Franchising and Noodles & Company

1. John Burr Franchising andNoodles & Company

2. 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.

3. Where franchising? • Used in service industries competing through networks under a shared trademark: • restaurants; • hotels; • car repair; • tax preparation. • Low human capital industries and low capital / lower risk.

5. Responsibilities • Franchisor provides: • Access to brand / trademarks • Blueprints / operations details • Training • Other support services (varies) • Franchisee provides: • Location • Local knowledge • Managerial effort • Franchise fee and royalty payment

6. Cui bono? • Franchisor gains access to capital: • Financial • Locational • Managerial • Franchisee gains: • Technology • Brand recognition

7. Is Franchising Entrepreneurship? • Theory • Franchisors and Franchisees: • Coordinate, • Bear Risk, • Innovate, • Arbitrage. • Practice • Franchising is a route into self-employment. • Franchising is a resource assembly method.

8. 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.

9. 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 competition

10. Source: Kalnins & LaFontaine, 2004

11. 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

12. 2005 Franchising Statistics Source: IFA

13. 2005 Franchising Statistics (2) Source: IFA

14. 2005 Franchising Statistics Source: IFA

15. Less Risky? • Franchise systems still fail at a high rate • Not that much better than non-franchised start-ups Source: Shane (1996)

16. Some Key Franchisee Issues • Evaluation of the business concept • Required investment • Franchise fee, royalty rates, other fees • Territory protection • Activity restrictions • Renewal rights

17. Franchising Resources • International Franchise Association (http://www.franchise.org/) • American Association of Franchisees & Dealers (http://www.aafd.org/) • Inc. Magazine • (http://www.inc.com/resources/franchise/) • Entrepreneur.com Franchise Zone (http://www.entrepreneur.com/franzone/) • Franchise Times Magazine (http://www.franchisetimes.com/index.php) • US Small Business Administration (http://www.sba.gov/smallbusinessplanner/start/buyafranchise/index.html) • FTC Franchising FAQ (http://www.ftc.gov/bcp/franchise/faq1.shtm)

18. Noodles & Company

19. Some NoodleyTakeaways (1) • Compared to growth through company-owned stores, franchisor might be able to achieve rapid growth and market penetration with a relatively low capital investment • 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?

20. 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 margin Will Franchisees be interested?

21. 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?

22. 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 Is this model sustainable? How?

23. Some Noodley Takeaways (5) • There may be strategic reasons to grow quickly? • Competitive reasons • Location availability • Financial reasons • Capital availability

24. Epilogue • 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 • http://www.noodles.com • http://www.youtube.com/watch?v=7nJ0QbCHnsY/