Los ANGELES BUSINESS JOURNAL® November 29 - December 6, 2004 Big Mac Attack McDonald IS Prepares to Challenge Subwayls Dominance Subway," said Zarco, a parruer at BY KATE BERRY Zarco Einhorn & Salkowski in Miami. Sta([Reporrer Growth pains fter 40 years of rapid growth, til! Subway Restaurants finally In the past, Subway has been criti­ A may have awakened the sleep­ cized - and occasionally sued - by its ing giant. Last month, McDonald's franchisees for a corporate structure Corp. began selling Subway-type sand­ that rewards rapid growth, sometimes wiches at a handful of u.s. and at the expense of existing franchise Canadian locations, and if the concept operators. is successful, the burger giant will like­ What distinguishes Subway from ly expand it to more of its stores- thus other fast-food franchisors is that the challenging Subway's control of fully parent company, Milford, Conn.-based one-third of a $17.3 billion deli sand­ Doctors Associates Inc., doesn't own wich market. any restaurants itself. Royalties flow to Last year, Subway overtook RINGO HW. CHIU/LABJ thc parent based on overall sales, but McDonald's as the largest restaurant Sandwiches: Made to order. individual fTanchisees are not granted group operating in Los Angeles chise and, after failing on a variety of exclusive territories, as in other fast­ County. Thi year, it added another 21 food operations. Stores are often diets, designed one that involved eating local stores to repeat as No. I with 416 opened nearby to existing locations, two Subway sandwiches a day - includ­ outlets. McDonald's, meanwhile, fell cannibalizing sales. to third with 348 locations, behind ing a bag ofchips and a soft drink - for Starbucks Corp. with 366. a year. In the 1990s, some franchisees filed lawsuits against Doctors Associates, When his college newspaper pub­ "Subway has come a long way in the claiming the company operated like a lished a story about Fogle shedding past five years," said Robel1 Zarco, pyramid scheme. one of the nation's top franchise 245 pounds, Subway executives seized lawyers. "They're essentially hitting on it, making Fogle the centerpiece of ZarcQ said this situation has competitors like a tidal wave." an ad campaign highlighting the improved in the past several years, as chain's low-fat sandwiches. His story Doctors Associates tries to minimize While Subway has shown amazing fed into emerging concerns about the the impact of new openings. Jt formed growth for many years - it now has 17,700 U.S. locations, versus 13,000 health effects of traditional fast foods, committee to decide if locations for McDonald's - it wasn't until 1999 and sales at Subway took off ow vir­ overlap each other, and existing fran­ that it became a fast-food phenome­ tually all fast-food restaurants have chisees get first dibs on new outlets non. added salads and healthier fare. nearby. That's when a 425-pound Indiana "Many more people who used to visit Today, Zarco represents franchisees University student named Jared Fogle McDonald's or Burger King, which are of Blimpie International Inc., Dunkin' became the chain's calling card. Fogle infamous for the high caloric content Donuts Inc., Burger King Brands Inc., lived eight blocks from a Subway fran- of their food, are now being diverted to McDonald's and Quiznos, in various litigations against their franchisor par­ ents - but no Subway franchisees. "I don't think there's a better chain out there that can give me the rate-of­ return as this chain," said Paul Gill, who opened his first Subway when he was 22 and now owns J9 outlets ­ including one at Dodger Stadium and another at Kai er Hospital on Sunset Boulevard, with a partner, Behzad Cohan. He still complains about rising rents and higher costs for tomatoes • RINGO H W. CHIIM..ABJ ("Subway start-up costs were more Chain: 'Anyone can make a sandwich,' says Subway franchisee Hardy Grewal. affordable in the old days than they are where from 18 percent to 25 percent of income," she said. "I have the respon­ today") but generally it's cheaper to sales as profit. sibility of people's livelihoods in my operate than other fast-food joints. hands and 1 find it extremely reward­ Nothing is cooked except the bread, Franchise structure ing to help them do a better job in their which means lower energy expense restaurants. " and lower start-up equipment costs. Subway contracts with separate Consumers have responded well to the companies, known as development OhCal Foods conducts monthly assembly-line set-up with sandwiches agents, which buy the rights to sell inspections ofevery Subway franchise made in front of them. franchisee leases in speci fie territo­ in Los Angeles, checking baking pro­ nes. cedures to temperature controls. Sales While turnover in the restaurant are tracked electronically so fran­ industry is high, training isn't too Money flows from the franchisees to chisees have no wiggle-room to cheat strenuous. development agents to Doctor's Associates, which is responsible for the development agent or franchisor "Anyone can make a sandwich," national advertising and computer sys­ by lowballing income. said Hardy Grewal, who owns 18 tems. The more outlets that are opened Grewal, who opened a Subway fran­ Subway franchises in Los Angeles. - Subway has 22,288 restaurants in 78 chise in 1989, said the key to his suc­ Today it costs $150,000 to $175,000 countries with $6.8 billion in sales ­ cess was jumping on the Subway to build a new Subway restaurant, with the higher the fran-chisor' s royalties. bandwagon early. He left a job as an a franchise fee of $12,000 - double Ruth Sender, president and chief accountant for Mitsubishi Motors what it was a decade ago. (A executive of Subway development Corp. and now owns 18 Subway out­ McDonald's, by contrast, can require agent OhCal Foods Inc. of Woodland lets, with four more on the way. He an investment of more than SI mil­ Hills, said agents take a cut ofthe roy­ now owns the Sylmar mini-mall where lion.) Buying an existing restaurant is alty payments in exchange for main­ he opened his first Subway location, more expensive; one franchisee taining the brand's identity, finding and he owns a Holiday Inn franchise in recently paid $1 million for a Subway new franchisees and negotiating leas­ Dallas. near USC, due to its high volume. e . Royalty fees typical run about 8 "When I saw what these stores were percent ofeach franchisee's total sales. Sales vary by location but Subway making, a light went off in my head," franchisees claim they can payoff the Earlier this month, Sender held a Grewal said. "It's not what it used to be initial invcstment in a year if the loca­ rally to get Los Angeles franchisees in 1989 because wages and rents were tion takes in $8,000 to $10,000 in pumped up about working for so low then. But sales are way, way sales per week. Subtracting the cost of Subway. Like multilevel marketers up." rent, employees and products and it's Amway Corp. and Herbalife possible to earn a living with just one International Inc., Subway encourages Bloomberg News COlJlribUled to this SIOIY. Subway in a prime location. franchisees to recruit new people into the business. Large Subway franchisees who got into the business more than a decade "We're their partner, so if they do ago claim they are pocketing any- better sales-wise, we generate more.