January 20, 2009

Matt MosleySuh-hee Choi

HTM 681First Topic

Franchising

Department of Hospitality and Tourism ManagementPurdue University

Franchise—Definition

A method of distribution A type of strategic alliance Agents involved in a franchise system1. The franchisor -- lends his trademark or trade name

and a business system2. The franchisee -- pays a royalty (+ an initial fee) for

the right to do business under the franchisor's name and system

the contract (technical meaning) the business that franchise operates (actual meaning)

http://www.franchise.org/faq.aspx

Franchise—Definition(from the Code of Federal Regulations) Any continuing commercial relationship or arrangement

in which the terms of the offer or contract specify, or the franchise seller promises or represents that:

(1)The franchisee will obtain the right to operate a business that is identified or associated with the franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;

(2)The franchisor will exert a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation; and

(3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment to the franchisor or its affiliate.

http://www.franchise.org/uploadedFiles/Franchise_Industry/Resources/Education_Foundation/FW%20Dec07%20p42-44.pdf

Benefits

Barbara Beshel, 2001, An Introduction to Franchising, IFA Educational Foundation

Disadvantages

Restrictions (product, pricing, site)Ongoing royalties and advertising fees.Bad reputation caused by

poor performance of other franchisees unforeseen problems of the franchisor free-riders

Limited duration of a franchise agreement

Barbara Beshel, 2001, An Introduction to Franchising, IFA Educational Foundation

Franchise Industries

Types of franchising

Single-unit franchise Multi-unit franchise

An area development franchise A master franchise

Theories

Resource Scarcity Financial + Intellectual Limitations: growth and survival doesn’t guarantee profitability.

Agency Theory Less monitoring costs Assumption: economic, rational actors, homogeneity of perception / action Costs of local monitoring Vs. Risks of free-riding Moral hazard issues

Combs, Michael, & Castrogiovanni, 2004Agency Theory : Lafontaine, 1992

Theories (suggested by Combs et al., 2004)

Upper echelons theory Emphasizes managers’ characteristics (previous experiences, age, etc.)

Resource-based theory Points out biased distribution / trade of resources Increase of conflict management capabilities Increase of competitive advantages Increase of franchising

Institutional theory Articulates the importance of social, environmental, institutional, legal factors Organizational behavior (propensity for predictability / stability)

Previous Research

What Motivates Franchising? • Comparing franchised / independent restaurants • Resource Scarcity ( The effect of resource scarcity on the proportion of franchised outlets)

Which industries are more franchised? Which regions are more franchised?

Control system Moral issues

Previous Research (cont.)

From the franchisors’ perspectives geographic expansion intellectual scarcity (Oxenfeldt and Kelly, 1969)financial scarcity (Oxenfeldt and Kelly, 1969)economies of scale (Oxenfeldt and Kelly, 1969)innovation (Bradach, 1997)survival and growth (Bates, 1995)

What Motivates Franchising?(Benefits of Franchising)

Previous Research (cont.)

Consumers’ perceptionHigher degrees of satisfaction (Young et al., 2008 – restaurant) Brand recognition

What Motivates Franchising?(Benefits of Franchising)

Site selection (Park & Khan, 2005) Fast Food and Restaurants (IFA, 2006)

Which industries are more franchised? Which regions are more franchised?

Previous Research (cont.)

e.g. Agency Theory perspectives Vertical problems – appropriating royalties, not adhering to standards, etc. Horizontal problems – free ride

Control Systems (Vazquez, 2008) Geographic issues (e.g. International franchising) Standardization Vs. Adaptation

Moral issues & Control systems

Previous Research (cont.)

Does franchising really work? What types of franchise perform well?

Financial Optimal franchise fee, royalty rate

Optimal franchising outlet % (e.g. Hsu & Jang, In Press)

Previous Research (cont.)