How Franchised Restaurants Can Adapt to a Post-Pandemic World

As the world emerges from the COVID-19 Pandemic, certain things will happily revert back to their pre-Pandemic state. However, the Pandemic has wrought lasting damage across much of the economy – and the restaurant industry is no exception.

This article will explore three of the Pandemic’s enduring impacts on franchised restaurant operations, and present recommendations franchisors can follow to best position themselves for future prosperity.

• Future Use of Food Aggregators

Many franchised restaurants turned to online ordering delivered and organized by third party aggregators, such as Uber Eats or SkipTheDishes (“Aggregator(s)”), for a much needed lifeline throughout the Pandemic. As capacity restrictions lift, franchised restaurants should now consider whether the long-term use of Aggregator platforms is financially and operationally viable. There are three primary considerations.

First, the Aggregator model makes it difficult for traditional restaurants to realize a profit on such sales. A traditional restaurant has three basic costs: food, labour, and occupancy/real-estate costs. Traditional restaurants can typically see a pre-tax profit of between 7-22%.[1] The service and commission fees charged by Aggregators are roughly 25% of the sale price paid by the customer on deliveries, and 10% for pickup orders from the restaurant.[2] Accordingly, online orders through Aggregator platforms are significantly less profitable than dine-in customers. In the case of traditional restaurant franchises, which owe royalty and other franchise-related fees in addition to its three basic costs, the struggle for profitability from Aggregator orders is more acute.[3]

Second, Aggregator deliveries increase the likelihood of intra-franchise disputes and competition. An Aggregator may take an order from one franchisee and deliver that order in another franchisee’s exclusive territory. In that case, the franchisor may be bound by the terms of the franchise agreement and/or the duty of good faith and fair dealing to intervene to stop such intra-franchise encroachment. Franchisors should ensure their franchise agreements clarify that they are not liable or responsible for the settlement of such intra-franchise disputes, and that franchisors can unilaterally require – or prohibit – the use of Aggregators.

Third, franchisors should consider the impact that Aggregator services has on their brand. Customers who order online likely expect similar quality of service to a dine-in experience. Aggregator-related issues (such as cold food or late delivery), while not necessarily the fault of the franchised restaurant, may nevertheless reflect poorly on the franchise’s brand. Moreover, the commotion associated with the delivery and pickup of Aggregator orders may detract from the atmosphere dine-in customers expect and deter them from returning.

Recommendation

Franchisors must first consider whether the continued use of Aggregator services is economically viable. If so, franchise agreements should be reviewed to ensure the franchisor: has the power to unilaterally require the use of Aggregator platforms; is not required to intervene in intra-franchise competition or territory encroachment disputes; and has methods to maintain the franchise’s brand in the event of Aggregator-related service disruptions.

• Time Intervals Between Required Renovations

Franchise systems often require periodic renovations to maintain a “fresh” brand in the marketplace. Often, franchise agreements allow the franchisor to request when such renovations must be completed. Such renovation requests are typically made at predictable and regular time intervals. As franchisees slowly recover from the effects of the Pandemic, franchisors should consider whether to extend the time interval between renovation requests.

The capacity restrictions caused by the Pandemic decreased the foot traffic and wear and tear of franchised restaurants. Chairs, tables, and carpets are much less used than in a typical two-year period such that any upgrades may be now premature or unnecessary. Moreover, while franchisees are generally in a more vulnerable financial position compared to pre-Pandemic times, prices of the materials and services necessary for renovations have sky-rocketed. Requiring a franchisee to pay for a renovation in this climate may be seen as unreasonable, and risks running afoul of the duty of good faith and fair dealing codified in section 3 of Ontario’s Arthur Wishart Act.[4]

The duty of good faith and fair dealing should be kept in mind in all franchisor dealings with the franchisee – including requests for renovations. To avoid potential complaints of an unfairly timed renovation request, franchisors should present the best business case of the reason for the timing of the request, and include evidence of the financial viability and necessity of the renovations to the franchisee’s business.

The franchisor should also consider the term of the agreement. There is a more compelling case to be made for a renovation in year five of a ten-year franchise term than in year nine, right before the term ends. Requesting a renovation late in the franchise term may be disputed as a violation of the duty of good faith and fair dealing as it does not allow the franchisee sufficient time to recoup its capital expenditure.

Recommendation

Franchisors should carefully consider the specific context of each franchise location before requesting renovations, including the term of the franchise agreement, amount of foot traffic compared to pre-Pandemic years, the franchisee’s financial situation, and prior commercial behaviour. Providing financial evidence of the value renovations would bring to a franchise location may prevent a claim for breach of the duty of good faith and fair dealing. Depending on the particular franchise, it may make sense to extend the typical time interval between renovation requests.

• Labour Shortages and Robots

Much has been written on the “Great Resignation”, in which the Pandemic and related governmental policies have pushed record numbers of workers to leave their jobs in search of greater employment opportunities, or out of the job market altogether. Franchised restaurants now struggle to maintain their quality of service while grappling with the resulting labour shortages.

Certain franchised restaurants have responded by increased reliance on technology. Partly to replace absent workers, and partly to attract new ones by offering more stimulating work, robots have increasingly assumed menial or dangerous tasks. Taking the form of self-serving payment kiosks, robotic deliveries of food, or robotic spatulas which flip and cook burgers, technology is increasingly filling the void caused by labour shortages at restaurants.

There are obvious benefits to franchisors and franchisees, not least of which is lower owed employee wages. If done correctly, incorporation of robotic technology can save money while offering a novel experience to customers.

Recommendation

If franchisors consider introducing robotics to their system, they should ensure their franchise agreements provide and/or are updated to expressly contemplate, and permit, them to do so. The franchise agreement should set out clear obligations associated with the use of robotic technology, including maintenance and standards of service, to which the franchisee will be held responsible.

Sotos LLP provides franchisors and franchisees with strategic advice on these and other issues arising from the ever-evolving legal landscape. If you would like to discuss how our firm can help your business, please contact us.

Ryan McCabe, Sotos LLP

Ryan is an associate at Sotos LLP. He carries on a commercial practice with a principal focus on franchising.

[1] McKinsey & Company, Ordering In: The Rapid Evolution of Food Delivery, September 2021, page 6.
[2] Ibid.
[3] Other restaurant models, such as ghost kitchens, operate with lower occupancy and real-estate costs, and are better positioned to remain profitable after paying Aggregator service and commission fees.
[4] Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3, s. 3.