It has been about three decades since international QSRs (quick service restaurants) first came to India in the 1990s. Since then, India’s homegrown QSRs have been bullish about replicating their growth in the West. The success of the international QSR brands in scaling up has come from the understanding that business has to be entirely system- and processdriven. They are seen to practice:
• Delegated controls: This reduces costs significantly and creates an environment of ‘common knowledge.’ The entire system responds to a challenge collectively
• Speedy system-wide implementation: As businesses go digital, speed is the new competitive advantage. Ideas are no one’s monopoly, the one who implements faster, implements better is likely to become the market leader
• Long-term evaluation horizons: There is an understanding that relentless quarterly and annual evaluation horizons will compromise long-term resilience.
Indian QSRs are already thinking this way. Because in respect to eating out, Indians are choosing branded options over unbranded ones; a natural outcome of economic progress. Hence, there is potential that the AOV (average order values) will also rise, giving homegrown QSRs the opportunity to set quality controls in place and serve world class products to their customers.
“Every franchisee makes a lot of money with every incremental sale. This is what keeps them very motivated to run their store well”
With the demand side sorted, the next question facing restaurants will be on the preferred mode of scaling up. Should they choose company-owned stores, or appoint franchisees? This is where I would like to share my personal experience with scaling up Jumboking, where I have tried both. I have emphasized time and again, that franchising serves the customer better in many ways. Let us evaluate two different expansion models.
To harness the full benefit of franchising, choose FOFO
Franchisee owned, franchisee operated (FOFO) operators are motivated franchisees and their livelihood is directly connected to the success of their unit store. When recruited, they add tremendous value.
They receive about 45 to 50 per cent of the gross margins generated from each sale, which is a big financial incentive. They take interest in the store and give the business the respect it deserves.
There is a small variation in this, where franchisees take on an investor role and outsource the operations. They give money but not their time. They look at the QSR business as one of their many investments. They are experimenting, constantly seeking a higher ROI and are not particularly vested in the success of a single store. They are probably at a level where they want their money to work for them and hence outsource operations to store managers.
This doesn’t work. Without adequate personal attention, the brand loses the vim and vigor of the entrepreneurial energy, which is the main advantage of the franchisee system.
Every franchisee makes a lot of money with every incremental sale. This is what keeps them very motivated to run their store well. They are a partner in the business in that sense and do not need external motivation to do a good job running the store.
In the case of company-owned, company-operated (COCO) stores, a team of professional store managers can be an asset. When motivated with career growth potential, they keep their store spiffy and operations streamlined.
However, they may not be too concerned with store profitability as their share of it is limited. Even when they are given an incentive of store sales and profitability; they are still doing a job and their take-home salary cannot be more than a certain percentage of their salary.
Crises are much better handled by entrepreneurial franchisees
Franchisees do a better job of optimizing store running costs as it affects their P&L directly. Store managers are normally incentivized by the top line which makes them take the eye off the bottom line.
Besides, any crises like repairs and maintenance, regulatory hiccups, or staffing shortages are managed very well by franchisees. Every cost associated with the store goes from their pocket and hence they don’t cut corners to reduce cost.
“Both of the business models work, but the path to success in franchising is like taking an elevator instead of taking the stairs”
They are more likely to find long-term solutions that are sturdier, as opposed to just managing one month’s P&L. They are also less likely to have ego conflicts with their staff – who are their employees, not peers. Hence, staff retention is better done by a good franchisee than a store manager.
Another important aspect is that even though a corporation may invest in technologies that assist customer database management, or inventory management, it is the owner-operator that will be able to use them best to impose fiscal discipline. Systemic leaks such as pilferage and poor customer service management are nipped in the bud because they impact the bottom line.
Common misconceptions of COCO
Entrepreneurs chase the COCO model thinking that they may make less money to begin with; however, with scale they will make 15 to 20 per cent PAT margins eventually. In contrast, as part of the FOFO model, they cannot earn more than the 10 per cent royalty which they may charge.
In reality the cost increase with scale is so high in COCO models that it offsets any gains made in marginal improvements at the store level.
Let’s understand this with an example. Consider two companies – A and B – having 1,000 stores each and doing 1,000 crore in annual sales
A operates the COCO model
• There would be at least 6,000 people on A’s payroll (assuming at least six employees per store)
• Even if attrition is low – say 10 per cent – A has to support a team of recruitment managers to service the stores
• The head office itself will have a sizable number of employees – trainers, operations auditors, financial auditors – who will be needed to check controls, keep food cost checks, or approve store expenses. Add to this area managers, cluster managers, and zonal managers, and at least one operations head. The HO strength might need over 100 people
• The owner of company A constantly feels that they can improve margins by charging higher rates, to keep up with the massive backend costs. But every time they do that, competing brands cut into their profits.
B operates the FOFO model
• Store employees are employees of the individual franchise. Their costs are covered as part of their operations costs
• To manage 1,000 stores, the head office has to appoint 20 area managers, four zonal managers, and one head of operations because the franchisee needs far less hand holding than a store manager. Including trainers, accountants, and auditors, this is a lean team of under 50 people
• Thanks to the lean structure and individual onus of execution, FOCO models will reach 1,000 stores in half the time that will be taken by COCO stores.
An extremely well-run COCO model with sound leadership and market dominance can clock an EBITDA of 15 to 20 per cent, and its PAT will hover in the range of 8 to 10 per cent. However, this is an ideal, and in most cases, eight out of 10 brands will contend with a PAT of five to six per cent.
Make no mistake: the numbers will be lower in the FOFO model. Most will clock an EBITDA of five to six per cent and a PAT close to four per cent. However, the probability that a FOFO model clocks four per cent PAT will happen in eight out of 10 brands, which scale to 1,000 crores in turnover.
Valuation mistakes when comparing COCO to FOFO
When it comes to valuations, entrepreneurs feel that a higher PAT will get them better valuations. The logic here is that valuations are a multiple of the top line. Hence, the fact that you get to book sales in bulk (instead of a franchise fee) seems quite lucrative.
What my experience says is that the really sharp investors understand:
- Return on capital employed (ROCE): This is much higher in FOFO models. In COCO, the capital employed is nearly infinite. It is very difficult to recover even your cost of capital which is not good at all
- Scalability: Thanks to the lean structure, individual accountability and growth path for franchisees, FOFO models scale much faster and wider
- Speed: Once the systems are set in place then stamping out stores at a rapid pace is relatively easier in the FOFO model.
The future for QSRs in India is a blue ocean laced with opportunity. Choosing franchising as the preferred mode of business will unlock vast and powerful opportunities for growth for focussed, asset-light players.
Both of the business models work, but the path to success in franchising is like taking an elevator instead of taking the stairs.
Dheeraj Gupta is the founder and MD of JUMBOKING Foods, India’s largest homegrown vegetarian burger franchise with over 155 outlets in Mumbai, New Bombay, Thane and Pune