The Rise and Fall of Subway: A rapid growth strategy has come at a cost

Subway sees profits fall

Pushing a rapid expansion plan that in 2013 saw 50 new shops open per week, Subway now has 44,000 restaurants in 110 countries, overtaking McDonald’s in 2002. The company aims to reach 100,000 locations.

But expansion seems to be coming at a cost: last year US sales fell 3% ($400 million), the biggest of any of the top 25 fast-food chains, and the company dropped two positions to become the third most popular fast-food restaurant for the first time in seven years.

Pete’s Super Submarines

The submarine-sandwich chain was founded in 1965 by 17-year-old Frederick DeLuca using $1,000 loaned from a family friend (Peter Buck, 50-50 partner) as Pete’s Super Submarines. The first shop didn’t do very well, so DeLuca opened a second “to create the image of success”. Nine years later, he started selling franchises under the new name Subway, and set a target to reach 5,000 shops by 1995. By 1994, Subway had beaten its goal.

“Eat Fresh” failing to tick the health box

With a focus on vegetables, low-fat produce, and nutritional information at budget prices (a lunch menu 6-inch sub and drink costs just £3), DeLuca’s chain arguably invented the idea of fresh fast-food. With a slogan “Eat Fresh”, Michelle Obama once praised Subway for “working to get kids excited about eating their vegetables”.

But over the years, Subway has struggled to maintain its healthy image in an increasingly health conscious market. Reports that, for example, the Meatball Marinara contains as much salt as 18 packets of ready-salted crisps, or a foot-long Big Philly Cheesesteak contains 1,000 calories, haven’t helped. Subway is no longer seen as fresh, but instead as processed, packed with fillers and additives.

Competition tapping into new trends has also entered the market – e.g. sushi, Thai, or Vietnamese chains, and gluten free or diet-specific fast-health-food restaurants -, offering higher quality ingredients to consumers who are willing to pay a little more for perceivably fresh, real food.

At the same time, Subway has saturated the market with franchises which compete with one another. Darren Tristano from food industry researcher Technomic comments: “Subway’s strategy has only been to open more stores, and ultimately those stores just cannibalize each other.”

Spreading the franchise

Indeed, reports indicate that franchisees have never been happy. DeLuca comments: “We faced accusations that Subway would sell a franchise to any old hick, to folks who couldn’t read English. Reporters started suggesting that franchisees couldn’t make a living operating our stores. We had all these people complaining to the Federal Trade Commission”.

Indeed, reportedly, unhappy franchisees are more prevalent at Subway than any other chain, as the US House of Representatives’ small-business committee which studied the franchise industry for six years comments: “Subway is the biggest problem in franchising and emerges as one of the key examples of every abuse you can think of”.

Franchisee complaints over the years have cited too many shops in their neighbourhood, high royalty and advertising fees (franchisees must pay 8% of gross sales, the highest royalty in the food-franchise industry), and clauses such as one giving DeLuca the power to seize and purchase any franchise without cause (some such clauses are illegal in certain US states, although many have now been removed).

DeLuca has also suffered major disputes with Subway’s landlords and agents – select franchisees which are paid for getting new stores open and supporting other franchisees in their region – over “unfair” terms (e.g. agents who fail to meet new-shop quotas can lose their territories). And in several cases, lawsuits have found that the company has conned or misled landlords by using shell companies.

DeLuca, now worth $2.6 billion in his own right, continues to focus on yet more franchises, but has thus far not responded to Subway falling out of fashion. It seems likely he will need to focus on reinventing the core product if he wants the next 56,000 shops he has planned to succeed.