The dark side of the dollar menu

A Subway sandwich is far more than the sum of its fillings, franchisee Keith Miller says.

Those ingredients cost roughly $2. Then he pays labour. Electricity. Gas. Royalties. Credit card transaction fees. Rent.

All told, Miller, who owns three Subway franchises in northern California, says it costs him well over $4 to produce one of Subway’s foot-long subs. And that is why, when the chain announced plans to drop the price of the sandwich to $4.99 starting in January, he and hundreds of Subway’s other 10,000 U.S. franchisees sent a strongly worded letter warning that the promotion could force some stores to close.

“The numbers don’t work for us,” said Miller, who also chairs an industry group, the Coalition of Franchisee Associations. “Ten years ago, they might have worked. But now they don’t, in my opinion.”

As fast-food chains across the country have slashed menu prices to revive flagging sales, a growing rift has emerged between some name-brand corporations and the local operators who run their outlets.

For years now, the retail industry has been shaken by giant companies that have been able to keep prices low, wooing consumers but squeezing suppliers and smaller competitors. But in the restaurant business, the push to keep prices low has pitted corporate headquarters against individual outlet owners - all operating under the same brand.

Corporations need to grow systemwide revenue to please board members and shareholders. But small-scale franchisees, who face rising costs and increased local competition, are far more concerned with store-level profits.

In addition to Subway’s plans to relaunch the $5 Footlong, McDonald’s will revive a version of its Dollar Menu next month. Taco Bell has promised to expand its selection of discount items, as have Wendy’s and Jack in the Box.

“This is an inherent financial conflict between franchisees and franchisers,” said J. Michael Dady, a lawyer at the Minneapolis firm Dady & Gardner who represents franchisees in conflicts with their corporate parents.

“And some have handled it much better than others have.”

To date, the uprising at Subway has been the most visible.

In late November, franchisees began circulating a petition that asked Subway to withdraw the foot-long deal, which they said would hurt their businesses.

Under the franchise system, chain restaurants such as Subway coordinate menus, product sourcing, store design and strategy across all locations. Local operators pay the chain to belong to that system. They also manage the day-to-day business of their stores – rent, labour, ingredients, utilities, maintenance and equipment – and draw their paychecks from whatever is left.

Discounts can cut dangerously deep into those margins, the petition says.

The document has been signed by nearly 900 people from 39 states who claim to own Subway franchises. Like Miller’s, many are small or family-run entities that operate only a handful of locations.

“Franchisees have repeatedly voiced concerns about frequent and deep discounting,” the petition reads. “Franchisees believe this constant deep discounting has been detrimental to the Brand – as well as restaurant profitability.”

Such a public revolt is highly unusual, said John Gordon, the founder of Pacific Management Consulting Group, a restaurant-oriented firm based in San Diego. The closest precedent is a 2009 lawsuit filed by Burger King franchisees who claimed they were losing money on every sale of the chain’s $1 double cheeseburger.

In a statement, Subway said that the petition does not represent the views of the majority its franchisees and that the promotion is optional. Business owners who opt out, however, may face disgruntled customers.

In a separate presentation to franchisees, Subway said the promotion was intended to help them stanch several years of falling traffic.

“We are in constant communication with our Franchisees and Development Agents,” the company said in its statement. “They are actively involved in many aspects of our decision-making process, and we welcome and encourage their feedback.”

But many franchisees say that corporate attempts to grow sales have added to a growing list of challenges.

Miller said that when he bought his first Subway 28 years ago, his margins could swell as high as 18 per cent. But since then, he said, competition has grown far more fierce and costs have risen dramatically for labour, utilities and rent.

Labour costs at fast-food restaurants have increased in each of the past three years, according to the financial-consulting firm BDO, the result of rising minimum wages and increased competition for employees.

In California, where the minimum wage will be $11 per hour starting Jan. 1, Miller’s labour costs are up 50 per cent from 10 years ago, he said. The cost of a full-price sub has risen only 20 per cent.

“It’s a hard cost per sandwich,” Miller said.