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As Franchises Collapse, Quiznos Launches 600 Company Stores

A Quiznos company-owned store at its head office building photo/tsparks

DENVER — In May Quiznos announced a new "growth initiative" to develop up to 600 new stores nationwide by the end of 2010, via both corporate-owned and Quiznos-funded joint venture opportunities. CEO Rick Schaden noted his strong belief in the Quiznos business model and stated, "We want to increase our corporate profitability by investing in these corporate-owned stores."

This is a radical departure from Quiznos' traditional business model of near-100 percent franchised outlets. It presently operates just three company-owned locations: two at the Denver Airport and one at the head office. The company has also announced a development initiative into convenience stores that will include breakfast. Its remodeled units call for new interior wallpaper and green/recyclable packaging. Sales improvements have been noted in the remodeled units that have already opened.

This effort occurred after Quiznos announced in April that it recently recapitalized, with its debt restructured and amended, and added significant equity infusions by investors.

Florida-based Hospitality Solutions' CEO Steve Belmonte, who is a former CEO of Ramada Hotels, thinks this is a bad use of capital. His consulting firm does hotel and restaurant analyses, assists with franchise agreements and negotiates real estate contracts. "There is a world of difference between franchising a restaurant and operating one. A franchisor is guaranteed a fixed percent, regardless if the operation is profitable, says Belmonte. He adds, "But when Quiznos opens company-owned stores, they will have a whole new world to deal with, like the labor market and restaurant operations."

Jude Ryan, a former Quiznos franchise owner in Union, New Jersey, agrees that Quiznos does not understand the nuts and bolts of operating a profitable restaurant. "Quiznos is experienced as enforcers, not as restaurant operators," notes Ryan. The ex-franchisee says that the franchisor's field consultants do not pass on best practices or what works at other stores. "The reps would come and tell me what corporate said I was supposed to do." He thinks their advice "is based on making the franchising firm profitable rather than my restaurant."

Analyst Belmonte suggests that Quiznos take the money that private equity firm CCMP Capital (formerly J.P. Morgan Partners, LLC) and partners gave the franchisor and funnel it into a lending division that provides a low-interest or even a no-interest loan to franchisees.

Quiznos past CEO, Greg Brenneman, heads up CCMP. The firm has also funded troubled franchise chain 1-2-3 Fit, which was recently bought out by franchisor conglomerate Diversified Health. And it is behind the Smashburger hamburger chain.

Belmonte continues that his suggestion of financing franchise owners instead of growing through creating company-owned stores would expand on the company's strength in franchising restaurants, rather than magnify its weakness in operating eateries. "When I was president and CEO of Ramada, the company went through a credit crunch," says Belmonte. "The management team decided to offer interest-free loans. Those loans were forgiven over the life of a 15-year agreement," he continues. "Provided they stayed with the system, the equity was forgiven."

"It was very successful," he adds.

Quiznos has been trying to figure out the right retail formula. It has rolled out many new value menu items and discounts since 2009. It has also experimented with smaller stores.

But former franchisee Ryan observes, "Customers became conditioned to Quiznos coupons. So when I stopped using coupons, customers stopped coming. I was forced to use the coupons again. We could not make a profit on coupon items, and Quiznos never compensated us for those coupons."

Source: Quiznos fran. disclosure doc.

As its franchises struggled to make a profit, The Quizno's Master LLC saw a major erosion of its chain.

The company's own Franchise Disclosure Document reports a significant decline of 940 franchised sandwich shops in the two-year period from the end of 2007 until the end of 2009. The Blue MauMau community has also reported a continued erosion in the number of Quiznos shops in operation in the U.S in 2010, with at present an accumulation of over 1,800 that have closed from a peak of 5,000 franchises.

"There were three stores in Union, now there is only one," observes Ryan about his own neighborhood. "Plainfield in our county also had a store closed."

One industry source, who wants to remain behind the scenes, thinks that this is just the tip of the iceberg for the sandwich chain. He notes that as much as 80 percent of Quiznos franchisees are struggling.

"A lot of franchisees are struggling," confirms Ryan. "My store closed in February, 2010 after four and a half years. I never made a profit from day one."

The anonymous restaurant analyst notes that Quiznos' new growth strategy, as it relates to today's restaurant economics, is born of a time where there is poor availability of credit and where it is extremely difficult to recruit franchisees.

Quiznos franchisees are complaining about exceptionally high operating costs, particularly food costs. It is such a bone of contention that some franchisees in Ontario, Canada have actually gathered in a class action lawsuit against the firm, accusing it of price gouging and secret kickbacks as a hidden method to raise royalties.

Worse, while costs were soaring, sandwich retail prices dictated from the franchising firm to its franchisees were plunging in an effort to attract store traffic.

Recently retired franchise owner Ryan adds, "As Quiznos lowered prices and the economy turned south, we reached the point where the business could not even cover the rent. We had to take more and more money from our own pockets [to cover business expenses]."

The franchisor's decision to expand by adding hundreds of company-owned and joint-venture stores has been driven by very poor operating economics for its franchisees.

The Quizno's Master LLC thinks it can do better.

But Hospitality Solutions' Belmonte emphasizes that franchisees, operators who have financial skin in the game, are far superior in running a store to a company manager. They have invested their life savings in their business. "A franchisee is who I want, not some corporate guy on salary," he declares.

The undisclosed analyst adds to Belmonte's observation that Quiznos now has to grapple with its own food, markups and supply distribution issues. Too-high food costs at its corporate locations would be damaging for a later IPO. Creative financing would be needed to sustain what franchisee development could occur. The analyst noted that while prior Quiznos' convenience store efforts were largely a bust, smaller store development, with lower menu prices in a stronger economy, seems to be an improvement.

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