Franchisees still operating in Russia have generated backlash. Here’s why restaurant chains still favor this business model

Papa John’s International Inc. on Thursday announced a deal with Sun Holdings, one of the pizza chain’s largest franchise partners, in which Sun Holdings will take control of 90 locations in Texas.

Only a few weeks ago, Papa John’s PZZA,
+1.45%
was headline news for a franchisee that continues to operate nearly 200 locations in Russia despite that country’s brutal attack on Ukraine and the company’s decision to halt operations in Russia.

Even with the possibility of controversy and any other issues that may arise, franchising is a popular business model for restaurant chains. Other restaurant companies with franchise operations include Yum Brands Inc., the parent company of Taco Bell. YUM,
+0.24%,
Wendy’s Co. WEN,
-1.23%
and parent company IHOP Dine Brands Inc. DIN,
-3.03%
McDonald’s Corp. MCD,
+0.80%
owns more than 800 restaurants in Russia, according to the New York Times, but franchises others there and elsewhere.

Franchising has proven to be a risk worth taking during the COVID-19 pandemic, experts say.

“When the pandemic hit, franchises adjusted accordingly, moving towards delivery, managing costs and attracting and retaining the workforce – a demonstration of their resilience and drive” , Rabobank analyst Tom Bailey wrote in a note released on Friday.

“Franchisors have focused on keeping their brands consistent, investing in technology to support efficiency, and providing financial support as needed (such as deferred rent and royalty payments). Meanwhile, franchisees have focused on keeping doors open, adjusting health and safety protocols as needed, and being as efficient as possible.

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These efficiencies include operating with fewer workers, adding or strengthening delivery service, and more.

“Compared to the April 2020 outlook, many franchise restaurants have performed very well,” the report said.

Rabobank estimates the typical cost to start a franchise at $2 million to $4 million, plus ongoing costs to maintain the franchise. This high price is increasingly making it a business for deep-pocketed investors, like private equity.

But there is an increasing amount of money being generated for investment. The franchise as a share of U.S. foodservice sales has grown 4% annually since 2015.

The franchise actually provides some security, according to Mark Kalinowski, a seasoned fast-food analyst and managing director of Kalinowski Equity Research. Franchisors collect royalties without the operational hassles of managing each individual location, for example. Kalinowski calls it “a much easier business, a much higher margin business” than Wall Street has generally favored over the years.

It’s true that franchisees running their restaurants in a way that generates bad press and worse comments on social media is not a good thing. But Kalinowski says the Russian-Ukrainian conflict is not the norm.

“It’s like a Wild West situation when a country goes off the rails by acting like a good neighbor,” he said. “It’s not as simple as closing the doors. Other people have the keys.

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Kalinowski and Rabobank say international franchising is important today and will be in the future. Twice as many units developed in the rest of the world compared to North America between 2016 and 2021, according to data provided by Rabobank.

David Bloom, director of development for Capriotti’s Sandwich Shop and Wing Zone chains, says the importance of having the “right partner” overseas is exponentially higher because of all the responsibilities the franchisee bears, from the real estate to the supply chain. He has overseen operations in 33 countries.

There may be a lot at stake, but Papa John’s situation in Russia is an aberration, he says. More often than not, franchisors and franchisees work as partners where the success of one is highly dependent on the success of the other.

“Bands that go overseas but don’t find the right partners often fail,” Capriotti said. “They end up having to invest their own resources in having the wrong partner.”

Companies have implemented strategies to avoid this fate.

“Often, franchisors establish a limited number of restaurants in a foreign market, manage them directly, and then gradually hand over subsequent development deals to proven and trusted local franchisees who know the market,” Rabobank said.

Despite headwinds, including supply chain and pandemic issues, Rabobank says the franchise is poised to grow. In the United States, advances in technology and the smart use of limited-time offers will help franchisors reap rewards, although the results may not be as strong as they have been over the past five last years.

“As American franchises strive to keep the American Dream at home, the overseas market is calling,” Rabobank wrote. “There is significant growth potential from Europe to Asia.”

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