Why Sbarro and Quiznos Failed

Source: Wikimedia Commons

Recently, two high profile bankruptcies dominated restaurant industry headlines. First Sbarro, the pizza chain found in countless malls nationwide, went belly up on March 10th for the second time in 3 years, while sub-sandwich maker Quiznos followed suit just four days later. Although both of these restaurants are privately held companies, investors can still learn from what went wrong. By identifying what makes certain companies losers, you can better appreciate what makes a winner especially in the highly competitive restaurant industry. 

Why Sbarro failed
Sbarro's failure resulted from its unhealthy debt-load. As long as its operations remained healthy, it could manage the debt. However, when consumers began to shun shopping malls -- Sbarro's main territory -- during the recession, the company entered a downward spiral. At its worst in 2011, the company had $487 million in debt along with $471 million in assets. This debt was greatly reduced when it reemerged from bankruptcy, but its current liabilities of $165 million still proved to be too much in the face of dropping foot traffic in America's malls. .

A large (and growing) debt problem gives a company less flexibility during tough times. To illustrate just how bad things have gotten for Sbarro, take a look at Buffalo Wild Wings  (NASDAQ: BWLD  )  Buffalo Wild Wings doesn't need to worry about declining traffic and a massive debt load. This company has faced a recession, chicken wing inflation, a tepid casual-dining environment, and a polar vortex virtually unscathed, and it still remains in high-growth mode.

BWLD Free Cash Flow (TTM) Chart

BWLD Free Cash Flow (TTM) data by YCharts

Buffalo Wild Wings' management has a long track record of taking cash flows and turning them into higher revenues and profits. Because it does not need to fret about creditors, this company has more money available to invest in the business and grow shareholder value.

Why Quiznos failed
Like Sbarro, Quiznos let its debt become a problem. However, ultimately the company's demise can be traced to two bigger issues.

First, Quiznos had a weak competitive advantage. The company surged from obscurity to the mainstream on the platform of "mmmm...Toasty!" At it's height in 2006/2007, the company had grown to 5,000 units. While the company offered delicious subs, Subway could easily buy toasters. By introducing toasted subs in 2005, Subway duplicated Quiznos's novelty. One year later, Quiznos began to unravel. It has shed over 60% of its units to its current count of less than 2,000. 

Source: Wikimedia Commons

One might be fooled into thinking that Chipotle Mexican Grill  (NYSE: CMG  )  also has a weak competitive advantage. After all, how hard is it to make a burrito? Competitors abound as Taco Bell has Cantina Bell and Jack in Box has Qdoba. However, Chipotle isn't about the burrito. It's about the source of the burrito. 

Competitors can not easily replicate Chipotle's food-sourcing machine. We're talking 100% sour cream from pasture-fed cows, naturally raised pork, 85% antibiotic-free chicken, and locally sourced vegetables. This hasn't been easy to do, and these higher-cost ingredients cut into profits. However, Chipotle's customers demand these things. Given the complexity of this sourcing, I doubt we'll see a true competitor in this area anytime soon.

Secondly, Quiznos' franchised business model had a serious flaw: it was nigh-impossible for a franchisee to turn a profit. Many franchisees lasted just three years, with some racking up $150,000 in operating losses in that time. These losses, on top of $300,000 in start-up costs, left many franchisee's no choice but to close. 

Opening a restaurant costs money and not everyone is cut out for it, so it's hard to completely fault Quiznos for every failed franchisee. However, the company brought new franchisees on board at a concerning rate. The 100th Quiznos opened in December 1995. By 2007, the company had 5,000 locations. Put another way, Quiznos opened more than one new location every day for 11 years. At that unbelievable expansion rate, the company had less-than-choosy criteria for who could and who couldn't become a franchisee.

This is reason to like the Potbelly  (NASDAQ: PBPB  )  selective franchise model. This chain will not grow to 5,000 locations in the next 11 years -- rather the company plans to expand by 10% per year, primarily through company-owned locations. Those who do wish to open Potbelly franchises have a high financial bar to clear -- opening a franchise could cost $750,000. This will keep many aspiring entrepreneurs away from Potbelly, leaving only the most highly motivated and business-savvy individuals to join the team.

A glimmer of hope
Bankruptcy is not necessarily the end of a restaurant chain. Both of these companies have the opportunity to reemerge from bankruptcy with hopes of flying high once again. Sbarro has a promising new fast casual concept called Pizza Cucinova, which would put the company on the right side of pizza trends for once. Quiznos franchisees have submitted proposals to change the franchise structure.  

Regardless of Sbarro's and Quizno's futures, investors should take note of their past failures and track future changes to gauge success. Learning from this can help as you analyze your favorite public restaurant and invest effectively in this highly dynamic sector. 

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Read/Post Comments (8) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 23, 2014, at 6:44 PM, Brilliant wrote:

    Frankly, and I am sure many will disagree, I am not falling for all of this gobbledygook.

    In my opinion the reason Quiznos failed is due the their lack of an appropriate amount of filling in their sandwiches and the fact they always tasted bland.

    I gave Quiznos a try about 5 times and each time was disappointed with the taste of their subs.

    Their quality is poor when compared to local sub shops and Publix Supermarket subs here in the south.

    You can only get away with a poor product for so long.

  • Report this Comment On March 23, 2014, at 8:36 PM, thequast wrote:

    @Brilliant

    One thing that we can both agree on is your statement "you can only get away with a poor product for so long." I am 100% with you there. You'll find many times in the restaurant industry, there are unproven concepts that already have ridiculous expansion plans. There are a couple fast casual pizza joints looking to expand to over 1,000 units, and then you find out they only have 2 currently. Poor products can expand quickly, but eventually that'll catch up with them, and the sand castle empire will fall apart.

    Was Quiznos poor product or a faulty franchise structure? Unfortunately product quality is a little subjective. I personally just hit up a location in South America, because it's the only place (in this particular country) that I can get a turkey sandwich or ranch dressing. I love the product. But portion size and price are off for me. In the end I think we'll all evaluate it a bit subjectively.

    Would a better product have succeeded for Quiznos? It's possible, but franchisees have been clamoring for change for some time. There's clearly something wrong with the setup.

    Thanks for reading and weighing in. I love being enriched by friendly discussion.

  • Report this Comment On March 23, 2014, at 9:40 PM, docheckit wrote:

    The big key missed in the article concerning Quiznos, was Subway's brilliant Quiznos killer!!

    The $5 footlong. It crushed their profits, and vaulted Subway to a top 3 brand.

    Although Subway franchisees were not happy with the promotion, overall it was the best thing for them at the time, it eliminated a big contender who was growing rapidly.

  • Report this Comment On March 23, 2014, at 9:42 PM, Wayners999 wrote:

    I had many bad experiences at quiznos and never like the low quality high prices of Sbarro. At quiznos in Crystal City, VA the manager though it would be really smart to put somebody that cannot speak more than broken un-understandable English as the order taker. Even after numerous complaints, who knows how many wrong orders, they made no change whatsoever. It was so frustrating I never went to that one again. I went to a new Quiznos near the Navy Yard. The cheapskate foreigner franchisee was so cheap he wouldn't put out napkins. You had to ASK and he would hand you 1 thin flimsy napkin. Never went back. They closed up shop shortly thereafter.

  • Report this Comment On March 23, 2014, at 9:48 PM, LemonyLogan wrote:

    @Brilliant

    How do you explain Subway? They have the most bland sandwiches on the planet, and their product is full of preservatives and chemicals yet people think it's healthy becasue of marketing. It's all about consumer perspective. Quiznos just didn't keep up. Here in Texas we have a ton of toasted sandwich shops now; Pot Bellies (mentioned in the article), Firehouse Subs, and Which Wich, all are superior to Quiznos because they conform to what the customer wants. I agree that they had a poor product but again, so does Subway yet they are still with us...hopefully not for long though!

  • Report this Comment On March 24, 2014, at 6:14 AM, vnilo wrote:

    8$ for a skimpy sub? No thanks.

  • Report this Comment On March 24, 2014, at 6:10 PM, thequast wrote:

    Thanks for all the comments. I appreciate all who took the time to read.

    @LemonyLogan

    You bring up an excellent point. Though I feel it would be subjective of me to say Subway is bland/not bland, but you bring up the point that sometimes a poor product can survive if the business is run right. Ideally you'd want an investment to have both product and good management.

  • Report this Comment On April 01, 2014, at 2:16 PM, tstorey1 wrote:

    Quizno's does not have the money to compete with Subway's marketing budget. Both chains offer low priced sandwiches using inexpensive ingredients.

    Without the differentiation possessed by Subway's ad spend, Quizno's was left to compete with every sandwich shop out there including thirty thousand plus C-stores and gas stations. A sub in a wrapper for $5 is available anywhere 24/7. Chipotle is a good example of a taco stand that has done a brilliant job of separating itself from the ocean of competitors.

    Sbarro's has watched the pizza segment grow to over 50,000 units in the US. Their product is at best, average. Every convenience store/gas station in the world will sell you some pizza. Tens of thousands of pizza places will deliver you a pizza anywhere. Sbarro's began in the 70's...how have they kept up?

    In both cases, product quality is at play for the following reason. Competition. The number of restaurants per capita continues to grow. If you don't offer a unique/superior food product? You're just another cheap sammy or slice duking it out with 7-11.

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