Solving Urban Challenges Through Fast Food

In 2009, the Subway sandwich chain received 142 loan guarantees worth nearly $27.7 million from the federal government's Small Business Administration. Subway is just one fast food company (even if it is the fast food chain with the most franchises worldwide). Meanwhile, in that same year, all the combined grocery stores in the United States appear to have received a total of seven SBA loan guarantees worth $4.1 million. Such disparities in federal loan support can help shed light on the question of why there are so many fast food restaurants relative to grocery stores in America's inner cities.

There are, of course, other relevant considerations. Perhaps the most obvious explanation as to why fast food restaurants tend to outnumber grocery stores in America's inner cities is that fast food is generally more profitable than the grocery business. Recent media reports indicate that margins for individual fast food franchisees are in the neighborhood of 4 to 6 percent, while those for grocery stores are "razor thin," averaging just 1.3 percent after taxes. Grocery stores also often occupy more square feet than fast food outlets. In city centers where space is limited, prospective grocers may be stymied by fewer real estate options, zoning restrictions, lack of available parking for customers, and costly leases.

And then there are fears of crime in urban areas. Despite reduced levels of violent crime in a number of America's major cities in recent years, grocery entrepreneurs may still be reluctant to open stores in inner cities because of concerns about robberies and vandalism. Mitigating these concerns requires considerable outlays, including installing security equipment and taking out insurance premiums that are especially costly for entrepreneurs doing business in "risky" areas. Of course, such costs of doing business in urban areas also apply to the fast food industry. But perhaps higher fast food margins make up for these expenses, whereas thinner grocery margins are insufficient to offset these costs.

Fast food's profitability relative to grocery retailing may not entirely account for its prevalence on inner-city blocks, however. There are other structural contributing factors. Consider, for instance, that national fast food companies often rely on individual franchisees to distribute their products. This means that individual fast food outlets representing regional and national chains have been able to qualify for federal loan guarantee programs for "small businesses." This contrasts with leading national grocery retailers, many of which are owned and operated by corporations rather than individual franchisees. Such an ownership structure often precludes grocery retailers from receiving the same government small business loan guarantees that are available to the fast food industry.

More specifically, the SBA, which guarantees loans of up to $3.75 million that individual businesses can borrow from commercial banks, imposes eligibility criteria on qualifying businesses' participation in its 7(a) Loan Program. To participate in the 7(a) Loan Program, the agency's "primary program for helping start-up and existing small businesses," qualifying businesses have to fit the definition of "small." According to current SBA regulations, this means that the annual gross receipts of qualifying grocery stores and supermarkets may not exceed $30 million, and that fast food and "limited service" restaurants cannot gross more than $10 million. These regulations favor national fast food companies over supermarket chains because many individual fast food restaurants are owned by franchisees and gross less than $10 million, while the majority of individual supermarkets representing national chains are owned by companies, conglomerates, and private equity firms that gross in excess of $30 million.

The Subway sandwich chain exemplifies how the fast food franchising model has been ideal for participation in the SBA's 7(a) Loan Program. With over 44,000 outlets as of 2016, Subway has more restaurant locations than any other fast food company in the world. All of its restaurants are franchised, with its U.S. locations pulling in an average of $452,000 in sales as of 2010. Not coincidentally, Subway has been far and away the leading recipient of SBA loan guarantees in recent years.

Over at McDonald's, the company reports that "more than 80%" of its outlets are currently owned and operated by franchisees. According to the fast food industry trade publication QSR (quick service restaurants), the average U.S. McDonald's restaurant took in annual sales of $2.4 million in 2010. At Kentucky Fried Chicken (part of the Yum! Brands conglomerate), 13,489 of the company's 18,198 locations were individually owned and operated as of 2013, with the average U.S. outlet (both franchised and corporate-owned) raking in $933,000 in annual sales in 2010. Similarly, two of the other major fast food chains, Burger King (part of the global private equity firm 3G Capital as of 2010) and Wendy's, have announced plans to transfer 100 percent and 85 percent of restaurant ownership to franchisees, respectively. Like the other fast food chains, industry figures from 2010 showed that Burger King and Wendy's franchisees registered annual sales under the SBA eligibility threshold of $10 million ($1.2 million and $1.4 million, respectively).

Unlike the fast food industry, most of the country's leading grocery retailers are not franchised and, given their billion-dollar gross sales, ineligible for SBA 7(a) loan guarantees. Led by Walmart, which grossed $422 billion worldwide in 2010, these companies include Target, Costco, Publix, Aldis, Trader Joe's, Whole Foods, and a handful of other supermarket chains. While a few national and regional grocery chains, such as IGA, Piggly Wiggly, Giant Eagle, Save-A-Lot, and ShopRite, are franchised, these stores account for a relatively small segment of the grocery sector. (Queries to two of the nation's large supermarket chains, Kroger and Safeway, regarding whether they are franchised to individual owners, have gone unanswered.)

There was the curious case of one franchised supermarket chain in the 1960s, however. In 1967, a Baltimore-based, black-owned company called the Jet Food Corporation announced plans to open a chain of franchised supermarkets in inner-city African-American communities; the company eventually opened supermarkets to considerable fanfare in Baltimore and Cleveland. According to Jet Food Corporation president Herman T. Smith, the company was founded with three objectives in mind: to ensure that profits remained in black communities, to create jobs, and to provide inner-city African-American consumers with access to high-quality, affordable groceries. It is uncertain whether the...