1. Assess Boston Chicken’s business strategy by identifying its critical success factors.

Boston Chicken wants to be an industry leader in the home replacement meal market. It plans
to sell products that allow an affordable alternative to home cooking. It also targets the market
by selling fresh and healthy products ranging from mashed potatoes, pot pies, baked rotisserie
chicken etc. Its key success factor is locating and growing in large metropolitan markets. It
leverages the concept of franchising for its growth. However, as opposed to traditional
franchising of selling franchises to many smaller franchisees, it focused on franchising to large
regional developers. The purpose of this strategy is to use the developers’ financing,
management and local information to grow further stores in that region.

Another success factor is its focus on home cook taste food and its constant communication
with its customers using technology to develop newer items for its menu. Technology was also
leveraged as it invested $8-10 million to build computer software that provided support for its
network of stores and helped in supply chain management, market study, collecting customer
feedback and financial reporting.

Other key factor is implementing long-term agreements with key suppliers to lock-in food price,
development of flagship stores and building drive-through lanes to improve off-peak hour sales.

2. What are the critical risks facing Boston Chicken during the period of the case?

Boston Chicken grew rapidly. From only 34 stores by the end of 1991 to 534 by the end of 1994,
the annual growth rate was over 500% with a new store being opened in every 2 days. The
revenue increase during this period was from $5.2 million to $96.2 million, and net income rose
to $16.2 million from a loss of $2.6 million. However, this fast growth also comes with a cost.
With tremendous, the added costs of salaries, cost of goods, administrative expenses increase
manifold. Although Boston Chicken has continued to see profits, there is no guarantee that if it
continues to grow at this pace, it will be able to realize profits in the longer term. The firm’s
revenues come from franchising fees, royalties and also in the form of interest because of the
credit line that the firm opens for all of its franchises. Lipton Financial Services argues that in
order to break even, Boston Chicken needs to earn at least $23,000 per week. However, actual
average weekly sales were less than that. Boston Chicken might not have been able to earn
enough cash flows to maintain its daily operating activities although its revenues from new
franchising might have been high.

Another big risk factor was competition. KFC is just one example. The moment KFC introduced
the new rotisserie chicken line up, its profits soared. Sales rose to $160 million. There is still a lot
of scope in this market for competitors to prey upon.

Boston Chicken is also looking to grow into the bagel market and establish itself as a breakfast
retailer. It invested $20 million in Progressive Bagels. This is a big risk because the firm is trying
to enter into a new market with a separate customer base and not everyone will be able to
associate BC as a breakfast retailer.
 3. How well are Boston Chicken’s key success factors and risks reflected (or not reflected)
in its accounting policies and financial statements?

Some of Boston Chicken’s revenue recognition is aggressive. From the case, we know that every
new franchise on its opening pays BC $35,000 plus a $10,000 fee to cover grand opening
expense. According to Note 2 of Notes to Consolidated Financial Statements, revenue derived
from initial franchise fees and area development fees is recognized when the franchise store
opens. This seems to be aggressive as this methodology can over inflate the revenues every year
when BC is in a growing phase and adding to the number of its stores. Ideally, revenue
generated from new franchise openings should be spread across the franchising period.
Unearned revenue could be recognized in the first year and then amortized over the franchise
period.

Same is the situation with royalties as well. From the Income statement, we can observe that
between 1993 and 1994, revenues related to franchise and royalties increase from 29.82% of
total revenues to 57.45% of total revenues.

It is stated in the capital resource section of the results of operations that the company entered
into a 75.9M master lease agreement to provide equipment to certain area developers and
certain company operated stores of which 66.1M had been taken. These leases are treated as
operating leases as opposed to capital leases. It can be determined that the leases were treated
as operating leases because there was no increase to assets or liabilities referring to leases on
the balance sheet. The reason the company would not want to capitalize its lease expense is
because a capital lease would increase the liability and asset sections of the balance sheet
66.1M raising the debt to equity ratio to .94 from .64. Reporting the lease as a capital lease has
the effect of raising the interest expense on the income statement and hindering the company’s
interest coverage ratio.

The company has committed to 332.5M in loans to its franchisees of which 201.3M has been
extended up from 44M in 1993. The company expects to collect 16.9M of notes receivable in
the year 1995 and has made no allowance for bad debts. The company also pays for national
and local advertising and collects 2% and 3% to 3.75% respectively for the advertising campaigns
from franchisees.

The advertising fund has run a deficit of 6.5M that was covered by the company and is listed as
due from affiliates on the balance sheet. This is an indication that franchisees are already having
difficulties meeting their current obligations and it is possible that some of the notes will be
uncollectible. By not creating an allowance for bad debts, the company is overstating its balance
sheet position

For 1994, total notes receivables is around $202 million. Assuming the company cannot collect
all the receivables and writes down 5% of the amount, this will bring the total assets and equity
by $10 million.
 4. Estimate the after-tax effects of having the Allowance for Franchisee Defaults be in
turn 1%, 3% and 5% of Notes Receivable to Franchisees at 12/25/1994. Are these
effects material or not, do you think? What is your reasoning?

5. Estimate and analyze the profitability of franchisees—are they profitable? Your

answer should demonstrate the use of data for company-owned stores, and/or data
on franchisee profitability provided by Boston Chicken. (Note: this is difficult, and also
requires some judgments. Help me in your answer to see your assumptions,
judgments, and reasoning.)

From the Income Statement, we see that in 1994, BC had total company operated stores
revenue of $40,916 thousands. The average number of stores within that year was an average of
total number of company operated stores in the beginning of the year to the number of stores
at the end of the year. This happens to be 39.5. We also have the gross margin from the income
statement. This happens to be 61%. We also happen to know the total deductions as part of
royalty, national and local sales advertising campaigns. From this approximate remaining 50% of
margin, if we deduct other expenses like SG&A, depreciation, interest and taxes, we might still
assume that the franchisees are profitable, although we do not have any hard number to prove
this fact.

We can now look at the franchisee profitability data provided by Boston Chicken. According to
management, average weekly store sales in third quarter of 1995 were $23,888 and EBITDA
margins were around 15-16%. Considering 52 weeks a year, that amounts to $1.2 million annual
sales per store. Considering 16% EBITDA margin, we can calculate the EBITDA. We need to
subtract depreciation and interest expenses to get final approximate profit per store. According
to our calculations, we can still see that the BC stores are not profitable.