As Seven Eleven Japan Goes…?

ERIC H. KARP, ESQ., GENERAL COUNSEL TO NCASEF

There’s a famous saying in American politics: “As Maine goes, so goes the nation.” This phrase originated from the fact that, between 1820 and 1958, Maine held its statewide and congressional elections in September rather than in November, in part because of frigid weather. It thus became a bellwether state whose choices, generally for members of the Republican Party, more often than not reflected the outcome of presidential contests.

One of my roles as General Counsel to the National Coalition is to closely monitor publicly available information about SEI derived from securities filings by its Japanese-held parent, Seven & i Holdings Co., Ltd., available for all the world to see on its website. These filings provide a wealth of information not available elsewhere and also hint about the future direction of the company in general, and SEI operations in the United States in particular. I encourage you visit that website at https://www.7andi.com/en/ir.html.

One of those areas relates to the evolving product mix in the stores. Based on figures for the nine months ended November 30, 2019, Seven-Eleven Japan (SEJ) stores derived 30.6 percent of sales from fast food and 13.1 percent from daily food. By contrast, SEI stores in the United States derived just 14.9 percent of sales from fast food and 4.9 percent from daily food. This means that the fast food and daily food categories in the Japanese stores represent 2.2 times as much revenue of United States stores.

SEJ discloses that stores in Japan derive a gross profit margin of 35.9 percent for fast food and 33.4 percent for daily food. SEI does not disclose gross profit margin by product category. Of course, with higher labor required to prepare, process and sell fast food and daily food, these higher gross profit margins are not an indication of the overall profitability of that market segment. As a reminder, during the protracted but ultimately unsuccessful attempt to negotiate a fair and balanced franchise agreement with SEI, the company was repeatedly asked to share data regarding the overall, bottom line profitability of fast food and daily food. SEI claimed that it did not possess such information. Many franchisees question how that could be true given the deep investment in those product categories.

Interestingly, SEJ stores had an overall gross profit margin of 32.1 percent as of November 30, 2019, compared to 35.0 percent for SEI stores. That nearly 3 percent differential is substantial and translates into millions of dollars of gross profit.

Given the materially different product mix and gross profit margins between stores in Japan and the United States, one might plausibly ask whether the profile of and trends in the Japanese stores portend the future for SEI franchisees.

A broad hint may be derived from the Financial Results Presentation issued by Seven & i on January 9, 2020. It includes a slide regarding a trial Grab and Go fresh food initiative in the Dallas area with Warabeya. That slide reports that year-over-year sales for October 2019 increased by 21.5 percent for Hot Food, 29 percent for Fresh Meals and 7.7 per-cent for Fresh Sandwiches.

This compared favorably with growth in these categories generally in the United States. The slide indicates that the company intends to expand these initiatives in the next reporting period.
Another slide in the same presentation regarding the 7Rewards Program reports substantial increases in active members, scan ratios, transactions, sales, and store visits. Examples of member-only offers include any size coffee for $1 (20 million units sold during the calendar quarter) and two 28-ounce Gatorade Zero bottles for $2.50 (2.7 million transac-tions). Franchisees are justifiably questioning the wisdom of deep discounting, which undermines the general provision in the franchise agreement giving franchisees the right to set retail prices, and raises serious concerns about unit level bottom line profitability.

SEJ reports even deeper discounted sales promotions derived from the app sales promotions that include: buy 5 cups of coffee and get the 6th free (71 coupons issued per store in the month of November 2019), buy 10 rice balls, get the 11th free (26 coupons per store), and buy 5 Seven Premium teas and get the 6th free. These promotions generated 3.0 million transactions in a single month. But the abiding question is how they affect the bottom line of Japanese franchisees.

In a related trend, SEI has publicly stated its goal to substantially increase the number of stores around the world. On January 17, 2020, Seven & i announced the acquisition of 109 stores in Oklahoma independently operated by Brown Thompson General Partnership and 7-Eleven, LLC. That same month, Joe DePinto celebrated in a press release the fact that the company had passed the 70,000 stores in the world threshold. He also announced that 7-Eleven now operates in 17 countries and this year will expand by opening stores in India for the first time. He went on to say that the company opens a store approximately every 3.5 hours. In Japan, the company has nearly 21,000 stores and a market share of somewhere between 35 percent and 40 percent.

These trends raise important questions. While hot food and fresh food seem to have higher gross profit margins, their overall profitability remains in serious doubt. But given the expanded presence of private label goods, will the gross margin of U.S. franchisees drift downward towards that currently being reported by Japanese franchisees? And while deep discounting in general and in particular through the apps may drive traffic, transaction counts and sales, once again, the most important question is whether franchisees can make a living from operating a franchise store. And will the drive for increasing market share, given a big boost by the 2018 acquisition of approximately 1,100 Sunoco stores, give SEI even more leverage to force deep discounting and changes in product mix on United States franchisees? And will any consequence from the fact that SEI shares any further decline in gross margin be offset by a steady increase in the number of stores in the system?

These developments make it more important than ever that the National Coalition stands united in its goal to protect its franchisee constituents.