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


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