Restaurants look to smaller spaces for growth

Some restaurant chains are adopting a novel strategy for growth: getting smaller.
The sluggish economy, difficulty obtaining loans, and the prospect of rising labor costs due to the federal health-care overhaul are pushing some chains to downsize stores so they can better attract new franchisees and open more restaurants profitably.

Soft Pretzel Franchise Systems Inc., which has a chain of 125 mostly franchise-owned Philly Pretzel Factory shops, has started opening "kiosks" in shopping malls, amusement parks, military bases and airports. The kiosks are a fraction of the size of its usual retail locations.

Chief Executive Dan DiZio said the move makes sense for a company whose biggest cost is labor—especially with the advent of the Affordable Care Act, which will require companies with 50 or more full-time workers to provide health insurance for those employees. Industries that employ a lot of hourly workers will be among the most affected by the health-care overhaul, scheduled to take effect next year. Restaurants, retailers and hotels have already begun shifting to more of a part-time work force.

"You could open six of these kiosks for the same number of full-time employees you'd have at one traditional store, and they can be part-time employees," Mr. DiZio said.

Philly Pretzel Factory's larger retail stores, which range from 1,400 to 1,800 square feet, also do a wholesale business selling pretzels to schools, and employ up to 12 mostly full-time workers. The 250- to 400-square-foot kiosks, which handle retail pretzel sales only, can be staffed with just two employees, making it an attractive option for owners of multiple franchises looking to expand without exceeding the 50-person threshold. The company says it is too soon to know whether the approach is succeeding.

Some larger chains, including Burger King Worldwide Inc. and Yum Brands Inc.'s Pizza Hut, began opening smaller-scale stores a few years ago.

Pizza Hut's smaller delivery and carryout stores, called "Delco Lite," have become a major part of the brand's recent turnaround, a spokesman said. The company has opened more than 300 Delco Lite locations and expects to build another 2,000 in the next decade. The new stores, which cost about half as much to build as traditional Pizza Huts, generate one of the best returns on capital in the company, which also includes Taco Bell and KFC, according to the spokesman.

Smaller stores also help companies cater to growing demand for takeout. Executives at Famous Dave's of America Inc., a chain of barbecue restaurants, noticed a growing percentage of business coming from people placing orders to go. The chain started opening smaller stores called Famous Dave's BBQ Shacks to cater to that crowd.

Tighter lending standards in the wake of the financial crisis have continued to make it tough for potential franchisees to get loans. Lending to small businesses hit the lowest level in 14 months in September, according to the Thomson Reuters/PayNet Small Business Lending Index. It has since risen slightly.

For restaurant chains, "it's all about making sure the franchisees can make money. If they build a 5,000-square-foot restaurant for $1.2 million and have to hire 50 people, can they make that money back? If they open one that's 2,000 square feet or a food court concept for $200,000, that might work better," said Steve Beagelman, chief executive of consulting firm SMB Franchise Advisors.

WZ Franchise Corp., which runs a chain of Wing Zone takeout and delivery chicken-wing restaurants, is shifting to drive-through restaurants with smaller dining rooms and fewer employees. The drive-through locations average 1,200 square feet with three employees, down from its traditional 1,500- to 1,800-square-foot restaurants staffed by five workers.

Wing Zone, which has about 100 outlets, opened three of its new format stores last year and plans to open 12 more this year, representing half of its new-restaurant openings for 2013. The drive-through locations ring up about 30% more in sales and are more profitable than those that offer delivery, said Adam Scott, Wing Zone's finance chief and co-founder. He said he expects the majority of new-store openings to eventually be the smaller drive-through units.

"Franchisees like simplicity, and this new format is all about simplicity," said Mr. Scott.

At Checkers Drive-In Restaurants Inc., a chain that specialized in double-lane drive-throughs, the cost of building the restaurants—which ran about $700,000—seemed formidable for many franchisees. The company in 2011 opened a single-lane prototype that cost about $500,000 to build. The prototype, which was built next door to a traditional store in Alabama that was demolished, generated $1.2 million in sales in its first year, compared with $770,000 from the previous store the year before it was torn down. The new store employs the same number of workers, but they are now more efficient, the company says.

"We had to have both drive-through lanes staffed regardless of whether both were in use, so there was idle time eating up a lot of efficiency," said Jennifer Durham, the company's vice president of franchise development.

Checkers plans to open several more single-lane restaurants and fewer double-lane stores.