Growth Strategy: Sitting Tight at IHOP
IHOP reinvented itself as a traditional franchisor. Now it's waiting for a response.
By David Farkas, Senior Editor -- Chain Leader, 6/1/2003
 CEO Julia A. Stewart |
Julia A. Stewart, IHOP Corp.’s chief executive, has never hidden her ambition to head a major restaurant company. A ladder-climber since the mid-1970s, she nearly got the chance when she joined Applebee’s as president in October ’98. She quit three years later after learning her boss, CEO Lloyd Hill, intended to hire an heir-apparent chief operating officer.
Stewart landed another president’s job shortly thereafter, this time at beleaguered IHOP, where she had worked as a teenager. A condition of employment: that she’d succeed longtime Chairman and CEO Richard K. Herzer, 70. That she did in May 2002.
Now 18 months into Stewart’s two-year contract, she is guiding the 1,118-unit company through its biggest and most interesting turnaround. Her goal is no less than making IHOP the No. 1 family-dining chain. To achieve it, she is ordering up thousands of mystery shoppers, a raft of limited-time offers and an aggressive media strategy that uses national cable TV and the slogan, “Come Hungry, Leave Happy.”
What’s more, in a significant departure from business as usual, she and new CFO Tom Conforti have transformed IHOP’s franchise development strategy. The pair announced in January that the publicly traded company will no longer develop sites for or fund franchisees, the bulk of whom operate one unit. Instead, beginning next year, franchisees must seek funds from third parties to finance growth.
As a result, the franchise fee is falling from $250,000 to $50,000, and franchisees can identify their own sites, which, presumably, they will develop more cheaply than IHOP. By losing the bank-like infrastructure, IHOP improves cash flow. Conforti’s estimates run from $40 million to $50 million by ’05. The savings will be plowed into the aforementioned marketing schemes, share repurchases and dividends to investors.
Setting Sights
A much bigger top line is precisely what’s needed if IHOP is to become the No. 1 family-dining chain. For starters, Stewart and her team have to supplant 1,676-unit Denny’s as the market share leader. Its $2.1 billion in sales last year gave it a 6.6 percent share among the top 100 chains vs. IHOP’s $1.5 billion and 4.5 percent share, according to market research firm Technomic. They must also close an 18-point gap in average attribute scores now separating IHOP from Cracker Barrel Old Country Store, the family dining leader in Restaurants and Institutions’ “Choice in Chains.”
Stewart, who spent her first three months at IHOP visiting restaurants, sounds upbeat about her chances. “It’s not a broken brand, and there’s a lot of commitment. That’s a good thing,” she says.
If her efforts at Applebee’s are indicative of what’s ahead, there’s little to worry about. There, after rolling out a new menu and introducing the “Eatin’ Good in the Neighborhood” campaign in 2000, same-store sales climbed by more than point. Just before she left, analysts rated APPB a strong buy and had hiked their price targets.
Not the case at IHOP. Three of four analysts who follow IHP rate it neutral. Until last quarter, ended March 31, same-store sales had been flat for two years. In late April a share of IHP was changing hands for $26, $10 off its 52-week high of $36.46.
But things are improving. Systemwide same-store sales rose a healthy 2.2 percent in the first quarter while sales jumped 13 percent, to $413.8 million, for the period. Stewart credited her new advertising strategy, launched in January, and a new product called Stuffed French Toast.
“Stuffed French Toast was the most successful promotion we’ve ever done,” declares veteran licensee Bob Leonard, who operates 127 IHOPs in Florida. “Instead of just a TV commercial, the promotion was all-encompassing. There were good media buying, good training materials, good POP.”
 CFO Tom Conforti (l.) promises restaurant-level returns will be competitive with other brands. CMO Gregg Nettleton has one goal in mind: "We want to get greater frequency from our guests." |
Sighting Customers
A former marketing executive herself, Stewart chalks up the gains to more sophisticated media buying. Unlike the past, IHOP now buys costlier but more effective targeted rating points. “Historically, advertising co-ops bought local spots, and the focus was on tonnage or gross rating points. So commercials aired at 2 a.m. Most of our guests are asleep then,” she explains. “Now we spend more but get more for the dollar.”
Today, ads for IHOP appear on cable channels like the Food Network and Lifetime and prime-access programs like “Friends” and “Seinfeld,” shows likely to attract heavy users of family-dining restaurants. “We’re reaching the right people,” Stewart declares.
Giving patrons a compelling reason to visit IHOP in the first place has been hard. An attitude, awareness and usage study undertaken last year showed the brand’s unaided awareness levels were low. (Aided awareness, on the other hand, is extremely high.) Stewart figured limited-time offers, like Stuffed French Toast, might work. Says Chief Marketing Officer Gregg Nettleton: “If you are talking about a brand you’re trying to wake up, you have to create a sense of urgency.”
IHOP is currently promoting flapjacks under the guise of “Paradise Pancakes.” The hook: sweet, tropical-like toppings.
Advertising giant McCann-Erickson produced a 30-second spot that features a businessman boarding a morning bus only to be surprised by a Hawaiian party on board—on its way to IHOP, of course. “IHOP used to be known for fun, and it’s going back to fun now,” says consultant Steve Pettise of Golden Spike Resource Group, who was the chain’s vice president of marketing from 1982 to 1996.
Making the Grade
Pancakes, which require no new training, are something of a safety valve for franchisees, now under the microscope of mystery shoppers. Stewart’s research also showed that hostesses and servers are less than friendly toward guests and that operations overall need work. “The biggest thing out there is the meet-and-seat interaction,” Stewart says. To help whip restaurants back into shape, she is paying for systemwide mystery shops—an estimated 20,000—that began last month after run-throughs in Texas and California. Each restaurant is scheduled for six evaluations per quarter.
By fall, she predicts, the company will have enough data to assign a standard score. That score combined with one from an “operations consultation” will be used to determine which franchisees get additional development agreements.
The scoring worries veteran franchisee Joe Katin, a test participant in Texas and a member of the company-sponsored Franchisee Advisory Board. He fears the bar will be set too high for many. He advised management to keep the standard in the 75 percent to 80 percent range. “I know I run really good stores, and my average [mystery shop] score was 83 percent,” he says.
Stewart insists that whatever the number is, “it’s one of many criteria” employed to identify good operators capable of growth.
Got the Dirt
Management believes there’s plenty of room for expansion. “We’ve completed an analysis of the dirt, and there are 400 to 800 sites left in the U.S.,” Stewart told investors at an April gathering in Atlanta.
By ditching its former expansion model—namely, playing banker to small-fry franchisees who typically only opened one restaurant—the company is now banking on well-capitalized developers and existing multiunit franchisees. This year, one of transformation, existing franchisees are opening 20 to 25 units under the new plan; next year, the number may grow to 80. One troubling issue: Small fries are 65 percent of the system. IHOP therefore may have to round up developers from outside its system if it’s to meet growth goals of 65 to 85 units in ’05.
Even multiunit franchisees who already use outside lenders are cautious about their chances to develop their current territories. “I would hope IHOP wants to work with me,” says Chris Millisci, who operates 19 units in Phoenix. “I can build a number of stores within reason, if they don’t get in my way.” Bob Leonard, whose development territory encompasses Florida, says he has felt pressure from management to allow new franchisees into the state. Leonard, who opens four to seven units a year, has thus far said no.
Some observers doubt that developers will be attracted to IHOP. After all, the segment itself is weak. On a compounded basis, Technomic predicts family-style chains will grow sales by merely 2 percent from ’01 to ’06. Worse, IHOP’s returns are reputed to be low. Analyst Dennis Joe of Sidoti & Co., wonders why anyone would want to sink $1.5 million into a unit. “If I’m going to deploy that much capital,” he asks, “why wouldn’t I go after a Panera, with a 50 percent cash-on-cash return?”
CFO Conforti, who hasn’t publicly divulged unit-level ROIs, is confident returns will be competitive. He cites multiunit franchisees who together have been opening 10 to 15 units a year without help from IHOP “in a system that was biased against them.” He is asking them to share their unit economics with him for analysis.
For the time being, Stewart, who recently announced lending programs with several parties, including GE Capital and the SBA, is counting on her own franchisees. “A large majority of our multiunit franchisees want to grow,” she claims. That’s good, since they’re likely her best bet for achievement.
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