Session 22 - Noodles and Co.ppt

John Burr
What is Franchising?
Legal--Franchising is an
organizational arrangement
created by contract between the
owner of a trademark and a
production technology (the
franchisOR) and a local
entrepreneur (the franchisEE).
Strategic--Franchising is an
organizational form chosen by
entrepreneurs to secure
competitive advantage.
Where franchising?
• Used in service industries competing
through networks under a shared
car repair;
tax preparation.
• Low human capital industries and low
capital / lower risk.
• Franchisor provides:
– Access to brand /
– Blueprints / operations
– Training
– Other support services
• Franchisee provides:
Local knowledge
Managerial effort
Franchise fee and
royalty payment
Cui bono?
• Franchisor gains
access to capital:
– Financial
– Locational
– Managerial
• Franchisee gains:
– Technology
– Brand recognition
Is Franchising Entrepreneurship?
• Theory
– Franchisors and
• Coordinate,
• Bear Risk,
• Innovate,
• Arbitrage.
• Practice
– Franchising is a
route into selfemployment.
– Franchising is a
resource assembly
Franchising & Agency costs
• Franchising solves an Agency Problem
– Unit managers are agents of owners (principal) and
may be ineffective or act in their best interest
• Need to do lots of due diligence on front end to be sure
manager is good.
• Need to monitor after you hire them.
– Franchisees are owners and not agents
 Franchising provides superior incentives for
local supervision than employment.
Franchising & Agency Costs
• Multiple unit franchises are an anomaly
– They reintroduce agency problem
• Potential explanations
– Franchisees may have special locational insight about demand
or customer tastes
– Reduces incentive for franchisee to free-ride
– Allows franchisees to take better advantage of marketing and
production efficiencies
– Lets franchisees better manage
Source: Kalnins & LaFontaine, 2004
Types of Franchises
• Business Format Franchise
– Probably the most well-known
– Franchisor provides business concept, right to use trademarks,
operations details, marketing advice to franchisee
– Examples: restaurants, hotels, copy centers, etc.
• Product Distribution Franchise
– Franchisor provides exclusive license to market products in a
specific location
– Examples: gas stations, auto dealers
• Business Opportunity Franchise
– Franchisee buys right to sell goods or services of franchisor in
addition to location assistance
– Examples: vending machines, amusement games
2005 Franchising Statistics
Source: IFA
2005 Franchising Statistics (2)
Source: IFA
2005 Franchising Statistics
Source: IFA
Less Risky?
• Franchise systems still fail at a high rate
• Not that much better than non-franchised startups
Source: Shane (1996)
Some Key Franchisee Issues
Evaluation of the business concept
Required investment
Franchise fee, royalty rates, other fees
Territory protection
Activity restrictions
Renewal rights
Franchising Resources
International Franchise Association (
American Association of Franchisees & Dealers (
Inc. Magazine
( Franchise Zone
• Franchise Times Magazine (
• US Small Business Administration
• FTC Franchising FAQ (
Some Noodley Takeaways (1)
• Compared to growth through company-owned stores,
franchisor might be able to achieve rapid growth and
market penetration with a relatively low capital
– Noodles & Co. had $10 million - enough capital for 20 stores,
lower than their planned growth of 32 in 2003. Expected to grow
45 in 2004, 64 in 2005, 100 in 2006. 231 stores requires $115
million over 4 years
– 2002 debt ratio = 36%
– Need equity
• Can they find interested investors?
• Is this how Kennedy wants to spend all his time?
Some Noodley Takeaways (2)
• There is a cost to lower risk - compared to growth
through company-owned stores, franchisor has lower
upside potential
– Franchisor only gets royalty versus full profit margin
– Will affect valuation of business
– Interestingly, Noodles & Co does not have a very attractive profit
G&A Exp
Depr Exp
Interest Exp.
Some Noodley Takeaways (3)
• Good service and unique culture comes at a
cost – 16.3% G&A Expense
– Will growth affect this?
– Will franchising affect this?
– Which stores should be company-owned and which
stores should be franchised?
Some Noodley Takeaways (4)
• If franchising is the desired route to growth, it
must be attractive to franchisees
– Concept is certainly attractive
– 16.3% General and Administrative expense is a killer
• No room for royalty
1 GM
2 Asst GM
2 Shift Mgr
Avg Rev / store
Some Noodley Takeaways (5)
• There may be strategic reasons to grow quickly?
– Competitive reasons
• Location availability
– Financial reasons
• Capital availability
• Kennedy decided to franchise –
– Will only work if the relationship between headquarters and
franchisee was a true partnership, rather than the usual fiefdom.
– $35,000 franchise fee
– 5% royalty
– Franchisees carefully screened
• Given psychological tests
• All franchisees given a “Noodles Buddy” – a seasoned corporate
manager who serves as a mentor
• Company assists with real estate selection and acquisition, as well
as restaurant design and construction
• Only considers operators who already run several restaurants and
are interested in opening 10 or more Noodles & Company locations

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