Friday, August 11, 2017

The Decline of the U.S. Shopping Mall and Franchising

It was an Austrian architect who designed the first shopping mall which opened its doors in Edina, MN in 1956. By the 1990s, 140 new malls opened every year. Then came Amazon, Netflix, eBay and online shopping. After 50 years of constant growth, no new mall was built in 2007. Between 2010 and 2013, mall visits declined by 50%, a trend that is likely to continue.
For decades, malls have been an attractive site for franchised businesses. How can they prepare for inevitable changes in the brick and mortar retail space? There are four crucial steps for a franchisor to avoid royalty revenue losses and help their affected franchisees to survive.
  1. Identify “mall” franchisees
  2. Put “mall” franchisees on a watch list
  3. Learn from best practice
  4. Adapt site selection criteria

According to Credit Suisse, about 25% of the current 1,100 U.S. malls will close by 2022. With the faltering malls, a whole host of shops and jobs will go, too. Just in 2017, about 8,600 stores are projected to close due to the ongoing collapse of the U.S. shopping mall. Many of them will be franchised stores and not just retail locations for clothing, frames or beauty products.
Think food courts. Many franchisors offer customized franchise agreements for food court locations, often with different initial and ongoing fees. Food court locations are attractive since they often require a lower investment but can generate good profit margins from a limited menu due to limited competition and excellent foot traffic.
According to Bloomberg, the average U.S. mall includes about 130 stores. Assuming that 50% of current mall stores are franchised businesses, about 71,500 franchised stores are located in a mall. If Credit Suisse’s projections are correct, 25% of these franchised stores — about 18,000 — would be affected by mall closures through 2022. That would account for about 2% of current franchised businesses in the United States.
To illustrate what the impact for a franchisor could be, let’s look at two brands that are likely to have a location in pretty much every mall, McDonald’s and Subway. Let’s also assume that a McDonald’s mall location generates about $500,000 a year with a royalty rate of 4%. For Subway, let’s assume $300,000 with a royalty rate of 8%. If the 275 U.S. malls projected to close really shut their doors between 2017 and 2022, McDonald’s and Subway need to keep a close eye on a total of up to 550 combined locations. The financial risk for McDonald’s is over $5 million in royalty revenue alone for these locations. Similarly, Subway could be looking at over $6 million of annual royalty revenues at risk.
While not a crisis for franchising, it will affect franchise systems, particularly the ones with a high share of mall location businesses. So, what should a franchisor do? First, find out how many franchisees in their system could be affected by a mall closure. These would include the ones with stores in the mall and close by. While it sounds simple, not all franchisors track their franchisees by type of location.
Second, put these “mall” franchisees on a watch list and have them help you monitor their location. This should go beyond simply looking at P&L data. How is the mall’s foot traffic? Are stores closing without any new ones opening? Is the quality of the stores in the mall going down? This is where the franchisee can help the franchisor draft contingency plans. Quickly develop relocation plans if the mall shows signs of being at risk of closure.
Third, learn from best practice. Several franchisors allow the franchise agreement to be “put on hold” after a closure caused by lease agreement issues or events that have nothing to do with a franchisee’s ability to run the business. For such periods, franchisees don’t leave the system even though their business has shut down. Some franchisors may even offer lower royalty and marketing fees for the transition period to minimize the franchisee’s losses and to ensure that the lights get switched on again quickly in a different location.
Fourth, adjust your site selection criteria. Not every mall is at risk and neither is the concept of a shopping mall doomed. Several mall operators have succeeded in creating new mall experiences and manage to attract millennials to return to the mall. Other malls specialize in luxury brands. You won’t find a Macy’s in them. Rather, they go for Louis Vuitton, Prada and the likes. And while such malls won’t likely be an alternative for low end franchise retail brands, well-heeled consumers will have a craving for a coffee, a doughnut or a burger. Still, a franchise brand’s real estate team needs to understand that the mall space has ceased to be a default site and the site selection process should reflect this.
The closure of U.S. malls is probably not a huge risk for most franchise brands. The financial risks for the franchisor is likely manageable. However, for some franchisees, the risk can be very high. Both, the franchisor and the franchisee have a good chance to manage that risk and avert a permanent closure if they collaborate closely and plan ahead for the benefit of both parties.

Sources: Bloomberg, Credit Suisse, FRANdata, IFA, LeOS Franchise Consulting, Time

Monday, July 24, 2017

The EU - from the Bottom — What a crazy belt buckle taught me about the EU

Like Mayor Jahns in Hugh Howey’s “Wool”, EU leaders should take a trip down the silo to find out whether they are removed or not. They could be surprised how much hope there still is for the EU and its promises. But they are running out of time.

My family and I just returned from a vacation on the Italian island of Sardinia. Like most tourists we visited the markets and bought little gifts for the kids and friends, mostly handcrafted things. As I am writing this, I am getting more concerned about the bull head belt buckle my son chose causing severe injury.

As the trader adjusted the belt for my son, we got to talk about our families' respective histories. Her parents had left Sardinia for Argentina where she was born. Indeed, she was named Argentina after her parents' new country. They emigrated because they literally had nothing to eat after WWII. After several years, they returned to their island, a decision Argentina now regrets. As she punched holes into the belt we just purchased, she went through a litany of Italy's economic woes, which according to Argentina were even worse on her home island. 
Rising prices, no jobs, especially for the young, the tide of immigrants who in her own words had it even worse than the Italians. It turns out, her own situation mirrored what is going on in the country and especially in Sardinia. Argentina claimed she could give us a bit of a discount this time, but wholesale prices for the next batch of goods she expected had just been raised. Other than tourism, there were no opportunities for the people of Sardinia. She continued that the island’s economy could not compete against the mainland in anything. The farms were too small and inefficient and only some rich islanders were able to reap the benefits of what the tourist industry brought to Sardinia. At this point, she sort of stopped herself as if she feared anyone else was listening.
Argentina has two sons in their early 20s. The older had emigrated to Rome, as she put it. After dropping out of a computer programming program, he is now scraping by on a job with the fashion retailer H&M which only hires the very young on temporary jobs. These jobs don't require companies to pay any benefits it seems. The younger one sat somewhat listlessly next to her, guarding the cashier and helping out. I had the impression this was not because Argentina needed his help but wanted her son to have something, anything, to do.
"The EU is not a union", Argentina said at some point. It was interesting that she didn't necessarily blame the Italian state. Yes, she did complain about how badly it handled the current situation but I believe what Argentina expressed was something like lost hope in something bigger that didn't deliver what she - and presumably others - hoped for.
On the upside, people still expect something from the EU. I saw more EU flags flying from official buildings and hotels than in most other European countries I visited. The downside is that the EU is running out of credibility. While the attention is on Brexit, unless the EU manages to conjure up tangible improvement for people like Argentina and her family, it will become the victim of local politics.
Argentina is educated, she has been around and seen things. Based on her comment on immigrants she doesn't strike me as someone who would easily fall for an extremist party. However, if people like her see her family's efforts to simply make a living, if not to advance, thwarted by corruption, the establishment hoarding opportunities for themselves vis-a-vis the state's and the EU's inability to reform, then all it needs is a local champion with a simple message to bring down one institution after the other.
Since 2016, a lot of things happened that only in 2014 most pundits and politicians would have dismissed as impossible. If politicians spent a little more time down the silo, they would have heard from Argentina and others about long term trends that many pundits simply missed.

Thursday, June 08, 2017

Financing Post the Great Recession

Will U.S. small businesses be the main beneficiaries of increased competition in the lending space?

The crisis is long over but we are not out of the woods yet. Most indices are up although consumer confidence and spending have yet to reach pre-crisis levels. In fact, as of 2014, based on 100 financial crises going back to the 1890s, it took an average of eight years for real income per person to return to pre-crisis level. By comparison, just seven of the 12 countries where systemic crises began in 2007-08 managed to get back to at least their starting point.
Banks worldwide are not in the best of shapes either and that has implications for lending. As of May 2017, the S&P 500 banks index is down 30% from its peak in May 2007. By comparison, the STOXX Europe 600 index of bank share prices is down two-thirds from its peak in May 2007.
Still, small business lending in the United States is up on all levels, including SBA lending, conventional lending and alternative lending. 
Overall, in the United States, 5,400 community banks provide 43% of small business loans. These are relatively small operations as over 5,000 have less than $1 billion in assets and more than 1,500 less than $100 million.
On the face of it, community banks appear in good shape. Between March 2016 and March 2017, their loan books grew by 7.7%, more than twice the rate at other, mainly much bigger, lenders. However, net income rose by 10.4%, against 12.7% for the whole industry. Returns on equity, at 9.2%, were a little below the average.
And there are other market forces at work and there are certain trends that may to a shift to an increasingly changing landscape for U.S. small business lending. Since many community banks are very small, they are increasingly consolidating. Mergers and the aftermath of the financial crisis resulted in a drop of over 30% in the number of U.S. community banks between 2006 and 2016. Just between 2008 and 2012, more than 400 U.S. community banks failed and only four have opened since.
Going forward, they are facing additional challenges. For starters, finding talent will be increasingly difficult for banks as some graduation trends show. Between 2006 and 2016, finance as a graduate subject dropped from 31% to 15% at MIT's Sloan School and from 55% to 37% at Columbia. By comparison, technology increased from 12% to 33% at Stanford while doubling at other schools. Further, retaining talent will also be harder. A small community bank in the middle of nowhere is not as attractive as a big player in New York.
In addition, fulfilling their regulatory obligations is increasingly costly. Between 2011 - the year after the Dodd-Frank act regulations - and 2015, the number of people working directly on "controls" at the U.S. largest bank JPMorgan increased from 24,000 to 43,000. While a biggie like JPMorgan is able to absorb such costs, many small community banks will struggle more. The Trump administration has promised to cut through the red tape and reduce regulatory requirements. However, that may take years.
More importantly, regulations and mergers aside, community banks have to find ways to handle competition from a completely different set of players. Enter digitalisation and so-called fintech start-ups. As of 2017, about 20% of U.S. small businesses look to online lenders when seeking a loan. Regular lenders are trying to counter this with increased digitalisation and streamlining to reduce the costs of the lending process. Still, they will have to watch their backs as more and more fintechs enter the market. For instance, in 2016, peer-to-peer lending in the United States reached $19 billion on the country's biggest platform. In addition, between 2012 and 2016, U.S. Fintech investment grew from an estimated $2.5 billion to $6 billion, with a peak of just under $8 billion in 2014.
While the U.S. lending market may experience a few disruptions, there is little reason to believe that lending overall will be negatively impacted in the long run. Rather, increased competition and alternative sources of lending capital could actually be advantageous for borrowers.

Sources: AltFi Data, Autonomous Research, Business Schools, The Economist, FRANdata, Harvard University, Thomson Reuters, U.S. Federal Deposit Insurance

Monday, May 22, 2017

Food Trucks — Fasted Growing Food Segment in the United States

Within the U.S. food industry, food trucks are the fastest growing segment. Between 2008 and 2016, the industry reached $1.2 billion. (The Economist)
As of 2017, in the United States, counties that have experienced higher growth in mobile-food services have also had a quicker growth in their restaurant and catering business. (U.S. Bureau of Labor Statistics)
Between 2005 and 2016, In Portland, OR, the share of food trucks per person in a metropolitan area grew from less than one to close to five. By comparison, over the same period, that share remained under one in Chicago, IL which has some of the strictest food truck regulations. (U.S. Census Bureau)
As of 2017, despite being home to more than 7,000 restaurants and 144 craft breweries, Chicago, IL, has just 70 food trucks.  (U.S. Bureau of Labor Statistics)
As of 2017, in New York, a food truck operator must obtain a two-year permit that comes with a 15-year waiting period — or rent one on the black market for as much as $25,000. (The Economist)

Wednesday, April 05, 2017

Franchising in Singapore

Franchise Update publishes LeOS Franchise Consulting's feature on Franchising in Singapore!! 

The city state offers plenty of opportunities for franchise brands. Strategically positioned at the heart of Southeast Asia with a multi-cultural society, the rule of law and one of the highest GDPs per capita, it is one of the most business friendly countries.
However, there are some challenges franchisors need to be aware of. Enjoy the feature.

Thursday, March 16, 2017

Krispy Kreme Expands further into Africa

Last year, Germany’s Reimann bought U.S.-based Krispy Kreme Doughnuts, an 80-year-old franchise. Now they company announced its move into Nigeria, the continent’s most populous country. This follows Krispy’s first African venture into South Africa in 2015.  Worldwide, the brand operates over 1,100 locations.
It seems, the Germans made a wise decision. In its domestic market, Krispy Kreme grew at a CAGR of 5% between 2009 and 2015. The company locations grew at a faster CAGR of 6% over the same period. The franchised store continuity rate was an average 96% each year pointing towards sustainable and stable growth. 
In addition, average store revenues increased at a CAGR of 6% to over $2 million between 2010 and 2015.

Now that the ultimate owner is German, there is hope for consumers in the country. So far, Krispy Kreme only operates locations on U.S. military bases.