Payment types and number of franchisees

Current studies of the franchise system usually assume that the number of franchisees is exogenous and irrelevant to the payment types. However, to a franchise system or a franchiser, the optimal number of franchisees is related to the payment types, e.g., franchise fee, royalty, etc. We develop a game-theoretical model and then use 1998 Bond's Franchise Guide Data for US franchise stores in order to test the theoretical predictions. According to our theoretical predictions, the optimal number of franchisees under a royalty is strictly less than that under a franchise fee. This is because royalties distort the effort incentive of franchisees and the franchiser can increase average revenue by having a smaller number of franchisees. A franchise fee will not distort the effort incentive of franchisees and can help achieve a higher profit for both the franchiser and the franchise system. When demand is certain, the optimal royalty rate to the franchise system is zero. Under a royalty payment, the royalty rate will be greater than zero if the franchiser maximises its own profit. Empirical results support our theoretical predictions: there is no significant relationship between franchise fee and number of franchisees. The number of franchisees has a significantly negative relationship with royalties, while it is significantly and positively correlated with the experience of the franchise system, area, training, and advertising fees required by the franchiser.     

Does the Franchisor Provide Value to Franchisees? Past,Current, and Future Value Assessments of Two Franchisee Types

The degree to which a franchise system penetrates a target market over time often is influenced by the rate to which its individual franchisees expand. Yet a franchisee's decision to expand the business operation depends, in part, on the perception of value that the franchisee expects to receive from the franchisor in return for a variety of fees (for example, entry fee, advertising fees, royalties). Moreover, the franchisee's experience with its franchisor may strengthen or weaken his or her perception of franchisor value. The change in perception of franchisor value can influence franchisees' decisions to expand their franchise operations. To date, scant research exists on factors influencing a franchisee's decision to expand. In the reported study, a four-stage analysis was conducted to examine empirically whether franchisees' opinions about the value of their franchisors changes over time. The study findings reveal that franchisees had the strongest, positive opinions when asked to recall an earlier decision to expand their franchise operations. These opinions weakened when franchisees contemplating expansion of their operations were asked for their current and anticipated future opinions of franchisor value. Overall, franchisees were undecided when asked about their perceptions of current franchisor value and anticipated future franchisor value. Implications of these findings for theory and practice of franchising are discussed.     

Franchising growth and franchisor entry and exit in the U.S. market: Myth and reality

Franchising has been and continues to be a very popular way to do business for a number of retailers and service businesses. However, the type of franchising that has been growing the most, namely business-format franchising, has not grown at the kind of phenomenal rates that the trade press often suggests. Since the Department of Commerce (DOC) canceled its publication Franchising in the Economy, we no longer have access to census-type data on franchising in the U.S. However, looking at the period during which the DOC did publish these data, one finds that the number of business-format franchisors is highly correlated with the number of units in these chains. Thus, we use data from recent issues of various franchisor directories to assess the number of franchisors in the U.S., and infer from this how business-format franchising has grown in the U.S. We find that business-format franchising has been growing over the last decade at a rate that is, at best, commensurate with the growth of the economy as a whole.We believe that the confusion about the extent of growth in franchising arises, in part, from the fact that many new firms enter into franchising each year, leading to the notion that this way of doing business is growing tremendously. However, we show that many firms also exit from franchising each year, for a net growth rate much below the entry rate.This paper shows that franchising is not a panacea for entrepreneurs, whether franchisor or franchisee. From the franchisor's viewpoint, the high rate of exits suggests that many firms fail despite franchising, and many others choose to stop franchising after trying it for a few years. Clearly, these firms have found that franchising is not right for them. Furthermore, the results show that the characteristics of the chain at the time it becomes involved in franchising, as described in the main franchisor directories—such as the royalty rate, the advertising fee, the franchise fee, the amount of capital required, and the sector of operation—have little capacity to explain “survival.” The main variable that affects “survival” among those that are typically reported in franchisor listings is the number of years that the franchisor has been in business before starting to franchise. Hence our results suggest this is one dimension in which franchisors can make decisions that affect the probability that they will be successful in franchising. Although we are unable to explain most of the variance in outcome, the results mostly imply that other, less easily observed or quantified characteristics of the chain and the franchisor, such as maybe the “innovativeness” of the product, the amount of support provided to franchisees, the financial backing of the franchisor, etc., likely influence “success” the most, and thus, are worth investigating further.From the perspective of franchisees, the amount of exit found here suggests that in the majority of systems, franchisees cannot expect that their franchisor will be around for the whole duration of their contract—which averages about 15 years according to the Department of Commerce. This does not mean that the majority of franchised businesses will find themselves in an “exiting” system—a small minority of very well-established franchisors accounts for the majority of franchised businesses, and these are likely to remain successful for years to come. But entrepreneurs buying franchises from less established systems are likely to face franchisor exit, either failure or departure. This paper confirms that franchisees should thoroughly investigate the franchise system they want to invest in, going beyond the information about royalty rates, advertising rates, rankings, etc., found in franchisor directories, and toward more product, market, and other less easily accessible information about the chain.     

Antecedents of early terminations in franchising: franchisor versus franchisee cancelations

Franchisors capitalize on franchisee entrepreneurial capacity to grow. However, enabling franchisees to develop their ventures may damage system consistency. This dilemma makes conflict particularly prevalent in the field of franchising. Nevertheless, prior research has reported an incomplete picture of factors leading to serious disagreement and premature termination in franchise partnerships. We address this gap, first, by adding the entrepreneurial autonomy of franchisees as a relevant but underexplored source of conflict and, second, by providing a more fine-grained analysis of franchisors’ versus franchisees’ drivers of termination. Specifically, we focus on the controversial issues of pricing and local advertising policies and analyze how expanding franchisees’ entrepreneurial autonomy in these decision areas is related to contract terminations depending on who ended the relationship (the franchisor or a franchisee). The study also highlights less controversial requirements and conditions (e.g., upfront investments, franchisor experience …) that may reduce early terminations. Our empirical objectives are met by using survey data from a sample of franchisor companies. The results show how the performance outcomes of entrepreneurial autonomy differ depending on the decision area in which it is exercised. Results also throw light on the consequences of various critical franchise policies that may be masked if both types of termination (franchisors vs. franchisees) are considered together.     

Crossing mother: Entrepreneur-franchisees' attempts to reduce franchisor influence

Contractual terms guide many entrepreneur-franchisees' actions with the franchisor. However, it is impossible for franchisors to completely specify all future actions. They compensate by continually attempting to influence franchisees, using what franchisees perceive as suasion in their ongoing interactions. We develop a theoretical framework for understanding the informal interaction dynamics between franchisors and franchisees.Most franchise arrangements include the payment of royalties based on sales. This encourages a growth-oriented strategy, usually appropriate for the franchisees during the initial stages of their operations. Whereas a franchising strategy can reduce entreprenerial risk for franchisees, it does not eliminate it. Thus, as sales of the franchisees increase, profit-oriented strategies will be favored because they represent the payoffs that accrue to continuing entrepreneurial effort and risk-taking. These strategies may be in opposition to franchisors' sales orientation when market conditions do not allow continual growth without margin penalties. A research model is developed, depicting the relationship between franchisees' strategies and performance, and the moderating effect that contractual goals and franchisees' perception of franchisors' attempts at suasion have on this relationship. A set of research hypotheses was then empirically tested using a large sample of franchisees from the commercial truck retailing industry.The results indicate that sales-growth and profit-growth goals are not always congruent. Balancing the goals of the franchisor and franchisee did not appear to be a popular option; either one or the other was emphasized. More importantly, the results indicate that when franchisees perceive attempts by franchisors to use suasion, lower levels of profits result, but there is no corresponding increase in the level of sales.In the long-term, franchisors are likely to determine that current contractual arrangements are not protecting their longer term interests. Thus, they will be expected to attempt to modify franchise contracts in ways that force franchisees to implement sales-gain strategies. This will require that entrepreneur-franchisees anticipate future events more carefully at the time they are examining the original franchise contract. Because most entrepreneurs are concerned with immediate survival at the start-up stage, this makes examination of the contract less likely to happen; the franchise option is attractive because it reduces such risks.We recommend that entrepreneurs write ex ante contingent claims contracts that ensure a gradual reduction of franchisor influence. Although this would assume a power or knowledge balance that favors the franchisees, which is unlikely during the start-up phase, it will change over time as franchisees gain a better understanding of the local competitive dynamics. Thus, it may well serve the franchisees to take a defensive posture or push a royalty arrangement that decreases the emphasis on sales over time. This is most likely to be effective where the entrepreneur is considering several competing franchises at the time of the signing of the contract.Finally, we recommend that entrepreneur-franchisees should not assume that the expert advice offered by their franchisor is always in their best interests. Although technical advice is more likely to be unbiased and should be fully exploited, as this is what makes the franchise valuable, strategic advice, or that which relates to goal setting may well be colored by the financial interests of the franchisor. Franchisors are unlikely to consider the possibility that franchisees would be better served by formulating their own strategies, nor are they likely to consider that the franchise network would be better off, in the longer term, by the collective impact associated with numerous franchisees independently formulating their own strategies. In short, although we do not suggest that franchisees should always assume that “crossing mother” is the best response to all perceived franchisor-suasion efforts, they should carefully examine all strategic advice.     

Antecedents leading to perceived franchise support

Abstract

Franchising is an important part of the U.S. economy. According to the International Franchise Association (IFA), franchising provides 9.0 million jobs and pays out 351 billion dollars in wages and benefits annually (2016). This study examines franchise relationships in the context of building franchisees’ perceptions of support from the franchisor. The literature was examined to determine if and what support provided by the franchisor has a positive impact on the franchisee. We examine four dimensions of organizational climate (i.e., initiating structure, leadership consideration, autonomy, and reward orientation), brand value/recognition and franchisee’s perception of the quality of the franchisor’s advertising as predictors of perceived franchise support. This study indicates there is a positive and significant impact between three types of organizational climate (i.e., leadership consideration, autonomy, and reward orientation). In addition, a positive impact to brand value recognition on perceived franchise support and a negative effect on initiating structure.     

Assessing the intangibles transferred in franchise businesses

In franchise systems, trade relationships between the franchisor and franchisee to exchange intangible resources for a franchise fee and subsequent payments are set up. This article provides data obtained by personal surveys on the restaurant industry franchise system in Mexico. The brand mark established by an initial investment, the time the franchise has operated, and its capacities to make profit are key factors in this exchange. The franchise size and its belonging to the Mexican Franchise Association are other intangible resources transferred in this relationship.     

Power and control in the franchise network: an investigation of ex-franchisees and brand piracy

This research considers the issue of franchisees who exit the franchise system in order to continue operating independently. The literature regarding incentives for entering franchising is reviewed in an attempt to reveal why franchisees become dissatisfied and leave. The use of power by the franchisor and its relationship to brand piracy by franchisees is explored. Franchisors and their current and former franchisees are interviewed to uncover insights into this phenomenon. Explanations concerning the effectiveness of contractual remedies, dissatisfaction with the franchise, level of dependence and expectations in the relationship, and franchisor-franchisee goal incongruence are proposed.     

Brand and performance signals in the choice of franchise opportunities

When choosing a franchise chain, potential franchisees must incorporate into their decision process the signals of franchise chain quality being sent to the market by the franchisor. Some of these signals along with potential franchisees' choices of franchise chain are analyzed. The results show that brand value and franchisee performance were the key signals used by Spanish franchisees during the period 2002 through 2008, when deciding to open a franchise outlet. The aim of this study was to contribute to strengthening the relationship between entrepreneurship and franchising in Spain from an empirical viewpoint.     

The Effects of Standardization and Trust on Franchisee's Performance and Satisfaction: A Study on Franchise Systems in the Growth Stage

Franchise systems aim to capitalize on both economies of scale and the benefits derived from localized operations. Although franchisees can be considered small businesses with some independence and local knowledge, compliance with system standardization may be critical to achieving scale benefits, as well as realizing and then maintaining the desired image during the growth stage of the franchise life cycle. However, standardization requirements from the franchisor demand that franchisees make specific investments in the system, which make franchisees more vulnerable to the franchisor. Therefore, whether a franchisee can trust the franchisor becomes an important factor that facilitates the relationship between standardization requirements and franchisees' overall sales and service performance in the market. This research focuses on franchisees in a growing franchise system and examines how the standardization requirements, trust in the franchisor, and the interaction term affect the sales and service performance of a franchisee and ultimately the franchisee's satisfaction. The findings support the hypotheses that, first, the standardization requirements positively affect both sales and service performance. Second, trust not only has main effects on satisfaction and performance constructs but also moderates positively the relationships between standardization requirements and sales/service performance.     

When the Music Stops Playing: Post-litigation Relationship Dissolution in Franchising

Franchise relationships engender franchisor–franchisee conflicts and are prone to premature dissolution. Building on agency theory and institutional theory, this study examines what specific reasons – from both franchisors’ and franchisees’ perspectives – may cause post-litigation relationship dissolution (PLRD) and how franchise regulations moderate these relationships. We argue that both franchisor and franchisee may misrepresent themselves before their relationship begins (adverse selection) and behave opportunistically after the contract is signed (moral hazard), that is, ‘dual agency’. Based on 20-year archival records of franchisor–franchisee relationship histories gleaned from multiple data sources, we found that PLRD is likely to be caused by franchisors’ passive moral hazard and by franchisees’ active moral hazard. In addition, franchisor adverse selection has a greater impact on PLRD than franchisee adverse selection. With regards to regulatory influences, the presence of relationship law weakens the impact of franchisees’ passive moral hazard, but not their active moral hazard, on PLRD. Contrary to what we hypothesize, the presence of registration law amplifies the impact of franchisee adverse selection on PLRD. Ultimately, this study creates a better understanding of the antecedents and curbing mechanisms of PLRD in franchising.     

The Determinants of Dual Distribution Revisited

This paper examines the use of what has been called “dual distribution” by firms. Dual distribution involves a firm using both company-owned stores and independently owned franchises to sell its product or service. Using panel data from 1048 companies for the years 2005 to 2009, I use a variety of estimators to determine the factors that influence the relative use of franchising by companies. A key focus of the paper is to control for the possible endogeneity of the franchise fee, royalty rate, and franchise ratio for the companies in the respective industries. Using a panel data estimator and lagged values of the franchise fee and royalty rate as instruments, I find that one reason the franchise fee and royalty rate do not appear to influence the relative use of franchising is due to industry- and firm-level fixed effects, which capture the variation in royalty rates and franchise fees at the company level.     

How Do Franchisees Assess Franchisor Trustworthiness?

This study investigates the antecedents of franchisees’ assessments of franchisor trustworthiness. It combines multiple theoretical perspectives to develop a framework that is empirically tested with survey data from 128 franchisees of a Dutch franchise system. The results show that franchisees’ perceptions of a franchisor's fulfillment of its functional duties on proactive and reactive quality assurance and strategic management positively influence franchisees’ assessments of franchisor trustworthiness. Moreover, the results show that the impact of the antecedents on franchisees’ trustworthiness assessments varies across franchisees: market competition attenuates the influence of strategic management and reactive quality assurance. Unit performance does not moderate the importance of the antecedents.     

Franchise management capabilities and franchisor performance under alternative franchise ownership strategies

Franchising is a key entrepreneurial growth strategy, but a well-known downside is franchisee free-riding. Drawing upon alliance capabilities research, we describe franchise management capabilities and suggest that they are one way franchisors reduce free-riding and thus enhance performance. We also submit that these capabilities are especially helpful for “plural form” franchisors who own outlets in parallel with franchisees. Using a sample of 229 franchisors, we show that franchise management capabilities relate positively to franchisor performance among plural form franchisors. For “turnkey” franchisors who franchise all, or almost all, outlets these capabilities relate indirectly to performance through lower opportunism and improved brand reputation. Franchise management capability is therefore an important new theoretical construct linking franchising to franchisor performance.     

Strategic Debt in Vertical Relations: Evidence from Franchising

In this paper, we examine the strategic use of debt in franchise organizations. We focus on both the franchisee's and the franchisor's capital structures. The primary goal of this study is to examine whether franchisors impose limits on franchisees’ debt levels to be able to increase their own leverage. We find that the franchisor's leverage is significantly related to the maximum leverage allowed for the franchisee. As the franchisor sets an upper limit on the franchisee's debt ratio, the franchisor can raise more debt and therefore seizes tax benefits, since interest payments are tax deductible. We find that this effect is stronger in chains with larger fractions of franchised outlets.     

When sergeants can outrank generals: Person-organization fit and the performance of franchisees as agents of their franchisor

We introduce a person-organization fit perspective to explain how franchise organization characteristics shape the link between franchisees' individual attributes and their performance as agents of their franchisor. Showcasing this idea, we develop arguments to suggest why the links between franchisees' agent performance and their prior industry and educational experiences are contingent upon the franchise organization's entrepreneurial orientation, centralization, and formalization. The results from multilevel analyses using the data of 276 franchisees from 47 franchise organizations largely support our ideas. We discuss the theoretical and practical implications of our study for franchising and beyond.     

The choice of master international franchising – A modified transaction cost model

This study develops and tests a novel transaction cost model of master international franchising. Based on data from international franchise firms headquartered in six countries, we show that master international franchising is the franchisor’s preferred governance mode under the following conditions: large bilateral franchisor’s and franchisees’ transaction-specific investments, high institutional uncertainty and high behavioral uncertainty. Our model extends the literature by presenting a modified transaction cost model of master international franchising that investigates the bonding effect of bilateral transaction-specific investments and environmental uncertainty as determinants of the franchisor’s choice of international governance mode. In addition, by using primary data from international franchise companies, our study contributes to the transaction cost literature in international business and international franchising that is mainly based on secondary data.     

Ethical implications of business format franchising

Franchising in the business format sector accounted for approximately 35 percent of retail sales in the U.S. in 1991. Consequently, the franchising industry has a clear ethical responsibility to the public. At the same time, there exists an ethical obligation of the two major factors in the industry — the franchisor and the franchise — toward each other. Because the franchise agreement, which is the basis of the relationship, is originated by the franchisor, an asymmetrical distribution of power often exists, resulting in opportunistic behavior by the franchisor. In other cases, questionable or unethical practices by franchisees likewise result in conflict. This paper examines some of the basic areas of the franchise relationship which result in conflict, and discusses the situation analysis in business format franchising, which shows promise for reduction of conflict and unethical behavior for the future.Gordon Storholm is Associate Professor of Marketing at St. John's University, New York, N.Y. He is an active member of the Society of Franchising and has published several articles in the franchising field. He has contributed to this Journal and has several years' experience as a consultant in the Franchising and Marketing fields.Eberhard E. Scheuing is Professor of Marketing at St. John's University, New York, N.Y. He is Director of the Business Research Institute and has published several books and articles in the marketing field. He is widely recognized as a leading authority in the field of ethics in service quality.     

Trust,Decision Rights Delegation,and Performance—The Case of Franchising

Previous research has not examined the relationship between trust, decentralization, and franchisor performance. Complementary to the literature on autonomy and relational governance from franchisees’ perspective, this study focuses on the franchisor's perspective on the impact of decentralization and trust on performance. Consistent with the embeddedness view, the results show that trust is a facilitator of decentralization in franchise networks, thereby increasing the positive performance effect of decision rights delegation. Overall, the study offers a new perspective on the relationship between formal governance—through decision rights allocation—and trust as a relational variable in interorganizational networks.