Experts and insiders say Subway is haunted by a fundamental flaw that is forcing the chain to close hundreds of locations

Subway closeKate Taylor

  • Experts and franchisees say that Subway's problems stem from its franchise system, which encourages franchisees to open thousands of inexpensive sandwich shops, often close enough to each other to cannibalize sales.
  • The chain has been criticized since the 1990s for encouraging uninformed franchisees to open an excessive number of locations.
  • As Subway has shuttered hundreds of locations in recent years, the chain's franchise system and potential for cannibalization is under the microscope again.
  • Some franchisees claim that they are being forced out of locations for minor infractions such as smudged glass or poorly chopped vegetables.
  • A Subway representative said that these negative experiences "do not reflect those of the majority of Subway's franchise owners."
  • Visit Business Insider's homepage for more stories.

Subway's franchise system helped turn the sandwich chain into a giant. Now, experts and insiders say it is causing problems.

Subway is the biggest chain in the US, with nearly 24,800 locations, almost as many as Starbucks and McDonald's combined. But, the chain is swiftly shrinking.

In 2016, Subway's US location count dropped by 359. It lost another 909 locations in 2017. It dropped another 1,108 locations in 2018.

Declining sales and shifting trends have played a role in the closures, with Nation's Restaurant News reporting that the chain's system sales dropped by 3.6% in 2018.

A large part of Subway's problem is the chain's unique franchise model, which encourages franchisees to open thousands of inexpensive locations around the world - often dangerously near existing Subway shops. With declining sales and too many locations, many Subway franchisees are struggling to make a living.

Subway's franchise model has been under fire since the '90s

Subway sandwichAmy Sussman / AP Images for Subway

The thousands of Subway locations across the US have been opened by franchisees - small business owners, working independently from the parent company.

It only costs $116,000 to $263,000 to open a Subway location today, making it one of the least expensive franchises in the restaurant industry. For comparison, it costs $1.3 million to $2.2 million to open a McDonald's franchise.

Read more: What it costs to open 12 of the biggest fast-food chains in the US, including McDonald's, Chick-fil-A, and Taco Bell

The low cost and ease of opening helped Subway grow at a rapid pace after cofounders Fred DeLuca and Peter Buck opened the first Subway shop in the late 1960s. But, by the '90s, many felt the chain was growing at an irresponsible pace.

"It used to be the joke on my side of the franchise industry that, not only will Subway as a corporation take anyone with money, but they'll open a location three streets over," franchise industry expert Joel Libava told Business Insider. "They don't care."

US House of Representatives' small-business committee blasted Subway's franchise contract in the '90s, with then-staff economist Dean Sagar saying, according to a Fortune article from 1998, "Subway is the biggest problem in franchising and emerges as one of the key examples of every abuse you can think of."

The company's 8% royalties - which are still in effect today - were and continue to be among the highest in the industry. The company's franchise agreement forces franchisees to settle disputes via arbitration, something that many experts say can give companies an unfair advantage.

Franchisees have long complained about Subway allowing locations to open near each other, risking cannibalizing businesses. Some franchisees say that development agents - franchisees who sell franchises and monitor other franchisees' compliance - are given too much power and fail to consider other franchisees' best interests.

"I saw the handwriting on the wall with the focus being on opening as many units as possible, even if it angered franchisees," Scott Godwin, who owned three Subway locations in Virginia until the early 1990s, told Business Insider in 2018.

Read more: 'Subway is dying': Battles at HQ are killing the world's largest fast-food chain - and many franchisees are turning against the CEO

In the 1998 Fortune article, then-executive Tina Perazzini said Subway did not worry much about cannibalizing franchisees' sales with new locations, telling the publication: "We put them up any f---ing place we could."

Another Subway executive told Fortune at the time that 30% to 50% of the company's franchisees were immigrants and many signed franchise agreements without understanding what they had agreed to.

"We faced accusations that Subway would sell a franchise to any old hick, to folks who couldn't read English," CEO and cofounder Fred DeLuca told Inc Magazine in 2013. "Reporters started suggesting that franchisees couldn't make a living operating our stores."

Subway's boom and bust

Subway shutteredA shuttered Subway location in Brooklyn, New YorkKate Taylor

DeLuca told Inc. that Subway fixed the cannibalization problem - which he considered overhyped - by setting up a site-review system.

Franchisees' rage against the system also likely died down simply because sales improved.

In 2000, Jared Fogle joined the chain as a spokesperson after losing hundreds of pounds on the "Subway diet," kicking off a fruitful chapter in Subway's history. Expansion exploded, with Subway passing McDonald's to become the biggest chain in the US in 2002 and the biggest in the world in 2010. The chain thrived during the recession, with the $5 footlong deal fueling a 17% sales boost in 2009.

However, lingering problems with Subway's franchise model resurfaced over the last decade as the company once again fell upon hard times.

DeLuca died in 2015, passing on the leadership of the company to his sister, Suzanne Greco. The same year, the company cut ties with Fogle, who is currently serving a nearly 16-year prison sentence after pleading guilty to paying for sex with minors and possessing child pornography. The chain's "eat fresh" motto fell flat as franchisees told Business Insider in late 2017 that they were stuck serving "mushy and rotten vegetables," while competitors rolled out locally grown ingredients.

Read more: Subway's 'mystery meat' and 'mushy and rotten vegetables' destroyed the 'Eat Fresh' advantage it spent years building

When no one wanted to eat at Subway anymore, the large number of restaurants and related cannibalization once again started causing problems for franchisees, many of whom struggled to turn a profit. In late 2017, one franchisee told Business Insider that up to one-third of Subway's locations could be unprofitable, citing internal conversations and national sales numbers.

"I have sadly watched my peers close their doors only to see Subway resell their investment to others with no benefit to them," one franchisee told Business Insider in early 2018. "It is inevitable that I will do the same in the near future."

She continued: "I wish we had an advocate. This was my retirement, and now, well, it's over."

'You've sold your soul'

subway sandwichSeth Wenig/ AP

As hundreds of locations shutter, some franchisees say that they're being forced out by development agents and Subway's corporate office for minor infractions such as smudged glass or poorly chopped vegetables.

Mark Shearer, who has served as an attorney for a number of Subway franchisees, told Business Insider that Subway's system is fundamentally broken.

Development agents can take away a franchisee's location due to perceived infractions. Then, these agents decide who takes control of the location - and could have the option to take it over themselves.

"It is such an inherent conflict of interest when you can mark your franchisee out of compliance, and then you also have the power to approve or disapprove of a transfer of that franchise," Shearer said.

In June, The New York Times reported that dozens of franchisees asked Greco to investigate development agents' actions forcing out franchisees in 2016. The request reportedly went unanswered.

To counter decisions made by development agents and corporate, Subway franchisees need to go through arbitration, as opposed to settling the case in court. In 2018, Subway took the equivalent of 29 actions for every 1,000 franchisees, mostly arbitrations, compared to 1.4 actions at McDonald's, Dunkin', Pizza Hut, Burger King, and Wendy's combined, John Gordon of Pacific Management Consulting Group told The Times.

A Subway representative said that these negative experiences "do not reflect those of the majority of Subway's franchise owners."

"Our clear and unwavering goal is to give every guest a great experience, and to give every franchise owner the tools for success," the representative said in an email to Business Insider.

Shearer says that many Subway franchisees live in fear that they could be forced out for a small infraction or treated unfairly in the chain's arbitration process.

"When you look at everything Subway can do to you, you've sold your soul," Shearer said.

Can Subway come back?

Greco stepped down as CEO of Subway in May 2018. Over the last year, the chain has tried to turn over a new leaf.

The company has been pushing a new restaurant design, with revamped menu boards, WiFi, USB ports, and updated furniture. Subway has added trendy new menu items, such as Halo Top milkshakes and Beyond Meatball Marinara sub sandwiches.

"[F]ranchise owners and their guests are positively responding to our innovative new menu options, increased convenience, and redesigned restaurants," a Subway representative told Business Insider. "As one of the largest networks of small business owners in the world, we recognize the need to continually evolve to meet the needs of our guests and franchise owners."

Still, experts aren't convinced that Subway can come back. Libava says that he expects Subway to remain "stagnant," with franchisees continuing to cut ties with the chain.

"If they don't get it together and if the franchisees don't feel like they have an opportunity to make money, I don't think they're going to last," Libava said.

If you're a Subway franchisee or employee with a story to share, reach out at ktaylor@businessinsider.com.

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