BUSINESS CLIMATE AND INTERNATIONAL FRANCHISE EXPANSION

Richard C. Hoffman,* Jonathan Munemo,

† and Sharon Watson

‡ 

January 2014

ABSTRACT

In this paper, we examine how a country’s business climate affects the international expansion

decisions of U.S. franchise companies. In doing so, we establish and test various hypotheses

regarding how franchise companies’ international expansion plans are influenced by elements of

a country’s business climate. To test these hypotheses, we estimate a panel regression model

using different specifications. Our estimates lend support to our hypotheses and demonstrate that

a country’s business climate is an important predictor of foreign firms’ expansion into that

country. Implications for practice and future research are also discussed.

* Professor, Perdue School of Business, Salisbury University,1101 Camden Ave, Salisbury, MD 21801, 1-410-548-

5398, Fax: 410- 677- 5375, E-mail: rchoffman@salisbury.edu.

† Assistant Professor, Perdue School of Business, Salisbury University, 1101 Camden Ave, Salisbury, MD 21801,1-

410-677-0057, E-mail: jxmunemo@salisbury.edu.

‡ Associate Professor, Dept. of Business Administration, Lerner College of Business & Economics, University of

Delaware, Newark, DE 19716, 1-302-831- 4560, E-mail: watsons@udel.edu.

 

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1. Introduction

Consider the following examples:

 

Increased political stability and more favorable regulations prompted the expansion ofAnytime Fitness into Qatar.

 

Papa John’s expansion into Russia was driven, in part, by the country’s modernization ofits business infrastructure.

In the past several decades, franchising has become an important strategy for business

growth, job creation, and economic development, and has been an effective method for firms to

enter foreign markets or expand internationally. Indeed, some of the first companies to establish

a significant presence in foreign markets have been franchise companies. As the two

introductory examples demonstrate, a favorable business climate plays a crucial role in franchise

companies’ decisions regarding the location of their international expansion efforts. Countries

differ widely with respect to how attractive their business environments are for new business

development. As noted by the World Bank’s Doing Business project, having the right set of

business regulations has an enormous impact on business growth and development within a

country, and has a profound effect on a country’s overall economic development (World Bank,

2013). In this study, we examine how a country’s business climate affects the international

expansion decisions of U.S. franchise companies. We begin by discussing the importance of

franchising in the development of a country’s economy. In the next section business climate is

defined and the use of transaction cost theory as the broad framework for this study is described.

Using transaction cost theory, we then develop hypotheses regarding how franchise companies’

international expansion plans may be influenced by elements of a country’s business climate.

We test these hypotheses using data collected over a seven year period on the expansion plans of

 

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U.S. franchise companies. Our results demonstrate that a country’s business climate is an

important predictor of foreign firms’ expansion into that country.

1.1. International Franchise Expansion

As a foreign market entry mode, franchising is prevalent, in large part, because it has

lower transaction costs. Franchising allows for rapid expansion with a lower capital layout, and

therefore, it has a corresponding lower cost and risk to the company. A large portion of the cost

and risk of market entry is borne by the franchisee, who has a partial ownership stake in the local

franchise. Franchising also can lower the transaction costs of market entry associated with

cultural and market differences, through the use of local franchisees, who have in-depth

knowledge of local cultural customs and business practices (e.g., Hoffman, Kincaid and Preble,

2008). Thus, the international expansion of franchise companies to dissimilar countries often is

quite rapid. Many of the U.S. companies that were early entrants into dissimilar countries such

as China and India were franchise companies. For example, in 1987 KFC was the first American

fast food company to open in China. Only twenty years later, the company had more than 1,800

outlets in 400 cities across China (Franchise Direct, 2008).

For these reasons, franchising has become an especially important driver of growth in

developing economies. For example, Brazil has an active franchising sector with 2010 sales of

approximately $48 billion, or just over two percent of Brazil’s GDP. According to the Brazilian

Franchising Association (ABF, 2011), Brazil had approximately 1,855 franchise systems

operating over 86,000 units. Moreover, the Russian Franchising Association reported that there

were more than 450 franchise systems and 8,500 franchisees operating in Russia in 2010 (World

Franchise Associates, 2011), with fast food (22% share) and retail (46% share) the leading

sectors in that country (Global Trade.net, 2010). In the past decade, franchising has become

 

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increasingly prevalent in China as well, due in part to new regulations in 2004 that more clearly

defined how foreign franchise businesses can operate in that country, making franchising a more

attractive investment (International Franchise Association, 2013). China’s franchise sector has

82,000 units and is growing at 49% annually, but still makes up only 3% of the country’s retail

sales, thus there still is much potential for growth (International Franchise Association, 2013). In

India, franchising is experiencing similar levels of growth, at over 30% annually, stimulated by

economic liberalization and reform (Shah, 2008). Yet, franchises account for only 2% of India’s

retail sales (Franchise Direct, 2013), indicating a market ready for growth. Franchising also

continues to be the preferred model for international businesses to expand quickly into the

rapidly developing economies of the Middle East (Young, 2010). The Middle East has a total

population of over 300 million, with 60 percent under 25 years old and over 400,000 high net-

worth individuals ready to invest in new businesses (Franchise UAE.com, 2011).

From these examples, it becomes clear that franchising has spread globally to become an

established method of doing business in numerous countries, including many developing

countries. Research (e.g., Teegen, 2000) has shown that a country’s business climate is an

important driver of new business creation, for both local companies as well as inward investment

by foreign franchise companies. Because of the important role of franchise companies in the

establishment and growth of new businesses in emerging economies, we need to understand how

the international expansion plans of franchise companies are affected by different elements of a

country’s business climate. In this study we examine the impact of local business climate factors

such as good governance, business regulations, taxes, and media availability on the international

expansion plans of U.S. franchise companies.

 

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2. Business Climate, Transaction Cost Theory and Franchising

Business climate is defined as the broad economic, political/regulatory, technological,

and socio-cultural sectors/institutions that characterize a national market (e.g., Ghemawat, 2001;

Alon, 2006; Hoffman, Kincaid and Preble, 2008). Our particular focus will be on the

political/regulatory climate as these sectors affect not only entry, but also on-going operations

and business transactions. We also examine select economic and technological characteristics

that are especially important to the franchising sector and to the time during which the study was

conducted.

The broad theoretical framework useful for guiding an examination of the effect a

country’s business climate has on business growth is transaction cost theory. According to

transaction cost theory, firms seek to expand in a cost effective manner to insure profitability

(e.g., Williamson, 1975). A key challenge to transaction efficiencies is uncertainty about the

future in the firm’s environment. Uncertainty increases the firm’s transaction costs, especially

with regard to search, information processing, and adaptation. According to Teece (1981), the

transfer of firm knowledge across borders may be carried out more efficiently within the firm by

using direct investment. Others (e.g., Contractor and Kundu, 1998; Fladmoe-Lindquist, 1996)

have identified franchising as a hybrid business form that lies between markets and hierarchies,

thereby, also providing efficiencies in market transactions.

In global markets, franchising allows for incremental decisions as expansion unfolds in

various markets, and the use of franchisees with local knowledge improves the decision

processes associated with the uncertainties of expanding into specific markets (Sashi and

Karupuur , 2002). The franchisor’s use of a largely standard business format helps reduce the

costs resulting from economies in purchasing, standard products/services, uniform brand and

 

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logo (Kauffmann and Eroglu, 1998), and provides administrative economies by using standard

operating procedures for each unit (Caves, 1996; Shane, 1996). In the next section we apply a

transaction cost perspective to help explain the influence a country’s business climate is likely to

have on the international expansion of franchising companies.

3. Business Climate and Franchise Expansion: Some Hypotheses

Up until the present, the majority of the studies examining market factors affecting

international franchise expansion have focused on macro country market characteristics, such as

economic growth, political risk/stability, cultural similarity, and geographic distance (e.g., Alon

& McKee, 1999; Hoffman, Kincaid & Preble, 2008; Michael, 2003). Other than some descriptive

surveys (e.g., Hoffman & Preble, 2004), there are no systematic studies that focus on how more

specific aspects of an international market’s business climate impact franchise expansion. Yet,

over the years, surveys consistently have revealed that the local business climate is a concern for

franchisors when expanding internationally (e.g., Hackett ; 1976; Preble and Hoffman, 1995).

Using transaction cost theory, we examine the following sources of uncertainty

associated with the business climate of international markets: political, technological, and

economic. Along with socio-cultural uncertainty, these are the primary areas of uncertainty

defined in the literature as affecting firms’ foreign entry mode (e.g., Anderson and Gatignon,

1986). Our hypotheses are organized to address some of the costs of entry associated with

confronting such uncertainties in international markets.

3.1. Political Uncertainty of the Business Climate

According to transaction cost theory, a particular source of uncertainty in international

markets is that associated with political uncertainty (Sashi and Karuppur, 2002). Changes in

industrial policy or business regulations pose risks that may increase the costs of doing business,

 

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such as restrictions on investment, repatriation of profits, and tax structure. All of these can

affect the cost structure of firms. The need to monitor the political risk of nations when

conducting foreign investment is well established in the literature (e.g., Alon and Martin, 1998;

Hamilton and Kashlak, 1999). Government policies pertaining to disclosure, tariffs, taxes,

profitability, etc. sometimes create uncertinty regarding entry costs and, thereby, affect

franchsiors’ perceived risk of foreign market entry (e.g., Eroglu, 1992; Hoffman & Preble,

2004). Furthermore, assessing the political risk of nations increases search and information

processing costs for firms anticipating international expansion.

Stability of government policies also impacts the conduct of franchise businesses because

franchise contracts vary significantly across countries (Fladmoe-Linquist, 1996). Moreover,

political instability has a negative impact on the franchisor’s ability to monitor franchisees in

foreign markets and, thereby, increases administrative costs for the firm (Fladmoe-Linquist &

Jacque, 1995). There is some evidence that the diffusion (e.g., Hoffman and Preble, 2001) and

penetration (Hoffman, et al., 2008) of franchise firms into foreign markets is facilitated by good

governance. Thus,

 Hypothesis 1: Good governance (political stability and government effectiveness) has a positive

impact on franchise expansion.

From the above discussion, it appears that reduced political uncertainty in a country at

the aggregate level tends to reduce transaction costs. However, at the firm level, it is the specific

business regulations associated with starting and managing the daily operations that have a more

direct impact on firm transaction costs. The analysis of business entry regulation is important for

U.S. franchisors’ future expansion plans for at least two additional reasons. First, as noted by the

World Bank (2004) and Klapper, Laeven & Rajan (2006), bureaucratic entry regulations are

costly and impede new firm creation, even in industries that naturally should have high entry,

 

8

such as franchising. Second, Klapper et al. (2006) also found that higher bureaucratic barriers to

entry in naturally high entry industries reduce productivity growth in these industries because the

disciplinary effects of competition are inhibited. Therefore, the effectiveness of franchising as a

strategy for business growth critically depends on the nature of the prevailing regulatory business

climate in foreign markets.

Sound business regulation (e.g., licenses, contracts, credit, labor, etc.) ensure that firms

tend to play by the same rules so that the market will determine success or failure, thus reducing

uncertainty for decision makers. At the same time, too much regulation may stifle competition

and, worse yet, add costs that impede profitable performance. For example, Latin American

countries with high levels of political stability, together with a deregulated environment, tend to

attract high levels of inward FDI (Bengoa & Sanchez-Robles, 2003). In another study, higher

market and labor regulations were negatively correlated with the entry of small and medium-

sized firms in OECD countries (Scarpetta, Hemmings, Tressel & Woo, 2002). Moreover,

Klapper et al. (2006) found that business regulations that are costly to the firm tend to reduce

firm entry into industries that normally have low entry barriers. Hackett (1976) revealed that

franchisors were concerned about regulations affecting taxes and profit repatriation as they

expanded internationally. In the following decades, other surveys revealed similar concerns

associated with international expansion. More recently, additional regulations specific to

franchising have been areas of concern for franchisors including disclosure requirements,

contract law (e.g., Preble and Hoffman, 1995), royalty taxes, value added taxes, and tariffs

(Hoffman & Preble, 2004). Consequently, specific business regulations and taxes remain an

important concern for international franchisors.Thus, on the one hand, business regulations

provide consistent rules for all, whereas, on the other hand, regulations such as excessive

 

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disclosure laws, licensing fees, or poor contract enforcement may also raise the costs of doing

business in a country market. Taking these contradictatory impacts into account, we expect that

there is some point of diminishing return to business regulation, beyond which it ceases to

promote a good business climate for firms. Hence,

 Hypothesis 2a: Business entry regulations will have positive impact on franchise

expansion as long as they reduce the costs of entry.

2b: Once regulations become excessive so as to increase the costs of entry, they will have

a negative impact on entry.

Certain business entry regulations are costly and impede new firm creation (World Bank,

2004; Klapper et al., 2006). For example, both the prevailing tax level and the uncertainty of a

nation’s tax policy have the tendency to increase transaction costs (e.g., Sashi and Karuppur,

2002). Taxes represent additional costs that reduce the rents (profits) that firms are able to

appropriate for themselves (e.g., Williamson, 1975). While today’s firms are aware of the need

for taxation, they prefer markets with a lower tax burden. Franchising firms are also concerned

with a variety of taxes (Hoffman & Preble, 2004) that may reduce the earnings of their

businesses, which often have low margins. Recently, a negative relationship was found between

corporate taxation rates and firm entry into foreign markets (Da Rin, Giacomo & Sembenelli,

2011). Since taxes increase transaction costs for firms, the impact of the tax climate on franchise

expansion is expected to be as follows:

 Hypothesis 3: A country’s corporate tax rate is negatively related to franchise expansion.

3.2. Technological Uncertainty of the Business Climate

In the context of this study, technological uncertainty refers to the condition of the

nation’s infrastructure, such as communication, transportation, and banking (e.g., Teegen, 2000;

Hoffman et al., 2008). Of particular importance to franchisors is the communications

infrastructure, and specifically, the availability of media. Media availability is crucial because

 

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today’s franchises offer branded products or services along with proven methods for operating

the business. The use of the brand name enables franchises to achieve economies across the

system (Caves and Murphy, 1976), as well as to attract franchisees (e.g., Zachary et al., 2011)

and customers. Consumers in most countries rely on the media for most of their product

information (e.g., Talkudar, Sudhir and Ainslie, 2002). Expansion of the franchise system is

motivated, in part, by the desire to develop and maintain brand equity, and it also permits the

development of scale economies in promotion and marketing costs over a larger number of units

(Carney and Gedaljovik, 1991), thereby, creating more efficiencies for the franchise system.

Furthermore, economies can be further achieved by using similar media (e.g., Hoffman et

al., 2008) in various country markets. Given the importance of branding, franchise systems are

confronted with technological uncertainty in international markets regarding whether they will

have the necessary media to continue to build brand equity and system promotional efficiencies.

For example, one study noted that franchisors were concerned with the regulation of signage in

China (Hoffman & Preble, 2004). Thus, media availability has been associated with both the

franchisors’ ability to build brand equity, and with higher levels of market penetration (Talukdar

et al., 2002). Thus, due to the importance of media for maintaining brand equity and promoting

system efficiencies in doing business across borders, the following is suggested:

 Hypothesis 4: The level of media infrastructure (internet access, teledensity)in a country

is positively related to franchise expansion.

3.3. Economic Uncertainty of the Business Climate

Economic growth is viewed as a positive feature that makes a foreign market attractive

for firms in general and franchisors in particular (e.g., Evans and Mavondo, 2002; Hoffman &

Preble, 2004). Economic uncertainty is the result of adverse economic events such as higher

interest rates, inflation, and changes in aggregate demand (e.g., Sashi and Karuppur, 2002).

 

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Unforeseen events such as recessions and financial crises also create uncertainty for decision

makers. Economic uncertainty creates higher perceived risk of market entry on the part of

franchisors (Eroglu, 1992) such that they are less likely to expand in markets without favorable

economic growth (e.g., Hoffman et al., 2008). Uncertain economic events may depress profits

either through higher costs of doing business associated with higher interest rates or reduced

revenues due to higher prices or lowered demand. Sudden economic events such as the onset of a

recession are likely to magnify the higher perceived risk of doing business in a market when

demand is likely to be depressed. The 2008-09 financial crisis occurred as a natural experiment

during the data collection period. It seemed opportune, therefore, to explore whether the financial

crisis had an impact on the international expansion plans of US franchisors.

The initial impact of the crisis appeared to slow down the international expansion of U. S.

franchises. However, this was short lived for two reasons as noted in a recent analysis of over

300 expansion plan announcements by U.S franchisors from 2005-2011 (Preble, Hoffman &

Watson, 2013). First, the crisis’s effect abroad lagged behind the US and as a result many

international markets were still attractive to U.S. firms. Secondly, even when the crisis affected

the emerging markets (which represented 70% of the target markets for U.S. firms), their

economies still grew at attractive rates in comparison to the USA. For example, in the two largest

markets for U.S. franchisors during this time period, China grew at no less than 8 %, and India

grew at no less than 4 % during the crisis. Thus, international markets proved to be more

attractive alternatives to the weak domestic market for U.S. franchisors. Thus, we suggest the

following:

 Hypothesis 5: The 2008-09 financial crisis will be positively related to franchise

expansion.

 

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4. Data and Empirical Strategy

4.1. Overview of the Data

We developed our sample using press announcements made by U.S. franchise companies

regarding expansion plans or moves they made into specific international markets. Press

announcements document specific expansion locations and numbers of units, which leads to a

more accurate measure of international expansion than previous studies that used surveys to

collect data about expansion plans (Preble and Hoffman, 1995; Hoffman and Preble, 2004).

These press announcements provide data on concrete expansion plans that already are being

implemented, not merely estimates of future expansion.

The data collection process consisted of several steps. First, we monitored SmartBrief

(ifa@smartbrief.com), the e-newsletter of the International Franchise Association (IFA), and

collected all announcements of international expansions. As the world’s largest franchise

association, the IFA serves as an important source of news for the franchise sector. SmartBrief is

an organization that provides e-newsletters in a number of industry sectors by searching

numerous sources of print and online news and information, summarizing and assembling the

results, and reporting them in a number of e-newsletters. The IFA SmartBrief is one of these e-

newsletters, and is published approximately every other day. Information in the IFA SmartBrief

includes announcements by IFA members, as well as news items from trade magazines and

websites, international and regional business media, and other sources of franchise related news,

providing a comprehensive set of franchise news. For this study, we collected all of the press

announcements made by U.S. franchisors regarding concrete plans they have for expanding their

international operations. The data were collected over a seven year period (2005-2011) from

 

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articles that appeared in the IFA SmartBrief that announced specific franchisor expansion plans

into foreign locales.

Thirty-eight firms made 101 announcements during this period that provided the data for

this study. Each press announcement was coded with respect to the country location of the

expansion, the number of units being opened, date of expansion, mode of entry, and the reasons

cited for the expansion into that location. The sample is dominated by firms in the lodging (26%,

e.g., Choice Hotels, Hilton, Marriott, etc.), restaurant ( 39%, e.g., Burger King, Dairy Queen,

McDonalds, Pizza Hut, Taco Bell, etc.) and retail (18%, Baskin-Robbins, Gap, Krispy Kreme,

Seven Eleven, etc.) industries. 

Country business regulation data were obtained from the World Bank’s Doing Business 

project (World Bank, 2013), which has made available objective measures of business

regulations and their enforcement across economies. Using standardized case studies, the Doing

 Business project provides comprehensive quantitative data on business regulations that are

comparable across 189 countries and over time. These data can thus be used to analyze specific

business strategies that U.S. franchisors can implement to enhance business productivity and

growth in international markets. We also used data on corporate tax, infrastructure, urban

population and economic development from the World Bank’s World Development Indicators 

(WDI) databank, as well as data on governance from the World Bank’s World Wide Governance

 Indicators databank.

4.2. Model Specification and Summary Statistics

The effect of business climate on U.S. franchisors’ future international expansion plans is

determined by estimating equation (1) below.

               (1)

 

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Subscript i denotes firm-i and subscript t denotes time. The dependent variable (franchise

expansion) is the number of units planned for a country market in the future (time t+s) divided

by the urban population of the country. This is consistent with prior measures of franchise

expansion (e.g., Hoffman and Preble, 2001). Turning to the right hand side of the equation (1),

three indicators are used to assess business regulations. The first is the distance to the frontier,

where the frontier is an aggregate score which reflects the most efficient regulatory practice. An

economy’s distance to the frontier is measured on a scale of 0 to 100, with zero representing the

worst performance and 100 the best or frontier. It enables us to capture the absolute quality of

the regulatory environment as well as its improvement over time. The second indicator is entry

regulation, measured by the cost of business start-up procedures as a percent of GNI per capita.

Our third indicator of business regulations is the national corporate tax rate, measured as a

percentage of profits.

In addition to business regulations, we also include several other variables that past

studies have identified as potentially important explanatory variables of franchise expansion (see

for example Hoffman et al., 2008). These include economic development measured by real GDP

per capita, and measures of media infrastructure and governance. The media infrastructure of

each country consisted of two variables- teledensity or number of phone lines per 100 people and

internet access or the number of internet users per 100 people. Governance was represented by

three indicators, namely, political stability, voice and accountability, and government

effectiveness. A dummy variable is also included to estimate the impact of the 2008-09 financial

crisis on franchise expansion. The parameter  captures firm fixed effects (firm heterogeneity

biases), and  is an independent and identically distributed mean-zero shock. Because of the

difference in timing between franchise expansion and the explanatory variables, endogeneity is

 

15

less of a problem. Variable descriptions are provided in Table 1. A few firms did not have data in

all periods (2005-2011), making the sample an unbalanced panel. Summary statistics for

franchise expansion and the business climate variables are shown in Table 2.

5. Findings

5.1. Distance to Frontier, Entry Regulation, and Future International Franchise

Expansion Plans

Results from equation (1) obtained by estimating different specifications are presented in

Table 3. A panel estimation is performed for all estimations in order to exploit both the cross-

section and time series dimensions of the data, and to capture any firm fixed effects which affect

franchise expansion. For all estimations, robust standard errors are provided in parentheses. In

the top panel, we focus on distance to the frontier and find that the estimated coefficient on

distance to the frontier is positive and statistically significant at the 1% level in column (1). This

implies that countries that are closing the gap from the frontier by adopting more efficient

business regulations are attractive destinations for US franchise expansion. However, business

regulations may in part reflect the level of development in the sense that countries with good

business regulations also generally tend to be more developed. We therefore control for a

country’s GDP per capita in column (2), and the estimated coefficient on distance to the frontier

remains positive and statistically significant at the 1% level. We are therefore confident that our

measure of distance to the frontier is not simply capturing the level of a country’s development.

Column (3) shows the results when the rest of the control variables are included. Again, we find

that the estimated coefficient on distance to the frontier is positive and statistically significant at

the 1% level.

In the bottom panel, the results in column (1) reveal that business entry regulation has a

positive effect on franchise expansion which is statistically significant at the 10% level,

 

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marginally supporting hypothesis 2a. Some regulation is necessary to insure that the rules are

similar for all organizations which reduces the cost of information search regarding this element

of the business climate. Moreover, the effect of the quadratic entry regulation term on franchise

expansion is negative and also statistically significant at the 10% level reflecting marginal

support for hypothesis 2b. The insignificance of entry regulation in column (2) could be the

result of omitted variable bias, and so we include additional controls in column (3), and the

results improve significantly. The positive impact of entry regulation on franchise expansion is

now statistically significant at the 5% level, and the negative quadratic term for entry regulation

is now statistically significant at the 1% level. The full model thus provides strong support for

both hypothesis 2a and hypothesis 2b. Taken together these results imply that up to a certain

point, an increase in entry regulation significantly improves franchise expansion. Thereafter,

higher entry regulation becomes excessive because it raises the costs of entry and, therefore,

significantly impedes franchise expansion.

5.2. Other Elements of the Business Climate

Political uncertainty stemming from lack of good governance at the country level was the

subject of the first hypothesis. The results reveal support for hypothesis 1 that good governance

matters for franchise expansion. The estimated coefficient on voice and accountability is positive

and statistically significant at the 1% level, and the estimated coefficient on government

effectiveness is also positive and statistically significant at the 10% level in the top panel and at

the 5% level in the bottom panel. Political stability also has a positive effect on franchise

expansion. It is, however, not reported because it had the least statistically significant coefficient.

Transaction costs associated with political uncertainty of specific regulations associated

with the start and operations of a business were the subject of the second hypothesis. Because

 

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taxes have the effect of raising the cost of doing business in a country, the third hypothesis

suggested that the nation’s corporate tax rate would have a negative impact on franchise

expansion. The results reveal a negative coefficient for taxes, which is statistically significant

and consistent with the finding that higher taxes lead to less franchise expansion, supporting

hypothesis 3. Conversely, foreign markets with lower corporate tax rates are significantly more

attractive destinations for U.S. franchise operations.

Franchisors also face technological uncertainty when trying to assess a nation’s

infrastructure as this also has a distinct impact on their costs of doing business. The fourth

hypothesis focused on communications infrastructure, because franchises are businesses which

offer branded products and services. The ability to develop and maintain brand equity is

important for franchise success to attract customers, thereby raising revenue, and to reduce

promotion costs by attracting more franchisors to the system. Key to success in this regard is

media availability in country markets. The results from Table 3 show that the availability of

communication infrastructure (internet access) has a positive effect on franchise expansion

which is significant at the 1% level. The estimated coefficient on teledensity was not statistically

significant and is therefore not reported.

Nothing causes economic uncertainty more than sudden economic shocks, such as a

financial crisis. Support was found for hypothesis 5 concerning the positive impact of the 2008-

09 financial crisis on the expansion of U.S. franchisors. The estimated coefficient for the crisis

variable is positive, and is statistically significant at the 1% level. As noted before, the crisis’s

effect abroad lagged behind the US and as a result many international markets were still

attractive to U.S. firms. Even when the crisis affected the emerging markets, their economies

 

18

still grew at attractive rates in comparison to the USA. Thus, international markets proved to be

more attractive alternatives to the weak domestic market for U.S. franchisors.

6. Summary and Implications

This is the first study to examine the actual expansion plans of franchising firms. All

previous studies (e.g., Arthur Andersen, 1996; Schletrich and Aliouche, 2006) have merely

surveyed their expansion intentions. As a result, the findings here are likely to more directly

relate to the firm’s actions vis a vis the business climate of host countries. Furthermore, previous

studies (e.g., Hoffman et al., 2008; Michael, 2003) have focused primarily on the macro

environmental climate of host countries and its effects on franchise expansion. By focusing on

more specific aspects of the business climate, we are able to identify those factors that most

directly impact the costs of entry and daily operations of franchise businesses in host countries.

International expansion poses uncertainty for firms concerning the business setting they

are likely to encounter in various markets. The potential costs of doing business in uncertain

conditions increase due to search and information processing costs as well as unknown demand

characteristics. This study sought to examine selected aspects of a country’s business climate

using a transaction cost perspective. In doing so, we established and tested several hypotheses

regarding expansion into country markets when faced with uncertainties posed by the broad

political climate as well as specific business regulations (entry and taxes), technological

infrastructure (e.g. media availability), and the economic uncertainty posed by the financial

crisis.

This study’s results found support for the hypothesis relating to the positive relationship

between good governance and franchise expansion. This supports similar findings for

multinationals in general (e.g., Hamilton and Kashlak, 1999) and franchisors in particular (e.g.,

 

19

Hoffman, et al., 2008). This study, however, provides stronger evidence that good government is

good for business because, unlike the previous studies, this research used direct measures of

governance such as the stability of the system, citizen participation, and the quality of public

service. Many previous studies have used measures of political risk which incorporate

investment and economic risk as well as political stability. Our results show the positive impacts

that a good governance system can have on business entry.

Of particular importance was the finding regarding business entry regulations. Having

some regulations helps define the playing field for all firms and reduces the costs of information

search for firms entering new markets. However, too much regulation increases the costs of

doing business, thereby, dissuading firms from entering markets at all. This also hurts the

economic development of nations that impose excessive regulations. Our data also suggest a

diminishing return from regulation after a certain point, a fact policy makers should be made

aware of. While taxes may be a fact of life in all nations, our data reveal that excessive taxation

also dissuades the entry of franchisors into nations. This indicates that tax policy does indeed

affect economic development from foreign investment.

The results also revealed that franchising firms need a good media infrastructure to build

and maintain brand equity and to spread their promotion costs over more franchised units to

create system-wide efficiencies. While prior studies (e.g., Hoffman et al., 2008; Michael, 2003)

have shown the importance of radio, TV, and newspapers for international franchise expansion,

this study extends the importance of the twenty first century media, the internet, as a source of

franchise expansion. Unlike other media, the internet permits franchising firms to have a

constant presence for customers and potential franchisees.

 

20

This is the first study to establish directly that the financial crisis had a positive effect on

international franchise expansion. In collecting longitudinal data, sudden unexpected changes

can be viewed as a problem, but in this case it proved to be an opportunity to study the impact of

an economic shock on business expansion. Furthermore, the use of longitudinal data permitted us

to capture the plans of franchising firms as they unfolded. This points to the added power of such

longitudinal data over cross-sectional data.

In addition, this study also supports the use of transaction cost theory as a theoretical

framework that is broad enough to examine the impact of national business climate on firm

growth. The theory encompasses decision uncertainty as well as examines the costs and revenue

impacts of actions taken by managers and their firms. It appears to be a parsimonious theory with

robust explanatory power.

Our data on franchise firms’ international expansion is limited to those expansions that

were reported in press announcements. Some firms may choose not to make public

announcements of their specific expansion plans. Thus, expansions that were not reported to the

press may not be included in our sample. However, the IFASmartBrief , the source of our

expansion data, proactively searches for and reports on news and information from a number of

sources, not just official press releases, and the IFA includes most major franchise companies as

members, so the set of announcements from which we draw our data is most likely fairly

representative of the franchise sector. Additionally, the franchise companies included in our

sample are active across a number of industries, including hotels and lodging, restaurants, auto

care, and fitness, so the results are fairly generalizable. We do not, however, have data on

manufacturing firms, so the results may not be as applicable to firms in that sector.

Despite these limitations, we offer some implications for practice and future research.

 

21

Managers would do well to become familiar with the specific business climate of an international

market prior to entry. Basic licensing, contract law, credit reports, taxes, and the like are

important but may also be costly. Having knowledge of the regulatory climate enables managers

to weigh the costs associated with business entry. Franchisors must also assess the availability of

appropriate media as this affects their ability to build brand equity efficiently as they expand into

new country markets.

While the results of this study indicate that a country’s business climate is related to the

international expansion location decisions of U.S. franchise companies, it also is important to

understand how the local business climate impacts the subsequent performance and growth of

the foreign business units established in the country. Future research should examine the longer

term effects of the elements of business climate studied here on franchise companies’ success

and future growth in host countries. Moreover, research determining the right amount of

regulation for business entry is both warranted and needed. Finally, while the use of franchise

data from franchise associations using surveys has already been established (e.g., Preble and

Hoffman, 1995; Hoffman and Preble, 2004), this study reveals that franchise association

websites provide a wealth of data which may be systematically collected over time to answer a

variety of research questions pertaining to the franchise sector.

 

22

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Table 1: Variables

Variables  Description Franchise expansion Number of franchise units a firm plans to establish abroad divided by

total urban population (in millions).Distance to frontier An aggregate measure of the distance of each economy to the

“frontier,” which represents the highest performance observed oneach of the indicators of business regulations. It ranges from 0 to100, where 0 represents the lowest performance and 100 the frontier.

Entry regulation Cost of business start-up procedures (% of GNI per capita).Teledensity Telephone lines per 100 people.Internet access Internet users per 100 people.Corporate tax Total tax rate (% of commercial profits).Political stability* The likelihood that the government will be destabilized by

unconstitutional or violent means, including terrorism.Voice and accountability* The extent to which a country’s citizens are able to participate in

selecting their government, as well as freedom of expression, freedomof association, and a free media.

Government effectiveness* The quality of public services, the capacity of the civil service and itsindependence from political pressures; and the quality of policyformulation.

Financial crisis Dummy variable for the financial crisis in 2009.Real GDP per capita GDP per capita (constant 2000 US$).

*It is measured on a scale ranging from -2.5 to 2.5, with higher values corresponding to better outcomes. 

 

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Table 2: Summary Statistics

Mean  Std. Dev.  Maximum  Minimum  Obs. 

Franchise expansion  1.38  4.77  45.18  0.00  101 

Distance to frontier  61.50  12.94  91.70  41.40  101 

Entry regulation  20.95  25.94  78.40  0.30  101 

Internet access  32.46  23.79  84.73  2.39  101 

Teledensity  21.35  14.39  61.21  2.87  101 

Corporate tax  52.95  18.57  81.20  14.10  101 

Political stability  -0.43  0.75  1.21  -1.56  101 

Voice and accountability  -0.43  1.04  1.53  -1.77  101 

Government effectiveness  0.33  0.68  2.27  -0.57  101 

Real GDP per capita  7755.16  11038.60  40837.27  577.66  101 

 

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Table 3: Regression Results(Dependent variable: franchise expansion)

Explanatory variables (1) (2) (3)

Top PanelDistance to frontier 0.067***

(0.016)0.159***(0.030)

0.068***(0.022)

Internet access 0.101***(0.018)

Voice and accountability  1.373***(0.367)

Government effectiveness  1.469*(0.883)

Financial crisis  1.162***(0.328)

Trend -0.783***(0.215)

Real GDP per capita  -0.137***(0.027)

-0.367***(0.086)

Constant -2.751(1.409)

-7.311(1.965)

-0.656(1.950)

Goodness of fit (R ) 0.51 0.53 0.60

 Bottom Panel  

Entry regulation 0.145*(0.079)

0.143(0.091)

0.372**(0.152)

Entry regulation squared -0.002*(0.001)

-0.002(0.001)

-0.004***(0.001)

Corporate tax -0.065***(0.016)

-0.066***(0.014)

-0.020**(0.008)

Internet access 0.226***(0.068)

Voice and accountability  0.757***(0.157)

Government effectiveness  2.315**(0.917)

Financial crisis 1.233***(0.265)

Trend  -1.158***(0.350)

Real GDP per capita  -0.002(0.021)

-0.448***(0.114)

Constant 3.770(0.461)

3.830(0.519)

-1.596(1.954)

Goodness of fit (R ) 0.53 0.53 0.67Observations 101 101 101Notes: (a) White (robust) standard errors are in parentheses. (b) *implies the coefficient is significant at the 10percent level. **implies the coefficient is significant at the 5 percent level. ***implies the coefficient is significantat the 1 percent level.