Quiznos Files for Bankruptcy; Can it Ever Compete With Subway?

Toasted subs are no match for $5 foot-longs, but Quiznos plans to come out the other side of bankruptcy and keep competing.

Mar 17, 2014 at 9:48AM

First, the pizza/pasta chain Sbarro filed for bankruptcy and now Quiznos has filed Chapter 11. The chain does not intend to go out of business and has filed a "pre-packaged" plan that the company said in a statement will reduce its debt from $600 million to $200 million. Only seven of the chain's 2,100 are company-owned with the rest being owned by franchisees who are not affected by the bankruptcy.

Here's the company release:

Quiznos has reached an agreement with its senior lenders on a "pre-packaged" restructuring plan that will reduce debt by more than $400 million. The plan is also intended to increase the company's flexibility as it executes operational enhancements designed to strengthen performance, revitalize the Quiznos brand and reinforce its promise as a fresh, high-quality and great-tasting alternative to traditional fast food offerings. 

All but seven of Quiznos' nearly 2,100 restaurants are independently owned and operated by franchisees in the U.S. and 30 other countries around the world. As separate businesses, these restaurants are not a part of the Chapter 11 proceedings and are open and operating as usual. Quiznos customers can expect their favorite high-quality menu offerings. 

Quiznos expects to continue operating in the ordinary course of business throughout the restructuring process and will continue working with its franchisees in the U.S. and internationally to strengthen the brand, build momentum and improve growth and profitability.

How Quiznos makes its money
Quiznos sells franchises and those franchisees pay the chain an initial licensing fee as well as a royalty on sales. The company -- which is not public so detailed records of its finances are not available -- likely also makes money selling its franchisees everything from food to napkins and cups. 

Quiznos makes more money when its restaurants are doing well. It also makes more money when the brand can entice more franchisees to decide to open Quiznos locations. That has been a challenge when the much larger Subway competes with a very similar product and makes low-cost (the aforementioned $5 foot-long) a key part of its advertising.

Customers are drawn to Subway because of the low-cost promotion. Quiznos has offered similar deals (it has tried $4 foot-longs), which might bring in customers, but they don't excite franchisees who can't make money on super-low-cost items. This is also a common complaint from McDonald's franchisees regarding its Dollar Menu.

Quiznos in its plan to exit bankruptcy is attempting to deal with this issue and lower costs for franchisees.

"Our business plan includes several key elements aimed at supporting our franchisees, including reducing food costs, implementing a franchise owner rebate program, in certain circumstances making loans available to franchisees for restaurant improvements, investing in advertising to improve location awareness, and providing new incentives for prospective franchisees," CEO Stuart K. Mathis said in a release. "We are also introducing new technology at the restaurants and taking other actions to help our franchisees operate their businesses more efficiently." 

Why is Quiznos struggling?
If you make your money on franchise fees and royalties, it's hard to be successful when the number of franchisees falls. Quiznos once had more than 5,000 stores, according to CNNMoney, but now it only has 2,100. Subway has nearly 20 times the number of stores, with about 40,000 locations in 100 countries, CNNMoney reported.

Another problem facing Quiznos is that its restaurants fail at a higher rate then Subway, with 25% of the shops going out of business. "One in four franchise owners was unable to make good on their SBA-backed loan," CNNMoney reported.

According to the same story, Subway had only a 7% failure rate.

Can Quiznos turn it around?
Subway and Quiznos sell essentially the same product. Quiznos seems to have a better product with its toasted subs and meat that looks like, well, meat. Subway however, has a huge advantage due to its size and cost advantages.

Scale makes everything cheaper for Subway. From food costs to advertising, the bigger chain has more buying power. Imagine splitting the cost of an ad campaign between 40,000 stores versus only 2,100. You can buy more ads with each store paying less. The same tracks out for everything else a restaurant must buy.

Coming out of bankruptcy and staying the course would be a recipe for disaster for Quiznos. Instead, the company should take aggressive steps to lower costs through technology. It should also stop competing with Subway and start differentiating its brand. Focus on quality not strictly price and cast the brand as an alternative that offers a higher-end experience.

Look at how Chipotle and Panera Bread have become lunchtime competitors to Subway without matching prices. It's possible for Quiznos to emerge from bankruptcy and thrive, but only if the company realizes that it can't compete with Subway. It has to be something different, even if the products look similar.

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Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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