Too often, the practice leads to high failure rates that penalize franchisors and leave owner-operators broke.
Jeff Osterfeld, CEO and founder of Penn Station Inc., has an aversion to failure, so much so that he takes every measure possible to make sure it doesn’t happen to any of his franchisees. Penn Station East Coast Subs has had only one failure in the 155 units it has opened, but that single flop, says Osterfeld, still stings.
“It has more to do with my personality than anything else,” says Osterfeld. “I’m a poor failure, and I have empathy with anyone who would lose their life savings.”
To hedge his bets against washouts, Osterfeld’s approach to growth has been deliberate, making sure that he doesn’t open the doors to just anyone who can afford the franchise fee. He is selective about who gets a franchise agreement, imposes strict stipulations on how they operate and develop and, in turn, offers franchisees an exceptional opportunity to succeed in a tough, competitive environment.
Little wonder, then, that he gets plenty of calls from prospective investors. He says he gets as many as 600 inquiries a year from prospective franchisees but just a tiny fraction result in a development agreement, usually for only a handful of stores.
Osterfeld talked to Smart Business about how he ensures success for his company and for his franchise owners.
How did you decide that franchising was the best way to expand?
I got out of Miami University in 1982 and opened up what was a delicatessen. At the same time, one of our competitors, Steak Escape, opened up. So did Great Steak and Fries, and I watched the lines at their stores.
Seeing the success that some of my competitors were having, I opened a second and third store that concentrated on the cheesesteaks and the submarines.
After three or four stores, I became somewhat frustrated by the fact that it seemed when I was behind the counter and hands-on, the customers were thanked, the fries were hot, the food was made right and all the cash went in the drawer. I became stretched and had three or four stores between Dayton and Cincinnati.
It was the situation where you’ve got your finger in the dam over here, and you plug this leak, and then that one over there springs a leak, and then the one you fixed three months before is leaking again.
I found myself bouncing back and forth between the stores and solving a lot of problems that were rooted in manpower, not having quality people to treat these stores the way I treated them. All the while, I was watching Chick-fil-A explode with their operation and model, and I thought, ‘This is a way to put the owner behind the counter.’
How did that help you grow the company?
Unlike a lot of people who go into (franchising) to grow as fast as they can because they don’t have to do so on their own money or on their own manpower and structure honestly, I went into this because it was the only way I saw to get that ownership mentality behind the counter.
We’ve had a pretty conservative record in terms of growth. We tell an awful lot of people no. It’s a pretty conservative approach, but we make sure that we get very hands-on people that want to be involved in the business on a day-to-day basis.
How do you qualify potential franchisees as a good fit?
We only do so with people who have been in the restaurant business. That gets rid of a lot of people who are trying to buy a retirement job, so to speak. We started doing that in the late ’80s, and I sold off some of the units that I owned. Immediately, they began to run better.
We also have a structure of ownership that requires active ownership in the franchise, including operations of the stores. Whether you open a single unit or multiple units, we require that you have a general manager that operates under our general manager guidelines. Our guidelines force the franchisee to either manage the store themselves in which case we know we have an ownership mentality behind the counter or hire a general manager.
In that case, they would have to sign an agreement with the general manager to split part of the profits with them. Then the general manager treats it like he’s an owner.
Why is experience in the restaurant business so critical?
First, the reason we want you involved in the restaurant business is not because we couldn’t teach someone from outside the restaurant business but rather because we find doing business with people who have already worked for whomever Burger King, Wendy’s McDonald’s, you name it that they knew exactly what they were getting into.
I think when you have a business like the restaurant business that is so reliant on an unskilled labor pool, it’s tough. It can eat you up, and it’s an emotional thing as opposed to an intellectual thing. We found that we’d get people from other systems, and all they’re really doing is comparing the machines their old piece of machinery, be it Long John Silver’s or Subway or whoever with us the new piece of machinery. We knew we could stack up very well in terms of return on investment. So when we came in and provided more service than they were used to better food costs, better paper costs, better profit margins, better sales than they were used to we’ve had little or no turnover. And they’re happy and therefore productive franchisees.
It put us in with a group of people who not only knew what they were getting into, but as is so often the case, when they look at us compared to where they had been, we shine from a financial standpoint.
With the emphasis on on-site management by the franchisee, how do you approach multi-unit development?
It seems that everyone that comes to you wants to do multistore deals, at least two or three, if not five, right out of the chute. We’ve got a guy right now who wants to do all of Atlanta.
What we try to do is talk them into doing a five-store deal, a three-, four-, five-store deal. We say, you need to identify a managing owner. A managing owner needs to have a background in the restaurant business, and they need to own at least 10 percent or 15 percent of the whole franchise.
The person will open up the first store. They can be the general manager for the first store, but by the time you go to your second, third, fourth store, we want that person to run the business and then supervise the general manager for each of those additional units.
What do potential franchisees need to demonstrate beyond a background in the restaurant business?
There are fundamental financial qualifications in any small business, and I think this is abundantly true in the restaurant business. Most fail because of a lack of capitalization or support.
We knew we were going to provide the support, but the undercapitalization piece, we had to learn that through the school of hard knocks. What happens is that you open up, it’s a gangbuster site, and everybody’s happy. But if you do like I did, the first three, four, five years you’re up and you struggle a little bit, it takes awhile to get up to average company volume.
People that are undercapitalized sometimes end up jumping ship, bailing out or going out of business, or we’re left to prop them up, none of which is good. So we try to make sure there’s enough capital in the business, that people have the appropriate staying power for the first year or two, in case it is less than a company average store, which often happens in a new area.
How to reach: Penn Station East Coast Subs, www.penn-station.com