that cult-like brand that makes one feel secure in the brand."

Corporate vs. Franchise Stores

For many, traditional wisdom has it that 1) corporate stores mean competition for franchise stores, 2) a concept and system dedicated 100% to franchising is a positive thing, and 3) having exclusive rights to an area is best. For others, that's a load of hooey.

"I get frustrated when I hear about franchise companies that are just a franchise company. They don't even own corporate stores, or they just own two or three," says Todd Beckman, founder and owner of The Tanning Company in St. Louis. "It's impossible to keep up with your industry if you're not doing it yourself. That's my philosophy," says Beckman, who owns and operates 20 stores himself.

Beckman is adamant on this point. "If you're looking for a franchise and they have only one corporate store or two, what kind of franchise can they really be for you? Because they're not really out there learning the industry from day to day, making sure they're staying on top of it," he says.

"We'll never stop opening stores. It's the best way to understand your industry and make sure you're doing the best job for your franchisees," he says. "We're not just going to just be a franchise company and sit here and take royalties. We're going to be out there opening up our own stores too, helping our brand grow together along with our franchisees and always working on making our program better."

Beckman also is a believer that opening corporate stores in the same market as franchise stores is a good thing-when done right. "We have franchisees around some of our stores, but we're there for the franchisees to help. If we've got corporate stores in those markets, then we're just making that market stronger. We don't try to compete with them at all. We make sure that doesn't happen."

After years of struggling to convince people his tanning concept was a winner, Beckman hit upon the idea of combining his salons with fitness centers. "I felt that I'd seen a niche in a market that would allow me to reach people who would understand what I'm doing. If I could get into the gym industry it would allow us to build the brand faster."

But he couldn't prove to the gym industry that it would work. "No one would believe me," he recalls, "so we had to create this on our own." He bought the rights to Gold's Gym in the St. Louis and Indianapolis markets, built his first combined operation in St. Louis, and it's been off to the races ever since.

"It was a success from day one. But that took us two years," he says. In St. Louis two Gold's Gym/Tanning Company sites are open, with two more under construction. As he expands the twin concepts of tanning and fitness to Indianapolis, he plans to do that market himself. "We're that excited about our program-we're going to keep growing corporate stores there too."

Ostrowe, in his initial meeting with Captain D's, was impressed by the company's willingness to build more company stores. "As an operator, I think it's important to know the franchisor sees the viability of the concept. I personally would shy away from companies that only franchise. I would question, 'Are your returns not there?'"

In addition, Ostrowe says his company is operationally driven and he needs to deal with people who speak his language. "I want to be able to sit down with the corporate director of operations and say, 'We're having this problem, are you?'" As he sees it, if a concept is 100% franchised, "Their goal is to sell more franchises and get more royalties. What is their priority?" he asks.

No problem, says Harris. Senior management at Captain D's are not afraid to roll up their sleeves. "They can go in and run a kitchen and not think twice about it. We want to see franchisees the same way, not only with the dedication to do that but the dedication to customer service."

Ma-and-Pa vs. the Big Boys

In the age of BIG, is it possible that franchisors have gone overboard in seeking multiple-unit deals, and are neglecting the very things that built the franchise industry into the global powerhouse it is today? Some people think so.

"In the old days, the ma-and-pa's were encouraged. You got one store, and if you got a great store and followed all the rules in five or six years you'd get a second store," says Camille's franchisee McCracken. "Today franchisors are saying, 'Unless you're going to be a regional player, we don't want you.' Nobody wants the ma and pa, the guy with the one store, anymore. And I think that's so much against the American spirit."

"That's the one thing I think franchisors are wrong about, and they're all doing it, which I find offensive," he says. "You would have a stronger network if you had great operators with one store. It's what built McDonald's and all the great hamburger chains. There were thousands of McDonald's and Hardee's franchisees who only had one or two stores, and they did a great job. They were there every day and the store was clean."

Why do they do it? "They want to make it easier for themselves. The more franchisees, the more headaches, the more people at conventions," he says. "I know why they're doing it and I think they're wrong."

Krispy Kreme, with about 20 developers for all 50 states, is a prime example of a franchisor pursuing multiple-unit deals exclusively. "There are other concepts where that may not work so successfully, and they are better expanding through single-unit operators," says Fiorentino.

"We sell territories and we also sell stores to individuals," says Tanning Company's Beckman. "To really grow the brand the way we want, we need to have individuals out there besides just area developers. It helps grow the brand faster."

Stability, Vision, Leadership

When it comes to cars, "Don't buy a first-year model" is often good advice. The same holds when shopping franchisors. Let them work out the kinks on someone else before you invest your hard-earned dollars. It can be good to get in early, but pioneers have a much higher fatality rate than those who follow.

"You want to make sure that the leadership in the organization has been stable, and that it's not a revolving door-from the operational standpoint as well as from a marketing standpoint," says Mitchell. "If an organization every couple of years is finding a new marketing agency, they don't have a focus yet." He says to look at their commitment and their history for growth, what they've done in the past, and what their future plans are.

Again, no problem at Captain D's, where senior management could possibly hold the all-time record for combined longevity in a franchise: president, 25 years; SVP operations, about 28 years; VP restaurant franchise operations, 25 years; and regional VP of operations, 30 years. And they're still relatively young men, says newcomer Harris, who came on board in May 2000.

As a multi-unit developer, you want the franchisor to know more than you and possess the talent set to help you, says Ostrowe, and not vice versa. (See sidebar, "Promises & Priorities.) "My team has experience with more than 100 restaurants, more than some franchisors." He sees Captain D's with a new VP of franchise marketing in place and a renewed commitment to building company stores and getting back to core disciplines. "I'm impressed with their management team," he says.

Support Mechanism

Leadership and experience lay the foundation for a franchisor to provide the everyday support required for the brand to grow. Mitchell likes what he's seen so far from Captain D's. "We've been thoroughly impressed so far with the level of cooperation and commitment to our being successful," says Mitchell. "Anything that we've asked for, any type of information or leadership that we've requested, it's been Johnny-on-the-spot. That's a great start for our relationship."

At Krispy Kreme, "There is support from every department: marketing, finance, operations, real estate, construction. Every piece of their company has been available to me and I have had access to it on an unlimited basis," says Fiorentino.

"I think you need to understand the ability of the franchisor and their own ability within their team; their ability as operators and their financial ability as investors," he says. "The last thing you want to do is sign to build 20 stores and hope you have the money when you get there. You've got to have a franchisor that has the ability to support you based on your needs."

Developers, too, must step up and support the franchise organization with their own resources. After all, at the multi-unit level, it's often a partnership of equals.

Yet no matter what level you're playing on, there's one more crucial ingredient required to get the most from the partnership, says Ostrowe. "It almost has to be a religious decision; you have to be committed to do whatever it takes."

People Power

On the surface, it seems to be all about business, but franchising always comes down to people (as does all good business). Sometimes a partner, client, or customer simply isn't worth the money. It's all a matter of finding the people you "play" best with.

"Every person I met who is with Camille's has been first-rate. They're down to earth, very likable. I think that's one of the secrets of their success," says McCracken. "I'm very happy with Camille's now that we're going down the road. They are very good people."

And while Mitchell appreciates a healthy profit as much as the next guy, or maybe more, the QSR industry is really about people for him, too. "It's more a people business than a restaurant business. We have the opportunity to affect a lot of people's lives every day."

It's What's Inside That Counts

At Camille's, owners David and Camille Rutkauskas are being extremely careful in selecting franchisees, says McCracken. "They've turned down a lot of deals. Money's not the answer, and I think they've done a very good job with that." Unless they see a passion for the business, he says, it's probably not a fit.

"David knew I had passion, he knew I had desire. He saw that burning desire. I think many franchisors will just pick up anybody who will fill out the form and put down the money. They're not doing that."

"Fire in the belly is essential," says Ostrowe, who has achieved a great deal at a young age. "You can't teach fire in the belly. You can't teach ambition, drive, personality. Businesses that try to teach those are wasting their time. I can teach someone to fry fish."