Hybrid forms and franchising

Question 1

Hybrid form?

Answer 1

Set of organisations such that coordination between those organisations takes place by means of the price mechanism and various other coordination mechanisms simultaneously - Douma and Schreuder

Hybrid forms are efficient for intermediate levels of asset specificity

Shows low asset specificity - transaction cost lowest for market, if high transaction costs lowest with hierarchies

Hybrid forms placed on line between markets and organisations

Question 2

Franchising?

Answer 2

Define franchise agreement as one lasting for a definite or indefinite period of time in which the owner of a protected trademark grants to another person/firm, for some consideration, the right to operate under this trademark for the purpose of producing or distributing a product/service - its central features are the rental of a decentralised production or distribution process

Have to sign a contract thus is a market element
High degree of coordination, needs high degree of standardisation

Question 3

Core types of franchise?

Answer 3

• Company sells right to use brand name etc. – looking at this type
• Privatisation – right to provide public good e.g., rail – won’t be covering this type

Question 4

Why examine?

Answer 4

• Overcoming Principal agent problems?
• Halfway house between internalisation and the market
• Rapid growth of the form
• Why is it different? –
• Not a technology licensing agreement due to central role of trademarks
• Differs from an agency relationship as franchisee cloaks himself in ID of the franchisable trademark
• Not a multi-unit enterprise bc franchisees operate as independent firms

Question 5

Common in sectors such as?

Answer 5

• Fast foods – McD
• Hotels and restaurants – Holiday Inn
• Car rentals – Hertz
• Petrol stations – Esso
• Retailing – Bodyshop

2 characteristics in common –
* Provide services which have to be produced locally while customer is present
* Large adv in developing and maintaining a business formula and brand name

Assets involved –
* Could be a name, idea, secret process, product, equipment

Question 6

Is developing of franchising something to do with current economic environment?

Answer 6

• Reaction to increasing market concentration – spar competing w Tesco
• Well suited to service and human intensive economic activities
• Changing structure of economy – more value added in services, gov encouragement for individual entrepreneurship and self-employment
• Rapid product life cycles
• The outsourcing culture

Question 7

Core facts - headlines?

Answer 7

• Growth in numbers and income
• British Franchising Association figures
• International dimension

Franchising industry turnover (£bn)
1984 - 0.9
2018 - 17.2

Number employed in UK franchising (000s)
2001 - 407
2018 - 710

Question 8

Franchising types - from Stern and Stanworth?

Answer 8

• Manufacturer – retailer – Esso
• Manufacturer – wholesaler – coca cola – may franchise independent bottlers who supply retailers
• Wholesaler – retailer franchise – Spar
• Trademark, trade name, licensor – retailer franchise – Hertz business format printing etc.

Question 9

Franchising types - Porters retailing analysis?

Answer 9

• Helps understanding of intersectoral distn of franchising and distribution of bargaining power
• Nature of PA problem arising
• Convenience – goods bought frequently, quality of transaction regarded less important – production must take place at site of consumption (fast food) or where locational convenience serves as sales promoting function (petrol)
• So only require standardisation and quality control in local outlets – franchisor has more power
• Non convenience – important transactions – seek info from retailer – retailer has local knowledge and expertise in selling – cars
• Franchisee may have more bargaining power in relationship
• Franchisor acts to share risk

Question 10

Advantages for franchisor?

Answer 10

• Enables to achieve national and international coverage for product more quickly
• Provides capital to franchiser – i.e. fees paid by franchisee
• Franchisees self employed so usually motivated to work hard and build up business – ensuring success for franchisor
• Can benefit from knowledge the franchisee has of the local market

Question 11

Advantages for franchisee?

Answer 11

• Chance to run own business w less risk
• Use of established trade name
• Head office advice
• Benefits of continuous market research etc. by HQ
• But – how autonomous/independent – swaps independence for security and fewer opp to diversify, growth limited

Question 12

Why franchise in economic terms?

Answer 12

• Why don’t firms integrate forwards
• Why don’t franchisee integrate backwards

Question 13

Resource scarcity thesis?

Answer 13

• Scarce financial and managerial resources
• An explanation for small service sector firms
• But cannot explain why large established companies continue to use franchising when they expand further

Question 14

Why franchise - administrative efficiency ideas?

Answer 14

• Analysed from agency theory and transaction cost perspective
• PA problems/ moral hazard/ opportunism/ free rider problem/ bounded rationality
• Also links to whole issues of why firms do/don’t exist
• Franchising allows one to test hypothesis regarding nature and limits of firm as type of organisation
• Advantages of reducing costs or increasing net revenues resulting from division of activities between independent enterprises
• Best way of dealing with TC/PA type problems
• Franchising is then almost vertical dis-integration – by contract

Question 15

Why franchise - the franchising decision?

Answer 15

• The franchisee and franchiser must agree, in great detail, how the franchisee shall embody and present the asset – as this will determine its value
• In bargaining, parties encounter sorts of difficulties reaching in arm’s length contract – Williamson advanced as VI explanation
• Firms or markets – dep on cost/benefit

Question 16

Why franchise - overcoming control problems?

Answer 16

• Preferable to VI in minimising coordination costs but providing for entrepreneurial discretion and flexibility
• E.g., lack of incentives for company owned outlets to min costs- agency problem
• Hired internal manager less incentive to monitor workers and does not bear full cost of sharing profits w workers – moral hazard

Question 17

Evidence?

Answer 17

• Kreuger 1991
• Steeper time profile of wages in company ownership – to reduce shirking and provide higher incentives
• Also franchising tends to prevail in larger organisations where monitoring outlets perhaps more difficult
• Substantial agency costs connected w co. ownership – restaurants under co ownership less profitable than franchised ones
• Franchisees generally work longer hours w more effort than company owned outlets – 90% new franchisees report much higher profits in yr1 than new starts – ideally franchisee obj same as franchisors – franchisees could then be considered like profit sharing managers

Question 18

Key issues - free riding?

Answer 18

• Value of franchisors asset dep on use made by franchisee
• E.g., franchised goods bought by people outside usual environment – just assume trademark implies quality
• Cheating by providing lower quality good, franchisee does not bear full cost of poor quality
• Result – returns to asset globally slowly reduced
• Compulsory input purchases?

Question 19

Franchisor may need to act as discriminating monopolist - how?

Answer 19

• Franchisee fees/non-returnable deposits – i.e. high initial payments force self-selection process in potential franchisees
• Royalties on gross sales – less variable than profit – reduces franchisor risk
• Tax on inputs – i.e. selling inputs at higher than MC
• Franchisor supplies fixed facilities – have key requirements for building design, transaction – specific investment

Question 20

Company ownership v franchisee?

Answer 20

• Minkler paper
• Both co-exist – i.e. one organisation runs both
• Company outlets and franchised outlets can be found in same town/city where monitoring costs would be the same – plural form symbiosis
• Life cycle – franchises more significant early on when firms face capital constraints – management economies early on
• Is there a point at which franchising replaced by direct monitoring
• Resource scarcity issues again

Question 21

Minkler 1990?

Answer 21

• Restaurants in the US–why some outlets owned and others not using monitoring and search theories.
• Monitoring hypotheses
• Ownership tenure (franchise or company-owned) is related to distance from monitoring HQ.
• Locations along motorways more likely to be company-owned Ownership tenure related to density of outlets.
• Search explanations:
• Company owned and franchised outlets exist in the same market at the same time – the franchisor can learn from the franchisee. Vertical integration occurs if the franchisor learns about a market from franchisee (life-cycle again)
• Distant outlets more likely to be franchised because these are more likely to be in markets unknown to the franchisor

Question 22

Conclusions?

Answer 22

• In summary the administrative efficiency thesis suggests that franchising exists because of supervision/monitoring PA problems of internal organisation, and the existence of transaction-specific investments – franchising then becomes a more efficient market form.
• However, there are potential problems for the franchisor– the franchisee and moral hazard – may engage in opportunistic behaviour - free ride- which could ultimately reduce the value of the common asset.
• The franchisor (maybe acting with limited information-bounded rationality) then uses the contract to overcome or limit these problems and to extract maximum rents. Importance of incentives.