Business overview: An investor's guide to Dunkin' Brands Group

Part 3
Business overview: An investor's guide to Dunkin' Brands Group (Part 3 of 10)

Why a franchise-focused business is Dunkin’ Brands’ golden ticket

Opening up shop

Dunkin’ Donuts has pursued an increasingly aggressive expansion strategy since its IPO. The key to this strategy is its franchise-centered business model. Management believes the lack of a significant amount of company-owned stores (35 total across Dunkin’ Donuts and Baskin-Robbin’s platforms) allows the company to focus on menu innovation, marketing, franchisee coaching, and other supportive initiatives to drive brand success. The fees associated with franchising a Dunkin’ Brands restaurant are the key revenue driver for Dunkin’ Brands Group.

initial franchise feeEnlarge GraphA potential franchisee will submit an application to the Dunkin’ Brands corporate office. Once approved, an agreement is signed and the franchisee will pay an initial fee exclusively covering the right to operate the franchised brand. The terms of this application and subsequent franchise agreement typically last for 20 years. Under certain circumstances, such as a franchisee leasing an existing property from the company or leasing a property from a third party for new store development will typically last for ten years with optional re-evaluations occurring every five years afterward. The franchisee will pay this fee up front when the agreement is binding (regardless of if or when the restaurant opens). Plus, the franchisee is required to pay a royalty fee. The going rate is 5.9% of gross sales in the United States as of the 2013 calendar year. A comparable franchise agreement is that of McDonald’s, which lasts for 20 years with an average royalty fee of 4.0% of gross sales.

The majority of international royalty fees are 5.0% of gross sales, but this rate is lower in larger markets. For example, the Korean joint venture partner has a lower rate. So the effective international royalty rate for FY2012 was 2.0%. Royalty fees are typically collected weekly—except in the case of Baskin-Robbin’s international franchises. The company generates revenue via the sale of ice cream products, so the effective royalty rate was roughly 0.7%. Royalty fees composed 63.7% of total revenues for FY2012.

Revenue analysis (FY2012)Enlarge Graph

Changes to the SDA

The various fees are modified on a case-by-case basis, outlined in Dunkin’ Brands franchising store development agreement contract (or SDA). Restaurants in developing markets are the most common recipient of a fee reduction. Corporate will occasionally reduce royalties for the first few years of a newly opened franchise in a developing market. Likewise, the company may reimburse the franchisee for local marketing efforts. Plus, Dunkin’ Brands will provide certain development incentives as specified by a qualified franchisee (qualifications are set forth in the addendum to the SDA). Management believes these incentives will drive development in infantile markets.

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