TO FRANCHISE OR NOT TO FRANCHISE - AN ANALYSIS OF DECISION RIGHTS ANDORGANIZATIONAL FORM SHARES

For innovators and entrepreneurs in service businesses, franchising is frequently suggested as a way to succeed and grow. Academic research has provided little guidance for potential franchisors, however. This article provides a model to guide that choice of organizational form u sing results from agency theory. Analytically, franchising is a way to allocate decisions within the franchise system between the franchisor and the franchisee in order to promote efficiency and provide incenti ves. Franchisees make decisions regarding local operations, such as ho urs, prices, and locations, because they have the knowledge about loca l trading conditions. Franchisors make decisions regarding the product , its production, and associated marketing efforts that together creat e the standardization that the trademark signals. The revenue of franc hise systems is divided to provide incentives to each party to support the allocation of decisions. Franchisors receive a percentage of gros s sales, typically 5%, to compensate them for use of the trademark and associated services. Franchisees keep the unit's profits after paying royalties. These profits motivate the franchisee to make the good dec isions that operate the unit efficiently. But franchising has limitati ons as well. First, by making franchisees invest in a unit in a specif ic geographic area, the franchise system exposes the franchisees to bu siness risk; it consists of local economic conditions beyond franchise es' control that could reduce or eliminate their capital. That risk co uld be eliminated by owning a geographically diversified portfolio of shares of units in different places, but then incentives are weakened. Second, the requirements of standardization under the common trademar k constrain franchisees from the full use of their human capital, incl uding their knowledge of local conditions. Some adaptations to the loc al market are prohibited by the requirement of standardization. So hig h levels of either business risk or human capital in an industry make franchising a less desirable choice of organizational form. These idea s are tested with interindustry data using an econometric discrete cho ice model on the share of sales through franchise systems (termed orga nizational form share). The methodology is identical to market share m odels used in economics and marketing. Business risk, as measured by p ercent of units that have failed in the industry in the last 3 years, and human capital required in the industry, as measured by average wag es paid, both negatively influence the share of sales through franchis e systems. The model can be applied by entrepreneurs considering franc hising, especially in industries not traditionally associated with fra nchising. Using public data sources identified in the study, a prospec tive franchisor can research the industry to determine if industry con ditions support franchising as the optimal choice of organizational fo rm. The empirical tests also suggest a second managerially relevant co nclusion: the decision of ''should we franchise?'' can be and should b e separated from the decision of ''how do we implement franchising?'' Factors previously shown to influence the implementation of franchisin g, the degree of ownership of units within the system, do not influenc e organizational form share, thus suggesting that the strategic decisi on of whether to franchise is distinct from the operating decision of how to implement franchising.