How franchising can deliver growth for neighbourhood restaurants

Following the COVID-19 pandemic, a notable shift in workplace dynamics has emerged, reshaping not only how we work but also how we dine. The rise of remote and hybrid working has blurred the lines between city centre business districts and local neighbourhoods, prompting a re-evaluation of dining habits. In response, restaurant brands are looking to expand in local neighbourhoods, drawing inspiration from successful models of the past.

In this article, we explore the role that franchising can play in developing this trend of neighbourhood restaurants.

Four years on and we are still experiencing the consequences of the COVID-19 pandemic. The pandemic forced organisations to allow remote working, with many adopting work-from-home policies to reduce the risk of virus transmission. Even now that the restrictions are lifted, many organisations adopt hybrid work models, allowing employees to split their time between working remotely and in the office. As a result, workers share their time more equally between city centre business districts and their local neighbourhood.  Similarly, dining habits have also changed.  During the working week, hybrid workers are increasingly exploring dining options closer to home, rather than relying solely on city centre restaurants. 

Growth of the neighbourhood restaurant

It is not surprising therefore that restaurants have recognised the opportunities offered by remote workers as they seek to increase the volume and diversity of eateries within local neighbourhoods.  In a recent edition of MCA, executives from both Gaucho and Noci described their two-part expansion strategies of continuing to open obvious city locations, but also expanding their proven neighbourhood models.

This focus on the local neighbourhood bistro is reminiscent of the Pierre Victoire restaurant chain, founded by Pierre Levicky in the 1980s. The chain had close to 150 restaurants at its height before falling into receivership in 1998. Pierre Victoire was positioned to tap into the local market, with a set menu price point that encouraged diners to visit once or twice a week. 

It is interesting that restaurant brands are recognising that there are now two, complimentary markets:  the city centre flagship restaurants and the smaller local neighbourhood restaurants. Brands are not deciding to expand one or the other, but increasingly looking to develop both. Many of these brands are planning to grow through opening corporately owned units, even in local neighbourhoods, but there are many reasons why a franchise model might provide a better platform for growth.

Franchising as a model for growth

So why would a business opt for franchising as a method of expansion? While it is true that franchising is not flawless, no system is. Franchisors and franchisees may not always share the same interests, leading to potential conflicts. Underperforming franchisees are not uncommon, raising questions about whether the effort justifies the return. So would a business not be right in thinking that building a corporately owned and operated chain would be easier to manage and more profitable?

The success of businesses like McDonald's, KFC, Pizza Hut and Domino's Pizza resoundingly disproves this notion. So why should restaurant brands be considering a franchise model to expand their neighbourhood concepts?  Franchising offers some unique advantages to any business looking to grow through a local network, including:

1.           Franchising provides access to alternative capital

Franchising can offer a solution to the capital and managerial constraints faced by expanding restaurant businesses. The traditional ways a business can access capital are either selling equity or raising a loan, although the latter may be difficult and costly in the early stages of a business’s development due to lack of collateral and a proven track record. In a typical franchise model, the franchisee provides the capital required to set up and operate the restaurant. Therefore, expanding businesses, particularly in the restaurant sector, use franchising as a way of accessing capital that would otherwise be unavailable to it, in a cost-effective way that also offers a fair reward to the financier (the franchisee).  Subsequently, franchising is often a more cost effective and realistic option. The smaller sites suitable for a neighbourhood restaurant will be attractive to a franchisee, with lower set up costs requiring lower initial investment. In addition to capital, franchising also provides an efficient way to obtain the managerial expertise needed to grow the business. Because a franchisee puts a significant amount of their own assets and time into the business, they are likely to purchase a franchise only if they are confident in their managerial abilities. 

2.           Franchising offers an improved risk/reward balance

Aside from accessing alternative capital, a corporately owned restaurant requires investment in real estate and human resources, and both bring increased liability for the brand owner. Under a franchise model, it is the franchisee that enters into the lease for the premises and hires the staff to operate the restaurant, therefore the franchisee takes the burden of these liabilities away from the brand owner.

3.           Franchising creates financial synergy, requiring less management

A corporate estate of restaurants requires a costly management system to ensure the units are all operating well. In contrast, a franchise system replaces the need for such a costly management system with powerful financial incentives: franchisees benefit from profits and risk losing their invested capital if their business under performs. The interests of the franchisor and franchisee are aligned. This financial synergy minimizes the need for monitoring and maximizes franchisee performance, benefiting both parties. Managerial ownership improves performance for both parties. That financial synergy is what drives a franchisee owner to outperform an employee manager. As a business owner itself, the franchisee sees a direct correlation between its performance and its economic reward. 

4.           Franchisees provide local knowledge and a connection with local communities

Franchising allows the restaurant brand to leverage the local market knowledge of its franchisees as it expands into new geographic areas. This knowledge can be invaluable when developing a concept specifically designed for local neighbourhoods. There is also real value in having a local business operating a restaurant within its own community. The "think global, act local" mantra is perfectly served by a franchise model. The global brand brings all the advantages of scale – product development and innovation, increased brand awareness and value, stronger purchasing power, etc – but combines this with the local franchisee's awareness of and participation in the local community. Pierre Victoire may have made mistakes back in the 1990s, but one thing they did very well was create a sense of neighbourhood through their franchised estate. Their restaurants were very much regarded as the local bistro, somewhere customers could frequent on the spur of the moment, once or twice a week, for no particular occasion, but where they would be recognised by the franchisee. What Pierre Victoire lacked was the right systems and legal framework to control its franchisees and ensure uniformity across their estate.

5.           Franchisees provide innovation

Franchising allows individuals with entrepreneurial spirit and drive to become part of the restaurant brand's system, bringing fresh ideas and energy to the organisation. Although innovation must be controlled to ensure quality standards and uniformity are maintained, it provides vigour to the brand and builds passion within its franchisees.

6.           Franchise systems can increase brand value

A franchise network creates more value than a corporately owned network. Low-cost capital, motivated managerial expertise, and better local market knowledge are three key resources that should reduce a franchisor’s overall risk and have a significant positive impact on a franchisor’s financial performance and future valuation.

Summary

There are obviously a number of risks that franchisors must accept as being inherent in franchising their businesses, not least the commercial risks resulting from franchisees breaching their obligations, and as a result damaging the franchisor’s brand. There are also lessons to be learned from other's mistakes.

For success, franchisees must be carefully selected and trained to adopt the franchisor's systems with minimal deviation. Quality and consistency are key. Consumers must know that they will receive the same quality of product and service no matter where the restaurant is located. Pierre Victoire struggled with this. Their franchisees were perhaps given too much freedom to interpret the brand in their own way. When it worked, it was a great consumer experience, but when it didn't, it wasn't. Perhaps Pierre Victoire was a victim of its own success, opening too many restaurants in too short a timeframe, with selection and training inevitably suffering. 

If done correctly, franchising offers significant commercial advantages by providing a unique platform to grow a successful network of neighbourhood restaurants.

David Bond is a partner in the Franchise & Distribution Group at European law firm, Fieldfisher LLP. If you would like to discuss any of the points raised in this article or in relation to franchising more generally, please contact David at david.bond@fieldfisher.com.