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THE SUBWAY STORY

by Simon Lord,
last updated 13/05/2011

From our archives - He started a sandwich shop to finance his way through college - by 1996. there were over 11,000 Subway stores around the world. On his visit to New Zealand to launch the chain here, franchising superstar Fred De Luca talked to Simon Lord about franchising - its potential and its problems.

This article was published in Franchise New Zealand magazine in March 1996. It is reproduced here for archive purposes. For a more recent article on Subway, click here.

On the day it opens to the public, New Zealand’s first Subway store is running smoothly, but slowly. The queue stretches out on to the Parnell pavement. It’s proof that the store is already popular, but the demand is pushing the new young staff team to the limit. No amount of practice could prepare them for this.

At a table at the front of the store I sit with a quiet man who talks softly, pausing occasionally to glance at the stopwatch on his wrist. ‘That guy took fourteen minutes from joining the queue to getting his order,’ he grimaces. ‘Should be three or four. They’ll learn.’

If anyone knows, he does. For my companion is Fred De Luca, founder of the Subway chain, who has guided the company to its position as the second-largest food franchise in the world and an unequalled ranking by the US Entrepreneur magazine as number one franchise in eight of the last nine years.

Legend

The Subway story is the stuff franchising legends are made of. As a 17 year old in Bridgeport, Connecticut, Fred needed to find a way to finance his way through college. A family friend suggested he start a sandwich store, offered to be his partner and put in $1000. Fred accepted - even though he had never made a sandwich himself before opening day. ‘It gave me some sympathy for the guys and girls behind the counter today,’ he smiles, looking at the hard-working team.

Thinking big, the new partnership set themselves a goal of 36 stores in 10 years. ‘Someone else had a chain of 30, so we thought that was realistic,’ Fred recalls. Franchising wasn’t part of the plan. Neither was failure, but they came close.

‘That first store was really bad,’ he confesses. ‘In fact, we considered closing after six months. Then we thought it might be the location, so we considered moving. But instead we opened a second store and that did pretty well. After 11 months we had three stores, and that’s when we really started to learn things.’

Fred now combined his pre-med studies at college (he graduated with degrees in psychology) with an education in the school of hard knocks. ‘We made mistakes - lots of them. We hadn’t realised the business was seasonal, so that came as a shock. Then it took us a while to work out what to do about it. But we learned, and we got more right than we got wrong, so we survived.’

By 1974 the company was 9 years old and had 16 stores. People had asked about franchises, but Fred hadn’t thought it was appropriate. ‘I thought franchising was about McDonalds or KFC - big chains with free-standing buildings. But we were still a long way away from our target of 36 stores and only had one year to go, so I asked a friend if he’d like to be our first franchisee. He said no.’

A few months later, though, the friend found himself out of work and reconsidered. That opened the floodgates. There are now 11,400 Subway stores around the world, generating a turnover of around US$3 billion in 1995. The chain is growing exponentially; last year Subway opened in New Zealand, Indonesia, Taiwan, Ecuador, Jordan, Switzerland and China - and that was just in November!

Changes

The changes that Subway has gone through in the last 20 years have been paralleled by changes in franchising itself. I asked Fred about some of those changes, and where he saw franchising headed.

‘In the beginning we rented a little office, took some small ads in the paper, and drew up a simple little franchise agreement on a single sheet of paper. It was all very basic and not difficult to run, but then we started growing. There are now 500 people at Subway’s World Headquarters, and the franchise disclosure document and agreement cost around US$200,000 to develop. It’s big business,’ he says.

The key to Subway’s overseas expansion has been the appointment of development agents rather than master franchisees in each country. ‘Originally we looked for masters, but we discovered they need to have substantial resources, must make a huge financial commitment and then go through a long training process to replicate the HQ function. That ruled out most individuals. Then we came up with this concept. Our development agents don’t try to do everything - only those things which are most effectively done in the field, like product sourcing, recruitment, site locations, ongoing management. Everything else - like the accounts - is handled by Connecticut.’

Does it work? ‘Oh yes. In communications, all countries are about as equally advanced as the US - although Americans don’t necessarily understand that yet. Take banking systems: all you have to do is talk to the right person initially and you’ll find most things can happen instantaneously. We use E-mail and voice-mail worldwide, and the trend will continue. Communication is a major part of franchising, and all these new methods make it easy - even in a system the size of ours. It means a franchise based here in NZ could be international in just the same way.

‘In addition, we try to choose development agents who know what they’re doing. Our agents here, Earl and Mark, were franchisees themselves - they had three Subways in British Columbia.’

Legislation & Litigation

We’ve seen a couple of reports recently which suggest the US franchising “bubble” has burst.  Some experts say that the level of legislation is making it difficult to develop or sell franchises, that people are waking up to the unfairness of franchise agreements, and that lawyers have discovered franchising is a lucrative source of litigation. How much of this is true?

‘I don’t think the level of litigation is necessarily higher than it was, say, ten years ago, but there’s certainly more legislation. People seem to think it’s wise to legislate in the area of business relationships, and I’m not sure you can - or should.

‘There are some good things - the Federal Trade Commission disclosure law, for example, says if you’re going to sell a franchise, here are the things a potential franchisee must know. It keeps things honest and fair. But a few years ago some states passed legislation setting out, for example, how far apart businesses operating the same franchise should be. I don’t think that’s very healthy. How do you compare a sandwich store to a car dealership, or a town location to a country one? The market will dictate. When people try to legislate business relationships, they tend to hurt the consumer most of all.

‘This thing about legislation is actually a problem. A few years ago I sat on the legislative committee of the IFA (the International Franchise Association, the US equivalent of the FAANZ). There were 40 lawyers and me in the room, and we were talking about disclosure documents. As the only franchisor, I stood up and asked “Wouldn’t it be simpler to have just one document acceptable nationwide?” They said “Shut up, kid, we already talked about that.’ Later, one of them took me aside and explained. These guys were all hired by the big companies, and it wasn’t really in their interests to make it easy for the little people.

We don’t have specific franchise legislation at all in New Zealand, but Australia is moving in that direction.

‘Obviously there need to be safeguards for franchisees, but too often the result of legislation is that the cost of complying actually makes it a very anti-competitive system in favour of the big franchisors. Now I’m one myself I guess I should be happy about that, but it’s kind of unfair. It makes it expensive for new franchises to enter the market, or for the small guys to get bigger. In the US, if people would accept the standard Federal Trade Commission document in all states it would reduce costs for franchisors and make them have to compete harder for franchisees - which has to be in the franchisees’ favour.’

What documentation do you give in New Zealand?

We follow the basic US rules, because we’re used to them and it works for us. There aren’t many countries where that wouldn’t apply. We assemble the disclosure document at Headquarters. Its purpose is to explain exactly what the franchise involves and remove any misunderstandings. It details exactly what franchisees have to pay and when, for example. When we send it out we get acknowledgement of receipt, and we won’t sell a franchise until someone has had the document in their possession for at least ten days. That gives them time to take independent legal or financial advice. We don’t insist that they do, but we get them to sign that we have advised them to. It protects both of us.

‘Our standard document is now 300 pages, so you can see why we stick to the same one everywhere. To be fair, a good portion of that is our list of owners. We like to encourage potential franchisees to contact owners at random - that way they get a whole range of comments, different perceptions and fewer illusions. I had dinner last night with a new NZ franchisee. He’d done his homework, all right. He’d talked to franchisees all over the world - Ireland, even Iceland, and about 30 in Australia.’

Are franchise agreements unfair?

‘Well, it’s often said that they’re one-sided, but there are 2,500 different franchises and franchise agreements in the US, and even in New Zealand, which is relatively new to franchising, people usually have a choice. Any sensible buyer is going to shop around. Sure, there’s only one Subway or McDonalds, but there comes a point where no matter how valuable the franchise is, the consumer - the buyer - will call “enough”. It’s the law of supply and demand. In the end, fair competition is the greatest safeguard of the franchisee’s rights.’

How do you see your role as CEO of Subway today?

‘I describe what I do as “super highway management”. I view people’s work as though they’re on a big freeway, starting here and wanting to be there. My job is to give them several routes, and provide rest stops for them along the way or exits if it gets too much. I try to help them avoid toll-booths or jack-knifes. I help them to avoid the traffic, then they have the space to move along at their own rate.

‘Without guidance, franchisees will go in a thousand different directions at once. They’ll waste a lot of energy. I try to keep them on the highway while all the time I’m looking for better routes. It’s what franchising is about - harnessing individual effort and capital and directing it so everyone benefits. I guess Subway does it pretty well.’

Fred De Luca, thank you.

This article was published in Franchise New Zealand magazine in March 1996. It is reproduced here for archive purposes. For a more recent article on Subway, click here.

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