Fly like Vapiano's or Fail like Friday's? Subway's Future in Estonia.

Subway Arrives in Estonia : Our Take

Yes, we know Subway is a large multinational company and isn't usually considered as a startup. Yes, we know they didn't receive EAS money. Yes, we know they don't really fit the profile of most companies and organizations we cover on our blog.

However, we think there is a lot to be learned from analyzing the potential of this venture. In Estonia, Subway is a franchisee, so the local owners are essentially starting from scratch. Countless restaurants in Estonia fail, so we thought an analysis of the numbers that drive the restaurant business would be of interest. One of us has expertise in this area, which enabled us to do a fairly thorough analysis.

A Brief History of Subway in Estonia

Subway opened their doors last week with an exclusive party on Thursday, complete with a band, DJs, ribbon-cutting ceremony, and even a speech by the US ambassador to Estonia. Anyone who has lived in the US, where Subways are more common than McDonalds, would find the fanfare quite surprising. The opening of a new Subway in the US is typically greeted with a resounding "meh" and nothing more. Estonians probably have the same reaction when a new R-Kiosk opens.

The opening of Subway seems to be the largest business event in Estonia this year, based on the widespread media coverage. There were 5 articles in Delfi about it just the last month, and another 3 in Äripäev in the same period.

Subway opened its doors to the public on Easter Sunday, and even that drew press coverage, with Delfi reporting on the status of how many people were waiting in line (not many, but we've heard the lines have been longer on some occasions since then). No one in Estonia at this point is unaware of Subway, given their heavy coverage in the media.

What was sadly lacking in all the media coverage was an analysis of their business model.  Will it work?

Now that their numbers are starting to come out we can start figuring out what it will take for Subway to succeed in Estonia. Subway has more locations worldwide than McDonalds, thanks to much lower start up costs and a franchise model that tolerates a higher level of stores per area.

How will this business model succeed in Estonia? The owners have plans to open up 20 restaurants in Estonia by 2019. By comparison, Hesburger has 30 restaurants in Estonia, while McDonalds has 10. It's nice to see they are dreaming big, but first they will have to prove the franchise can be profitable in Estonia.

Let's focus on the first store opened and try to get an idea of what they must make monthly to break even and how many sandwiches sold per day that equals.

We'll build a basic budget for the restaurant, and use that to calculate an estimated break even point.

 

Fixed Costs

We'll start with the fixed costs of the restaurant. Fixed costs are costs that are incurred regardless of sales. An example is rent, where you have to pay it whether you sell 1 sandwich or 1,000 sandwiches

First let's look at the physical space. There is the initial build out to have it looking like a Subway. Subway expects franchisees to pay between 90,000 and 180,000 euros for this build out. The Estonian one looks really nice so we'll budget it at the midrange point of 120,000 euros.


As we are looking at a monthly break even, let's break the 120,000 cost out over 10 years and make it interest-free. This build out is a long term investment in the business, but the cost must be regained and accounted for. So we'll pay back 12,000 a year for 10 years, or 1,000 a month.

On top of that we have to pay the initial fee for joining the Subway franchise. This is $15,000 in the US and for the sake of keeping the numbers easy, let's call it 12,000 euros or another 100 a month for 10 years.


Next up we have to pay rent on the space. They have 40 seats in their location at Estonia pst 7, which is next to Solaris. It's not inside one the of main malls, but it has a bunch of seating. A bit of research on City24 and we can estimate they are definitely paying more than 1,000 a month and probably closer to 2,000. Let's call it 1,200 without VAT. We'll account for all VAT later as a variable cost.

Next up are utilities including electricity, water, area maintenance, heating, and any other costs the landlord will pass on to the tenant. It's a restaurant focused on a bakery so this should skew higher than the average retail establishment. The bill will vary drastically from summer to winter but it would be highly doubtful the bill would go below 500 and quite realistic to expect it to hit 1,500 euros/month in the cold of winter. Let's budget it at 800 euros/month and hope for the best.

We've got the place built out, rented, and the lights turned on. Now let's get some staff. To calculate how many we need, we'll use the hours of business Subway Estonia lists on their Facebook page. They haven't quite got their weekend hours down yet but for this budget we'll guess they have the same Saturday hours as Friday and the same Sunday hours as a week day.
Add it all up and we get that they are open 490 hours a month.

How many employees should be working at any one time? According to our sources, Subway Estonia has 22 employees. This makes us skew the number high. Let's go for 4 and see how close we get to their amount of employees. From what we've seen at Subway this week, they do typically have at least 4 workers on shift at a time.

If all the workers are full time and put in 160 hours a month and the store is open 490 hours a month while needing 4 employees working at all times, then we need 12.25 full timers. We are still nowhere near 22. But much like the 20 stores idea, let's count the 22 number as a bit optimistic and simply say we need 13 full time employees.

How much should we pay them? Let's hope the restaurant is able to offer above minimum wage while staying a good bit below average Estonian overall wage. So we'll go for 350 net wage per full time employee. That's 4,550 euros going into the hardworking sandwich artists' pockets, but there are still social taxes to deal with.

As we are paying 350 net we still have to account for the employees' and employer's taxes on those wages. Taken together this rate is 66% of the net wage. With 4,550 net wages per month we are looking at an additional 3,000 in social taxes.

We'll definitely need a bookkeeping service to help make sure those taxes and employees are paid. For that many employees let's expect to pay around 500 a month for this service.

Time to think about things like internet, security, trash pick up, replacing lightbulbs, window cleaning, and other such minor costs. The more a small business can lock these down the better, but starting up, this going to be expensive. Subway might well be paying G4S for a premium package or they might have 0 security expense. Altogether let's budget 300 for this.

Add everything up and we get a fixed cost of 11,450 euros/month. A little safety cushion would nice so we'll go up to 12,000.

 

Variable Costs

Time to look at the variable costs. Variable costs are costs which do vary based on sales.

The first is VAT, which runs 20% We did not add this in to any of the fixed costs to keep things simple.

The second is Subway's charge for product (food). This number is relatively easy to find online and so we can put it at 30%. We think it may actually end up higher in Estonia, since much of the product is imported from abroad and transport costs on perishable goods can drive up this number.

Next up is Subway's marketing fee, adjusted to the local market: 10%

Add it all up and we have 60% variable cost.

After these costs are paid the owners get 40% of each euro to pay all the fixed costs plus make a profit.

With fixed cost and variable cost in hand we can make a basic equation which will show how much money our estimated Subway must make for the owners to not lose money in an average month.

-12,000 + .40x = 0
x= 30,000

Our estimate shows that Subway has to make 30,000 euros a month in revenue to earn absolutely nothing. On these estimates, it is interesting to note that the most room for variance can occur in the fixed costs as the variable costs are mostly set by the franchisor and government (taxes). In other words, the only way to get this number lower is to hire fewer people, or pay less rent.

30,000 / 30 days a month results in a daily required take of 1,000 euros.

Now for some fun: let's look at their prices and see how many sales that equals.

Thanks to all the media coverage including photos of their menu, we see the cheapest sandwich is 3 euros and the most expensive is 6 euros for a footlong sub. In addition to sandwiches they sell drinks, chips and cookies. With these items and price points we can guess an average sale will be 5-6 euros. Let's use the low end of this (not everyone orders a footlong), so 5 euros per sale.

1,000 / 5 = 200 sandwich sales per day.

 

A Moneymaker?

So can Subway sell 200 sandwiches a day? Remember that is in order for its owners to break even, not to make a profit.

We can quickly do the math to figure out how many sandwiches per day they have to sell if each of
the two owners wants to take home 1,000 euros a month. First we'll add in the profit tax rates at
21% to get to 2,420 then add that to the fixed cost in the equation. A little bit of math later
and we see in order to get this decent level of profit they need to make 1,200 euros a day or
roughly 240 sandwiches. In a 15-hour work day that is a sandwich every 3.75 minutes.

Can they do it? It's not difficult to imagine selling that type of volume during the lunch and dinner rush times, but will they also do that kind of volume at times of the day like 9am or 4pm, for example? We don't think so. Even the lunch rush will be limited by how quickly they can make sandwiches. The fastest Subway sandwich maker in the world can make a sandwich in 45 seconds, so we're guessing preparation times will be closer to 2 minutes at best.

What they will probably do is work on cutting back their fixed costs, especially staffing. Right now, they open at 8am every morning during the workweek, and we don't think many people get a craving for a roast beef footlong sub at that time of day.

We do enjoy a Subway sub from time to time, and their arrival in Estonia was welcome. But with the limited size of the Estonian market, we don't think they will have the success they hope for.