January 20, 2009 Matt Mosley Suh-hee Choi Franchising HTM 681 First Topic Department of Hospitality and Tourism Management Purdue University

Franchise—Definition A method of distribution A type of strategic alliance Agents involved in a franchise system The franchisor -- lends his trademark or trade name and a business system 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

A method of distribution

A type of strategic alliance

Agents involved in a franchise system

The franchisor -- lends his trademark or trade name and a business system

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)

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: 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; 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.

(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:

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;

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

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

Franchise Industries

Types of franchising Single-unit franchise Multi-unit franchise An area development franchise A master franchise

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, 2004 Agency Theory : Lafontaine, 1992

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

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)

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 Control system 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? 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)

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)

Previous Research (cont.) Consumers’ perception Higher degrees of satisfaction (Young et al., 2008 – restaurant) Brand recognition What Motivates Franchising? (Benefits of Franchising)

Consumers’ perception

Higher degrees of satisfaction (Young et al., 2008 – restaurant)

Brand recognition

Site selection (Park & Khan, 2005) Fast Food and Restaurants (IFA, 2006) Previous Research (cont.) Which industries are more franchised? Which regions are more franchised?

Site selection (Park & Khan, 2005)

Fast Food and Restaurants (IFA, 2006)

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 Previous Research (cont.) Moral issues & Control systems

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

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.)

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)