Sbarro and Quiznos: What Happened?

<p>The business press is still reporting on Sbarro&#39;s and Quiznos&#39; Chapter-11 bankruptcy filings of two weeks ago. Both have been troubled firms for a long time. <!--break--> One filed Chapter 11 just two years ago in 2012, Sbarro, and the other restructured its debt to avoid Chapter 11. That was Quiznos in December 2011. There are several common denominators present in the circumstances of both companies.</p>

<h3><strong>Both brands avoided &ldquo;customer customization&rdquo; in their product development efforts to their great detriment</strong>.</h3>

<p>Each ignored one of the great restaurant consumer developments of the 2000-2010 decade, that they should have seen coming. Sbarro served pre prepared very Americanized Italian food, kept warm in a cafeteria display, while Quiznos actually &ldquo;hid&rdquo; its product preparation process from customers view and were loath to change its practices to customize for customers. This was a failure of corporate research and development, poor operations development &nbsp;and corporate hubris. Quiznos had no comparable company operated units to build sales platforms.</p>

<h3><strong>Both companies were acquired by private equity firms at big prices from family founders, in 2006, which resulted in big debt.&nbsp; </strong></h3>

<p>Mid Ocean Partners acquired Sbarro for $450 million in November 2006, J.P. Morgan Partners and its successor CCMP Capital acquired 49% of Quiznos for $585 million in March 2006, while the founding Schaden family kept 51% of the then theoretical equity via its CCP Equity firm. The buyout price was believed to be over 12 times EBITDA at Quiznos and above 10 times at Sbarro, both nosebleed valuations that were hard to service going forward.</p>

<h3><strong>Both brands had poor locations that were ravaged by the recession</strong>.</h3>

<p>Sbarro was very heavily into mall food courts and Quiznos very heavily into retail strip centers. Both were ground zero for the massive retail consumer pull back in 2008-2010, and both in overdeveloped real estate sectors.&nbsp; <strong><em>Interestingly, neither brand could figure out how to develop concepts beyond these comfort zones, and neither got international working fast enough.</em></strong></p>

<h3><strong>Both brands talked about making changes but were unable to devote outsider senior executive focus to make it work</strong>.</h3>

<p>Greg Brennerman of CCMP was <a href="http://dealbook.nytimes.com/2008/08/19/for-new-ccmp-chairman-private-eq…; target="_blank">quoted in the New York Times</a> in 2008 saying that &lsquo;&rsquo;its clearly a market where [private equity (PE)] operations are back&rdquo;. He stayed in the Quiznos CEO role only 1.5 years.</p>

<p>Mid Ocean&rsquo;s successor <a href="http://www.businessinsider.com/sbarros-turnaround-plan-go-upscale-2012-…; target="_blank">hired restaurant vet Jim Greco</a>, who had a plan, also, but only stayed one year.</p>

<h3><strong>A lot of stakeholders lost with both brands.&nbsp; </strong></h3>

<p>Debt holders, franchisees, vendors and employees all lost. At Quiznos, the debt is expected to fall to around $200 million, after this March 2014 Chapter-11, down from about $875 million in 2006. That&rsquo;s $675 million in investor &ldquo;haircuts&rdquo; of written off hard debt. The franchisee losses are bigger. By any charitable count, 3000 plus US Quiznos franchisee units have closed, with a projected loss of capital, buildout and operating loss of $500K per unit, <strong><em>or over $1.5 billion in the </em></strong><strong><em>US</em></strong><strong><em>. </em></strong>&nbsp;</p>

<p>At Sbarro, over 200 company units have closed. along with that employee base. Landlords are out. Franchisees will have a difficult time following and being supported by a franchisor that can&#39;t run company units. The company debt started out with $400 million in 2007 and is tracking towards zero, meaning debt <strong>investors will have lost a cool $400 million</strong>. &nbsp; &nbsp;&nbsp;<strong>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; </strong></p>

<h3><strong>What to do? </strong></h3>

<p>As always the mantra is to do better due diligence before purchasing/investing, force change within brands via outsiders coming in, focus on the customer and what they want and need, insure the store level economic model works for franchisees, and watch the company&#39;s debt amount.</p>

Comments

Quizno's very different from Sbarro

While not disagreeing with your observations regarding Quizno's, you gloss over the fundamental problem.

Quizno's originated in a business model that was rapacious to the point of insustainability. Certainly there were some adjustments that could have been made to enhance customer experience, but I don't know of any Quizno's franchisee who would say that was the main problem.

Quizno's operates in the same retail settings (both strip mall and urban streetfront) as their competitors. Quizno's had no greater success in urban than in suburban settings.

Even the newer franchisees who picked up stores at pennies on the dollar could not make them work because the unit level economics were negative. Quizno's hid much of the true royalty cost in the mandatory food and paper goods purchasing, and virtually none of the franchisees could figure out how to break even.

Sbarro may be a fixable system if they follow your advice. Quizno's is not viable unless they address the fundamental greed which was the core of the Schaden model.

you are so right. When food

you are so right. When food costs exceed 40%, it doesn't matter too much about the other costs - expenses exceeded revenues! When franchisee costs exceed revenues IN SPITE OF A GREAT PRODUCT, the system fails.

Quiznos.

Finally, someone with some practical sense. Quiznos franchisees lost money because their food costs exceeded 40%. Their food costs exceeded 40% as a result of the franchisor, itself. I had 10 Quiznos for sale at one point and all the buyers had to do was assume the leases. They are not for sale any longer. They didn't sell, either.

Quiznos Franchise Association

Don't forget that franchise owners have not have a voice even after the class action lawsuit which created a company sponsored association. Current board members (or a least the president) get a thrill up their leg by being in the presence of crooked corporate executives. With that thrill, they will not demand any meaningful changes. Kind of like Chris Matthews had when Obama got elected.

Bob Baber The Tipping Point

His suicide highlighted the issues with Schaden and Quiznos and left many franchisees in a no win situation. Declare bankruptcy or face lawsuits and be forced into bankruptcy. The only positive was that Quiznos and most of the no account landlords Q did business with were too greedy and gave a lot of franchisees the hole the size of a truck to walk through and end the Q nightmare. Unfortunately Baber wasn't one of them. Those franchisees who walked in and paid little or nothing could've dug just a little and learned what scum Schaden and Brannerman are. Learned why Baber did what he did. Hard to believe anyone would buy a Quiznos. Harder to believe there are those who will buy a Smash-burger franchise but sometimes a person's most comfortable position with a Schaden "opportunity" is bent over.

Quizno's very different from Sbarro

John, I totally agree Quizno's is very different from Sbarro. Quiznos had a flawed franchise format and sold thousands of franchises through high powered franchise sales seminars. I dealt with some Quiznos franchisees who were desperate to sell but couldn't because the business model was so flawed. With all due respect to Sbarro, I would suggest their demise was more strategic in nature and not the result of an agressive and flawed franchise model.

Franchise Practices

Ed, thanks for the note. The purpose of my article was to highlight the restaurant operational other problem issues beyond the franchsing model. Anyone who has read my posts over the years (and knows my long background on US Quiznos analysis) and who reads and understands the perspective that all on BMM have documented for years, already knows of the flaws of the US Quiznos franchise model.

Quiznos screwed me

I was sold a franchise on false statements by their development people.I had given them the twenty plus thousand dollars. Then I found a great location and it was time to do the pro-forma. It took two minutes from order to the register for one customer. There was not enough time in the day to make sandwiches for a profit.

Too top it off, I had signed up for the smaller restaurant (130k), before our build out Quizno's told us that the smaller unit was going to cost upwards of (200k) due to a new retrofit.

Long story short, legally we would of had to travel to Colorado to try the case. They beat us out of our money. Owning one of their franchises would of been a financial disaster. We were very lucky to understand we had been had.

It has been documented that some individual(s)who had invested their life savings, had financial ruin and committed suicide. I guess we are the lucky ones?

All the best to the rest,

Fortunate

Quizno's is an interesting case study in limits of disclosure

Quizno's is an example of where I would part company with Michael Seid and the IFA party line position.

It is true that anyone who purchased a Quizno's within the past 5 (if not 10) years needs to go on the Internet more often: the many reasons for that debacle were well known and reported in the media going back at least to 2004.

But prior to that, and even after that if you solely relied on the Offering Circular, you would have not had any way of knowing how bad the system was unless you had QSR experience.

What struck me when I first went to a Quizno's was the footprint (big rent $$), bottlenecks leading to low throughput (reducing # units and thus revenue$$) and the large number of employees relative to competitor Subway.

Those problems a prospective buyer could have ascertained IF they had QSR experience or retained someone who did. But the whole point of franchising is that you are purchasing a "proven business model" and in addition most attorneys (even franchisee attorneys) are not going to give you advice about thruput and workflow.

Making matters worse is the disguised royalty rate. The franchisor required operators to purchase goods at high prices (in order to pay for vendor kickbacks), and even completely unnecessary goods such as the famous Haz Mat suit that franchisees were supposed to wear if someone cut themself with a sandwich knife.

This last point is a key dispute which I have with the IFA and folks including Michael Seid. Where a franchisor is given discretion not cabined by any franchisee remedy, there can be (and often is) a huge amount of abuse.

Back in the 1950s, this was extensively debated in the larger commercial/business context and the result was the good faith language now found in the UCC. Franchisors have vigorously opposed such a duty, most recently in the proposed California language suggested by Bob Purvin of the AAFD.

One other thought: the logical rebuttal would be to avoid purchasing a franchise unless it had been around long enough to get a reputation for fair dealing. And that is sound advice.

However... the problem with Quizno's is the contractual (and hence judicially-enforceable) ability to abuse the franchisee-- EX-POST--in the interest of lining the franchisor's pockets. So long as that ability exists, there will be systems such as Quizno's.

Even if Quizno's had been a legitimate franchise which treated its franchisees fairly, the system could have been sold to someone who instituted new practices which were not fair to franchisees, nor contemplated by franchisees at the time they purchased the franchise.

The IFA vehemently opposes the imposition of a duty of good faith, and that should give you pause when considering purchase of a franchise, as well as in assessing whether the IFA truly represents the best interests of franchising (as opposed to representing the best interests of one-half of the franchise equation).