Last week Domino's confirmed to Ad Age that some of its outlets have been shuttered as a result of the financial meltdown. "It is true that there have been some franchisees that have closed due to lost business and because of difficulty getting credit to see them through," said Domino's spokesman Tim McIntyre. "I believe you will find this to be true in virtually every franchise business." He declined to say how many stores have closed.
The picture was similar at Yum Brands, owner of Pizza Hut, KFC and Taco Bell. Chief Financial Officer Richard Caruccio said his franchisees were having a tougher time obtaining loans. "Credit-market conditions have affected our refranchising efforts, as lenders have increased their equity requirements for our franchisees," he said. "Additionally, lenders have intensified their review process, which has added time to complete certain transactions."
The corporation is in the process of selling company-owned stores to franchisees, as well as rolling out its Wing Street platform to all U.S. Pizza Hut locations. Franchisees are spending between $40,000 and $70,000 per restaurant to make the necessary modifications. Pizza Hut has Wing Streets in 1,700 of its 7,500 U.S. locations. Yum hopes to reach a critical mass by the end of 2009 so that national advertising efforts can begin.
Alisa Harrison, spokeswoman for the International Franchise Association, said the industry is in a holding pattern, waiting to see the effects of the $700 billion bailout package it championed last month. "I don't think we'll see any opening up of credit until we see some of the bad debt move off of the books," she said.
In spite of the pinch, some franchisors are getting crafty. Hardy Grewal, who owns the franchise rights to Subway restaurants in Los Angeles and Orange County, Calif., said development hasn't slowed, but he's working with existing multiunit franchisees, who are now putting down between 30% and 50% down payments on loans. The previous minimum, he said, was 20%. Mr. Grewal said he's in the process of establishing a private-equity group to lend his franchisees money.
Mike Orcutt, who owns 79 Domino's franchises in Georgia, South Carolina and Alabama, said the situation will be hardest on operators newer to the business, particularly because they have had shorter relationships with banks. "I think there will be some falling out of players that aren't performing as well," he said, adding that he expects to see it with "franchisees and operators all across the fast-food marketplace."
Financial tumult has scuttled even the best-laid plans. "Some battle plans may have been drawn before the recent freeze and the stock market declines," said Ken Costello, an attorney with the Los Angeles firm of Bryan Cave who represents franchisors. "[It's] put us in a different climate, and there's a chance that franchisors will rethink those kinds of requirements." Mr. Costello said he expects banks to start seeking security interests in their restaurant loans.
McDonald's is in the process of building specialty coffee bars in its 14,000 U.S. locations, for about $100,000 apiece. The company, which declined to comment, has said everything remains on track. Franchisees are, at the very least, facing more-exhaustive examination and higher interest rates.
"There will absolutely be more scrutiny," said Jonah Kaufman, chairman, McDonald's national advertising committee, at the RBC Capital Markets Consumer Conference last week. "They will definitely be looking at your ratios, your cash flow, your P&L, which they always did, but I know they are going to take a harder look. What will change, absolutely, will be interest rates."
RBC analyst Larry Miller said the real problem for franchisees may simply be that lenders are gun shy. "I think where it will have an impact is as franchisees go to the bank and say, 'I have 20 units, and I need to get funding to roll out a new program, and I need a million bucks' because of the scale of some those franchise organizations, [some banks are] going to say, 'No, I'm not going to do that,'" he said.