Why smaller rivals are eating Subway's lunch

Last Updated Aug 30, 2016 3:29 PM EDT

Being the biggest kid on the block can be tough. Take Subway, the largest restaurant chain by number of locations. Size hasn’t stopped it from losing ground to smaller upstarts that some experts say offer better-quality food at competitive prices. Of course, the conviction of Subway’s longtime spokesman Jared Fogle on child molestation charges last year hasn’t helped, either.

According to market research firm Technomic, U.S. sales as the Milford, Connecticut-based chain, which has more than 27,000 domestic locations, dropped 3.4 percent last year to $11.5 billion in 2015.

But Jersey Mike’s Subs, which Nation’s Restaurant’s News says has been the country’s fastest-growing chain for the past three years, reported $675 million in sales last year, a 28.6 percent increase. And sales at Firehouse Subs, which has 943 restaurants, rose 17.4 percent to $648.5 million, while Jimmy John’s saw sales surge 17.2 percent to $2.02 billion.

Subway “didn’t keep up with the times,” said Mark Kalinowski, a restaurant industry analyst at Nomura Securities.  “Consumers want more quality for the same amount of money.”

Subway has certainly hit a rough patch. Besides the negative publicity about Fogle, the chain had to deal with consumer concerns over a chemical it used in its bread that was also used in yoga mats, even though experts had countered that the chemical azodicarbonamide was safe. Add to that the so-called law of large numbers, which says growth becomes more difficult for companies the larger they get.

Along the way, however, Subway also became complacent, according to some restaurant industry watchers.

“To be frank, they didn’t keep their menu as fresh as they could have,” said Sara Lockyer, editor-in-chief of Nation’s Restaurant News, a trade publication. “They didn’t innovate in the way that other chains are innovating.”

Technomics President Darren Tristano agrees. “Subway has to leverage their convenience and affordability but close the gap between their position and that of fast-casual operators by improving the healthfulness of its ingredients,” he said. “They have made big strides to do this with their antibiotic free chicken.”

Subway’s “Five Dollar Footlong” promotion was one of the most successful of its kind in restaurant industry history when it launched during the recession, but it has lost its resonance, Lockyer said. “When the economy started getting better, customers didn’t necessarily need only to spend $5 on lunch,” she added.

A spokesman for Subway declined to comment for this story. In a recent statement to Bloomberg Businessweek, the chain noted, “Our brand led the way for thousands of entrepreneurs to own and operate their own business around the world and for other brands to enter the sandwich segment.”

Technomics’ Tristano points to another area where Subway could improve: “They need to get ahead of the on-demand delivery trend and consider building grab-n-go cases with sandwiches that can be refrigerated, and broadening to include salads, which are a strong, attractive seller.”  [Editor’s note: A Subway representative emailed the following statement after publication: “Subway currently offers a variety of 18 core salads on its menu and guests have the opportunity to make any of their favorite subs a salad.”]

Jersey Mike’s, which has seen its store count more than double since 2013 from 700 to more than 1,500 now, lets the quality of its ingredients win over customers as opposed to the bombastic marketing campaigns that have been a Subway staple for years. Jersey Mike’s, which only recently began advertising nationally, also prides itself on its involvement in the communities where its operates.

“Consumers today have a much more sophisticated palette than they ever have,” Lockyer said. “Quick and relatively great and perhaps not so great isn’t what a consumer wants.”

Like Starbuck’s (SBUX), Jersey Mike’s puts on a show for its customers, using a manual deli slicer for its cold cuts and cooking hot sandwiches to order on flattop grills instead of using microwaves. The Manasquan, New Jersey-based company didn’t respond to a request for comment on this story.

“The slicer is the quarterback of the store,” Jersey Mike’s President Hoyt Jones told Bloomberg. “It’s a coveted position.”

Apparently, consumers feel that Jersey Mike’s and its rivals are a cut above Subway when it comes to quality.

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    Jonathan Berr is an award-winning journalist and podcaster based in New Jersey whose main focus is on business and economic issues.