Subway got too big. Franchisees paid a price
Jul 12, 2019
Subway is the largest fast-food company in the world by store count, with more than 24,000 restaurants in the United States alone.
By Tiffany Hsu and Rachel Abrams
Manoj Tripathi couldn’t shake the feeling that someone had a vendetta against his Subway sandwich shop. A franchisee for nearly two decades, he had done everything he could to keep his restaurant, in a strip mall in Northern California, in perfect condition. But lately it seemed like someone was out to get him.
It was the middle of 2017, and inspectors sent by Subway’s regional manager were finding a new problem to cite each month: a handprint on the glass door, the wrong brand of bathroom soap, cucumber slices that were too thick, he said. They seemed to be little things, but with each write-up, Tripathi’s grip on his store weakened. If he racked up enough infractions, Subway could terminate his contract and take control of the business.
When an inspector named Rebecca Husler arrived one day that September, Tripathi thought his restaurant was pristine. Then he noticed that a single light fixture needed a new bulb. Tripathi rushed out to buy a replacement, but by the time he returned, Husler had marked it as a violation. A year later, just as he feared, he lost the Subway.
Tripathi wasn’t paranoid. Husler really was out to get him. She had specific instructions from her boss, the regional Subway supervisor, to find fault with the store, she said in an interview.
“I was kind of his hit man,” she said, sipping an iced tea at a Starbucks in the Bay Area. Husler worked for the regional supervisor for nearly a year, she said, and she has come to regret the role she played in pushing a group of store owners out of their investments. The light-bulb moment with Tripathi, especially, gave her pause. “We’re ruining these people,” she said.
Subway is the largest fast-food company in the world by store count, with more than 24,000 restaurants in the United States alone. It got that way thanks in large part to entrepreneurial immigrants. Unlike at chains such as McDonald’s and Burger King, where many franchises are operated by investment firms, Subway owners are mostly individuals and families. The company’s co-founder, Fred DeLuca, made stores easy to open; most new franchisees are charged a $15,000 initial fee, compared to $45,000 at McDonald’s. In exchange, Subway operators must hand over more revenue than at many other chains — 8% of gross sales — while also agreeing to other fees and stipulations.
For half a century, the system worked to mutual advantage. Subway’s value hit $12.3 billion, and countless first-generation Americans bootstrapped their way to success, one foot-long at a time.
By the time DeLuca died in 2015, though, the company was struggling. Rivals like Jimmy John’s and Quiznos had grown, and Subway’s spokesman, Jared Fogle, pleaded guilty to child sex and pornography charges. DeLuca’s sister, Suzanne Greco, took over as chief executive, inheriting a company that many felt had grown too fast and haphazardly. In 2016, for the first time ever, more Subway stores closed than opened. But while many franchisees shut down because of underperformance, others operating profitable locations began to feel targeted, too.
‘My blood is boiling’
For many owners, Subway’s internal workings are a mystery. The chain, which is private, offers far less financial information than other global fast-food peers. In the most recent version of a disclosure document given to prospective franchisees, which is more than 600 pages long, the company notes that it can revise its rules “at any time during the term of your Franchise Agreement under any condition and to any extent.”
The document would be difficult for anyone to process. But Alexander Dembski, who trained many new Subway owners over a 34-year career, estimated to Fortune in 1998 that 30% to 50% of the chain’s franchisees were immigrants and that more than a third of applicants scored poorly on proficiency tests in math and English.
Before his death, DeLuca was accused of using bullying tactics that left many operators struggling to recoup their investments, leading to lawsuits, regulatory run-ins, government investigations and constant complaints from franchisees. One of the most persistent areas of protest has involved a class of Subway managers known as development agents.
Subway parcels its vast network of stores into more than 100 regional fiefs. Each is overseen by a development agent, who recruits new franchisees, approves buyers for existing stores and sends inspectors — known as field consultants — to conduct monthly reviews. But usually, development agents are also franchisees themselves. When that is the case, they are both in charge of and competing with other store operators, and their own locations are inspected by people they hire.
These feel like conflicts of interest to many Subway owners — giving development agents the means and motivation to shut down competing stores and take over profitable ones by manipulating inspections. Many franchisees who have lost their restaurants say that they have recouped little of their original investments. Intervention from Subway’s headquarters in Connecticut is rare.
Don Fertman, Subway’s chief development officer and a veteran of the company for 38 years, said that owning restaurants helps give development agents “a better understanding of all aspects of owning a small business.” He said the company reviews the agents’ work and expects them to uphold ethical standards, dealing with violations “on a case-by-case basis.”
Across the country, franchisees have lodged complaints and filed lawsuits. In West Virginia, Bhrugesh and Utpala Vyas ran three stores, two of them top performers in the territory, they said. In a 2017 filing in federal court in Connecticut, Utpala Vyas accused the local development agent, the man’s son and an inspector of conspiring to take over the stores by concocting “unreasonably harsh evaluations.”
A judge ruled against Vyas. Records from local health departments and Subway show that at least two of the stores are now co-owned by the inspector and the development agent. “I feel very bad, and my blood is boiling,” Bhrugesh Vyas said. “This was our hard-earned money.”
Fertman said that complaints like those Vyas filed are “unfounded” and that Subway “makes every effort” to help noncompliant franchisees improve. He added that the company is “in the business of selling sandwiches — not closing restaurants, not marking people out of compliance.”
“Our business development agents are well-respected members of our business community,” he said. “And when we hear these allegations, I would say that they are false.” He said he was not aware of any exceptions.
For years, the Subway system’s opacity and aggressive pace of development — DeLuca once dreamed of opening 50,000 stores by 2017 — went hand in hand. The company encouraged stores to open within blocks of existing locations, with development agents often giving the established franchisees a choice: Operate the new restaurant themselves or compete with someone recruited by Subway. Franchisees, feeling pressured, sometimes took the first option.
“It was assumed that the stores would, eventually, become sustainable,” Tripathi said. An immigrant from India, he bought into Subway’s expansion in a major way. After two decades spent at companies like Jamba Juice and the Body Shop, opening Subway franchises was his chance to take charge. At one point, he owned 38 stores, and by 2015 he was among the largest franchisees in California’s East Bay region.
That was when Greco took over Subway, and the company’s store count began to shrink. In the East Bay, Tripathi was under the jurisdiction of a development agent named Chirayu Patel, known as Akki. He oversaw a huge, choice territory that included most of Northern California and western Nevada. Patel also owned dozens of Subway stores.
In 2016, he convened a franchisee meeting in a Sacramento warehouse. He told everyone that Subway wanted to improve its strongest restaurants and shut down the weaker ones, according to Nikku Aulakh, a franchisee who was present.
She left the gathering alarmed. She and many fellow franchisees had been pushed for years to invest huge sums in new stores that were now struggling. Subway’s franchise contract forbids the company from unilaterally closing stores just because sales are weak. But franchisees can lose control of their restaurants for failing to meet Subway’s operating standards — violations cited by inspectors employed by development agents like Patel.
Aulakh said Patel eventually pressured her into closing or selling her four stores in Sacramento, after they received a slew of bad evaluations. “I would have liked to stay in business for another 10 to 15 years,” she said. “I wanted to make more money, but I had no other choice.”
Vishal Sharma, a franchisee in Nevada who owned three stores, described another meeting that Patel convened in Reno the same year. In front of some 20 store operators, Patel said that he had “the money to buy the best lawyers,” Sharma recalled. “At the time, we weren’t scared. We thought that maybe that was just his style. Then we figure out that this guy’s template is not developing the territory, it’s taking away the territory.” (Patel said in an email that he had been informing the franchisees that Subway’s lawyers were available to answer legal questions.)
At one point, a franchisee sent Patel an anonymous complaint; he responded with an email to a large group of them, which was reviewed by The Times. He threatened a lawsuit that “would be so huge it would nearly take all of your life earnings in Subway in fighting this suit. Please don’t test me especially when you don’t have any basis.”
Subway terminated Sharma’s contracts in 2017. Last December, in state court, he accused Patel of using “rigged compliances” and Subway of employing an “usual structure where the local agent is a supervisor, as well as a competitor.” The case was ordered into arbitration in Connecticut, but Sharma is appealing the decision.
Husler, the inspector who called herself Patel’s “hit man,” said that Patel considered his own interests when determining what stores would be sent to arbitration, and likely closed. When it came time to conduct inspections, she said, Patel made it “very clear that his stores were to pass” and that “the people he wanted out of the system were to fail out of the system.”
The Times reviewed text messages about individual franchisees in which Patel assigned evaluations to certain inspectors “so we can get this guy out of the system.” But when it came to his own stores, there was a different standard, according to Effie Lennox, a former inspector who worked for Patel in Northern California from 2007 to 2010. She said that he asked her not to report violations at his locations and to email him about them instead.
“That was the problem: He was a franchisee and a development agent,” she said. “And especially with someone like him, having that conflict of interest is the worst-case scenario for the franchisee, because he’s in it for his own benefit, not for theirs.”
Lennox said that she often went behind Patel’s back to warn franchisees that they were being targeted. “These are people’s livelihoods,” she said. “I felt like I needed to undo the damage that he was doing to these poor people.”
In an email to The Times, Patel said that he had acted appropriately at all times and that his goal is for all of the stores in his territory to be successful. He said that evaluations at stores owned by Tripathi, Aulakh and Sharma were “conducted in a manner consistent with evaluations of other Subway restaurants.” There were problems with sales at Tripathi’s stores and food safety at Sharma’s locations, he said. Patel added that he and his team “have no intention of deliberately falsifying” evaluations and would never train inspectors to do so, and that noncompliant restaurant owners are given the chance to correct violations.
Pleading for help
Dozens of franchisees in the region decided to appeal to Greco for help. Tripathi was one of them. “There is a deep sense of morass within the franchisee community,” the group wrote in a 2016 letter. Soon after, they wrote again, asking that Greco “designate somebody impartial to look into the matter.” The franchisees said that they suspected Subway’s development agents of commissioning “unfair/biased/questionable evaluations” and forcing franchisees out “at a throwaway price.” They feared retaliation. “Needless to say, time is of the essence,” they wrote.
Greco did not respond, they said. (Subway said it always has “open lines for franchisees through multiple channels of communication.”) But Patel heard about the letter and was enraged, Husler said. He wanted all of the franchisees involved ejected from his region, she said. Husler recalled Patel instructing her: “Go in there and just throw your probe right into that food. It’s not going to make temperature, and you can mark them out of compliance.”
“He actually gave us specifics on what he wanted us to do,” Husler added — such as directing her to visit during shifts with inexperienced employees who were more likely to make mistakes.
Not all of the franchisees who have left the Subway system operated their stores perfectly, and many ran afoul of local health inspectors in addition to the company’s evaluators. But dozens of franchisees contend that issues that never bothered Subway during its rapid expansion suddenly put them out of business in recent years.
Those franchisees feel that they have little recourse. Near Sacramento, Minal Khatri and her husband owned a Subway in a prime location, just off the freeway. After Patel’s inspector repeatedly marked it out of compliance around 2014, she recalled, she and her husband started to fight constantly: Why were they failing? Why couldn’t he get everything into compliance? Khatri said they both repeatedly asked Subway headquarters for advice but never got a response. Eventually, the company took her into arbitration, and she said she was told to find a buyer for her store or risk forcible closing.
Patel rejected all of the candidates she found, she said; records indicate that he now owns her restaurant. Khatri and her husband divorced. It was only after it became clear that Patel wanted to buy her store, she said, that she realized her husband might not have been to blame for everything after all. Patel said the Khatris asked him to buy the restaurant.
Another franchisee, Kanwardeep Virk, said that starting in 2006, he operated four stores in the Lake Tahoe area that were profitable and compliant with Subway’s standards — his “babies,” he called them. Suddenly, at the beginning of 2016, he said, he started failing evaluations. He said one inspector sabotaged a meatball storage bag by puncturing it with a thermometer and then waiting to record its temperature.
Subway started arbitration proceedings against Virk. Such cases are typically heard near Subway’s headquarters in Connecticut. Many store owners cannot afford to travel to defend their stores in person and argue their cases by phone or by filing documents.
In 2018, Subway initiated the equivalent of 29 litigation actions (mostly arbitrations) per 1,000 franchisees, compared to 1.4 actions for McDonald’s, Dunkin’ Donuts, Pizza Hut, Burger King and Wendy’s combined, according to an analysis of the companies’ disclosure documents by John Gordon, a restaurant industry expert at Pacific Management Consulting Group.
Eventually, Virk gave up. Patel now owns two of his former stores. In his emailed statement, Patel wrote that the restaurants had problems with food safety and labor practices and owed back rent, and that Virk himself arranged to close or transfer them.
The Federal Trade Commission requires Subway to produce an annual list of franchisees with permanently closed stores, which the company said “allows prospective franchise owners the opportunity to contact them to discuss their experience with Subway.” But many franchisees who received termination letters after being deemed noncompliant eventually sold their stores — sometimes under duress and often for far less than they believed the stores were worth, several franchisees said. Those locations are recorded as transfers.
Franchisees say that this classification allows Subway and other franchisers to mislead potential store owners. But government oversight is limited. The FTC’s compliance guide for franchisers has not been updated in more than a decade. Lois Greisman, the associate director of the Division of Marketing Practices, said that the agency had not focused on franchise misconduct or taken any franchise-related enforcement action in years.
‘It’s not worth it anymore’
Subway is in the midst of an ambitious makeover campaign, hiring a firm that has worked with Tiffany & Co. and Saks Fifth Avenue, adding to its menu and stocking remodeled stores with new technology.
Since DeLuca’s death, the company has been on shaky footing. It was slower than many rivals to launch a digital loyalty program and mobile ordering options. Revenue fell to $10.4 billion last year, down 9.5% from 2015, according to the market research firm Technomic. In recent months, the chain has added a new chief information officer, a chief marketing officer and a North American vice president. Greco retired last year.
Subway’s store count has shrunk by more than 2,000 since 2015. “We have to look at each and every location and optimize our footprint accordingly,” said Fertman, Subway’s chief development officer. “We have to make sure, ultimately, that we have the right restaurants in the right locations.” Other executives have called it an “optimization” effort.
Sen. Catherine Cortez Masto, D-Nev., wrote in a letter in May to the Small Business Administration that franchisees had accused Subway of “using minor infractions to steal the stores from owners through a rigged arbitration system,” citing reporting by the New York Post. “I am troubled by increasing complaints from entrepreneurs about unfair practices that are causing them financial difficulties,” she wrote. The agency said in its reply that, out of 1,551 federally backed loans approved for Subway franchisees in the past decade, 12% were charged off, or deemed unlikely to be repaid — a far higher rate than the average franchise loan.
Subway, in an email, said that the franchisees who alleged misconduct were “anomalies” and that its surveys and “listening tours” found that 80% of franchisees in the system want to keep working with the company.
On the day after Memorial Day, Tripathi and his wife, Sadhana, stopped by one of the 10 Subways they still own, in an outdoor shopping mall in Orinda, California. The cashier at the restaurant cracked jokes with customers. Fans spun overhead. Every light bulb shone.
The Tripathis said they fear they could lose yet more of their stores. They sued Subway and Patel in 2016 in California court, accusing the development agent of “using a variety of techniques including trumped-up and false inspection reports to justify terminating certain franchises.” Subway invoked the clause in the franchisee contract that requires disputes to be resolved in private arbitration in Connecticut. The Tripathis have filed an appeal for the case to proceed in California.
Tripathi, a trained engineer with a business degree, and his wife, who holds a doctorate in chemistry, said they were mostly able to read and understand the reams of legal documents produced by the conflict. Many of their fellow franchisees cannot, they said. “The reason we were fighting them is that we can,” he said.
But he and his wife are getting tired of the Subway system. “We worked so hard; we gave up our own careers,” she said. “We’ve been through so much, but it’s not worth it anymore.”
Source: ET Retail.com