Who pays for price promotions?

In recessionary times, one of the most popular ways for franchises to compete for customers is to offer fixed-price deals or better value propositions. It may keep the tills ringing but, unless properly planned, such promotions can have a disastrous effect upon the bottom line for franchisees. The Wall Street Journal recently reported on promotions being offered in the US by food franchises such as McDonald's, Subway and Quizno's.

One particular promotion, for a new pastrami sandwich at Subway in New York, attracted particular criticism from franchisees. This offered customers a coupon for a free trial sandwich, with no other purchase being necessary. Subway provided free pastrami, but the franchisees had to supply bread, cheese and other condiments - at a cost of about $1.50 to $1.75 per sandwich. Add the cost of the potential lost sale from giving away a free product and the economics of the promotion look somewhat dicey.

I know from my own days in fast food that the franchisor's marketing team would undoubtedly claim that they had achieved their objective of driving new customers to the stores. However, there is a very fine balance between huge success and huge failure - and queues out of the doors are as likely to denote the latter as the former.

In many ways, price-driven promotions are anathema to franchises, which tend to market on service and quality rather than pure price. As Al Dunn, the former CEO of McDonald's in New Zealand, commented in our article on Coping with Recession, ‘Stay away from a price war or you'll get dragged into the commodity business and margins will evaporate. Instead, change your product mix. Offer new groupings of products that are more value-focussed. If you're clever about it, that won't necessarily mean reduced margins and will attract more people too.'

We've seen price wars before in New Zealand, most notably in the pizza market when Pizza Haven and Silvio's drove prices down to the point where they both exited the market, while quality providers like Eagle Boys and Hell thrived. We also have the example of the much talked-about Georgie Pie, which made the mistake (among others) of getting locked into ‘dollar value' menus that allowed little room for manoeuvre on margins.

As the Wall Street Journal article points out, franchisees often have little or no choice as to whether to participate in a promotion or not. This is reasonable: where there is major marketing around an offer, to restrict it to ‘participating stores only' would be a poor use of marketing funds. But any promotion does need to be carefully structured to be profitable and does need to gain significant buy-in from franchisees if it is to be truly successful. This is where a Franchise Advisory Council can be hugely valuable.

Because there is another issue at stake here too. In most franchises, the franchisee's income depends on what is left on the bottom line. The franchisor's income is defined by the franchisee's top line - the sales level on which a percentage royalty is paid. A promotion - even a short-term one - that ignores this inconvenient truth can leave a very bitter taste in the mouth for franchisees.

Read more on how marketing funds are managed in top New Zealand franchises here.

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