Patrick J. Kaufmann

The Evolution of Ownersip Patterns in Franchise Systems

Two sets of competing theories have been proposed to explain the existence offranchising; one set based on resource constraints and another on incentives issues. As individual franchise systems mature, these theories predict dryerent patterns in the evolution of the mix offranchisedand company-owned outlets. In this paper, we report the results of an empirical study of franchise system evolution. The jindings generally support the incentives-based rationale for franchising, but they also support a modified resource constraint theory, one which recognizes the synergistic efSects of dual distribution. franchise systems, like other organizations, have life cycles that predict various aspects of their structure and processes. More specifically, they reasoned that the resource scarcity that drove expanding chain retailers to embrace franchising early in their system’s life cycle would lessen as the system became more established. The costs associated with managing franchisees gradually would outweigh the benefits associated with the resources that the franchisees provided, and the systems would move toward chains of company-owned, rather than franchised, outlets. Although the specifics of Oxenfeldt and Kelly’s hypothesis have been questioned (see Dant, Kaufmann, and Paswan 1992 for a review of the empirical literature on this subject), its underlying insight remains compelling. Resources and motivations are likely to change over time in a franchise system, and such changes should impact the ownership structure of that system. In this paper, we explore some of the changes that take place within franchise systems as they proceed from the granting of the first franchise to maturity. The primary purpose is to determine whether the pattern of unit ownership, that is the mix of companyowned and franchised outlets, changes in a predictable manner over time.

Multi-unit franchising: Growth and management issues

Abstract Entrepreneurs in a number of retailing sectors have eschewed the creation of company-owned chains and have embraced franchising as a preferred method for growing their businesses. There have been two leading reasons proposed for this preference. First, that franchisees provide the financial capital necessary for expansion, and second that franchisees manage the outlets better than company employees would if the unit were company owned. Interestingly, although many entrepreneur/franchisors confirm the relevance of the capital acquisition argument in their decision-making, theoretical analysis has discounted its importance. Instead, researchers have focused on the incentives of employee store-managers to misrepresent their ability and their effort as the dominant impetus behind franchising. Misrepresentation by employees as to ability and effort imposes costs and inefficiencies on the entrepreneurs chain. Arguing that franchising solves these problems by having the stores managed by persons with claims to the profits, these researchers have, by and large, rejected the capital acquisition argument for franchising in favor of this incentive-based rationale. Within this view, multi-unit franchising presents a curious anomaly. Multi-unit franchising, either through the incremental expansion by the franchisee one unit at a time or through the rights to open multiple units contained in an area development agreement, creates a collection of mini-chains within the franchise system. These mini-chains are operated by employee store-managers. Of course, they are employees of the franchisee, but they are employees nonetheless, and as franchise researchers have traditionally argued regarding the entrepreneurs employees, they will have incentives to misrepresent their ability and effort. Moreover, multi-unit franchising is ubiquitous. If multi-unit franchising is at odds with the incentive rationale for franchising, and it has a positive association with the growth of franchise systems, it must be providing the entrepreneur with some other benefit. In this study, we argue that the benefit it provides is access to capital. Through a study of fast-food franchise systems, we demonstrate that the more a chain engages in multi-unit franchising (i.e., the greater the proportion of multi-unit franchisees it has), the faster it grows, even faster than franchise systems generally. Moreover, we show that the level of commitment franchisors feel toward continuing to franchise is negatively related to the average number of units per franchisee and negatively related to their ability to obtain financial capital elsewhere. In other words, although multi-unit franchising helps an entrepreneur grow his or her business by providing increased access to capital, store level incentive problems get increasingly troublesome as franchisees get more and more units. It would appear, therefore, that capital acquisition is a relevant reason for engaging in franchising after all.

Structural and strategic dynamics in franchising

Abstract In this paper we examine the changes in ownership patterns of franchise systems as they mature. We compare the predictions made by three alternative theories within the context of the fast food industry. Signaling theory predicts that franchise systems will move toward a greater reliance on franchised outlets as systems mature, while resource acquisition theory (or as it is sometimes known, ownership redirection thesis) predicts a tendency in the opposite direction. A third theoretical perspective, tapered integration or plural forms, suggests a tendency toward maintaining a steady state of mixed distribution. Results indicate that although franchisors value the benefits of the mix of ownership types and do maintain that mix over time, there is some evidence of a greater tendency to permanently convert existing franchised outlets to company-owned outlets as fast food systems mature and gain greater access to resources.

Franchising and the domain of entrepreneurship research

Abstract In this essay, we explore the relationship between franchising and entrepreneurship in general, and their research domains in particular. We begin by categorizing the focus of various representative definitions of entrepreneurship as: (1) traits, (2) processes, or (3) activities, and adopt the view that identifying the unique research domain of entrepreneurship is a more worthwhile endeavor than attempting to reach definitional consensus. We subsequently discuss the differences between entrepreneurship in the manufacturing and retailing contexts, and the particular features of franchising as it relates to the study of retailing entrepreneurship. Specifically, four areas are examined: the franchisor’s role in creating an innovative concept, the franchisee’s role in bringing the franchisor’s concept to new markets, the franchisee’s acceptance of risk, and the special issues surrounding the pervasive practice of multi-unit franchising. We conclude with a brief discussion of the reasons for including the study of franchising, franchisors, and franchisees as integral areas within the distinctive domain of entrepreneurship research, and similarly exhort franchising researchers to explore the implications of their work for the study of entrepreneurship.

The dimensions of commercial exchange

A method for measuring the structure of commercial exchange relationships is developed using contracting norms borrowed from Relational Exchange Theory. The norms are operationalized for a range of industry nonspecific governance structures and empirically evaluated. Results provide support for a multidimensional construction of the governance of commercial exchange relationships.

Franchising and the choice of self-employment

Abstract This paper reports the findings of a study of the decision to purchase a franchise within the broader context of the decision to become self-employed. The sample is taken from individuals who had indicated an interest in self-employment and franchising three years prior to the current study. In the interim, some had purchased franchises, some had opened or bought independent businesses, and some had remained employed by others. The differences among these groups are examined. Some support was found for the posited relationship between the personal benefits of self-employment and the decision to purchase a franchise or independent business. The importance attached to the financial and business benefits of franchising is positively related to the decision to purchase a franchise. Finally, there was some evidence that franchising offered greater choice of sectors. Franchisees were less likely than independent business owners to operate within sectors where they had previous experience.

Locus of control and entrepreneurship in the Russian Republic

An internal locus of control has been linked empirically to entrepreneurial activity. In changing to a market economy, therefore, the Russian Republic may face hidden psychological barriers if 70 years of a closely managed economy has Induced a perception of control located In powerful others rather than oneself. Levensons (three-dimensional) locus of control scale Is administered In the former Soviet Union and the results compared to baseline data across various countries and cultures. The findings Indicate that when compared to most countries, the Russian respondents did possess lower Internal locus of control scores and In some Instances higher powerful other scores.

The pricing of franchise rights

Abstract Franchise contracts typically contain two forms of payment from franchisee to franchisor: the initial franchise fee and the ongoing royalty payment. Economic analysis and empirical examination yield two different predictions about how these payments should relate to one another. In this study using system level data, we find a positive relationship between the initial franchise fee and royalty rate when controlling for average outlet sales. This is consistent with the argument that the initial franchise fee is not a vehicle for extracting the surplus downstream rents left after royalty payments. Implications for franchise research and practice are discussed, as is the importance of regulatory changes that may make sales data available through franchise disclosure requirements.

Multi-unit retail site selection processes: incorporating opening delays and unidentified competition

Abstract Multiunit site selection models have long ignored the impact of time delays in store openings. To determine the effect of this limitation and to identify a solution, we compare three multiunit site selection procedures. The first is a sequential procedure that selects sites and then opens them one at a time. The second is a global approach that selects all future sites in a single decision process. Third, is a proposed anticipated-delay procedure that incorporates opening delays, firm planning horizons and discount rates in determining appropriate sites for multiunit retail systems. We further compare the results of these site-selection procedures to similar procedures that incorporate leakage to unidentified competitors when seeking locations for new outlets. We make the comparisons based upon discounted revenues by using a two-party, game-like simulation. The simulation estimates revenue results under the various alternatives while allowing for reactive and preemptive competitive store openings. Our results indicate that the anticipated-delay procedure incorporating leakage produces a significantly better revenue stream than either the standard sequential or global approach procedures.

Deception in retailer high-low pricing: A “rule of reason” approach

Abstract Marking up to mark down and referring to a fictitious “regular” price in retail advertising can deceive consumers and cause consumer injury. The practice, known as high-low pricing, has become widespread in the intensely competitive retail environment. Consumers respond to this practice by drawing one of several inferences about the value of the product and the prevailing competitive price. Whether the consumer is deceived depends on the inference drawn. This paper integrates legal, public policy, consumer behavior, and retailing perspectives to examine the issue and propose retailer and regulatory solutions. To date, regulators have attempted to impose a “per se” approach. Through analysis of retailer motivations, consumer behavior and the May D&F case, a “Rule of Reason” approach is suggested as an alternative solution to this issue of significant concern to retailers and public policymakers alike.