Economics and Management of Networks

Franchisee Versus Company Ownership – An Empirical Analysis of Franchisor Profit (P. 31)

Thomas Ehrmann and Georg Spranger
Abstract.
In this paper, we examine ownership structures of franchise chains and evaluate their impact on franchisor profit. Specifically we compare pure forms of franchising with those that use both company-owned and franchised outlets within one chain – a phenomenon termed the plural form. Theoretically such plural arrangements are supposed to provide franchisors with lower costs, higher growth, greater total-quality, and reduced business risk.

Empirical results of this study indicate the superiority of company-owned businesses over franchised units in generating franchisor profits. Moreover plurally organized systems compensate for losses from franchising with profits from company units and outperform purely franchised competitors in overall profitability. Despite a clear financial inferiority of franchise outlets, franchisors of our sample do not convert plural structures into wholly-owned chains. Much more when organizing the chain, franchisors face an (skewed) inverse u-shaped profitablity curve with both pure franchising and pure company-ownership lying at the (undesirable) extremes and with a performance peak somewhere in between.

Keywords.
Franchising, plural form, ownership redirection, company ownership, chains

1 Introduction
"As all of you know, the name of the game is not really franchising. The name of the game is company stores. …It becomes obvious to you, if two hundred company- owned units out of 1600-1700 overall units produce 60 percent of the net after tax profit, the real name of the game is owning the stores yourself" Economic transactions within firms are organized either by hierarchy or by price mechanisms – or by a mixture of both.

Concerning the matter of franchising, only a minority of today’s leading franchise chains relies on pricing systems alone. The vast majority operates a minor but still significant number of company-owned stores (the hierarchy) side by side with their franchisees (the price system). Since Bradach and Eccles (1989) examined such special hybrid arrangements, mixes of company and franchise units within the same system, have been known as plural forms.

In contrast to early research propositions by Oxenfeldt and Kelly (1968), Hunt (1973), Caves and Murphy (1976) and Martin (1988), plurally organized franchise chains have not significantly altered their structure into entirely franchised or company-owned systems. Thus plural forms appear to be a stable organizational phenomenon. Upon these findings, organization science began to explain the widespread use of plural forms by researching its advantages over pure franchise systems (Bradach 1997, Ehrmann and Spranger 2004).

Compared to pure hierarchy (full vertical integration) or pure price systems (pure franchise chain), plural forms are firstly supposed to lower overall agency (i.e. monitoring) cost and the cost of searching for and implementing local and highly specific information. Secondly, it is argued that plurality improves system and process quality by the following effects: By signaling internal franchisor information to the franchisee, thus overcoming inefficiencies arising from asymmetrical information, by preventing conflicts among contracting parties through aligning divergent interests of principals (franchisors) and potential agents (potential franchisees),