Information technology (IT) enables a new refinement of the horizontal
network organization. We show that IT can be applied to a hybrid form
of market and hierarchy, franchising, and demonstrate how the resulti
ng horizontal network organization can be an improved organization for
m. Specifically, we use IT-enabled ''ownership of customers'' to refin
e the horizontal network organization and show how that refinement can
alleviate the problem of franchise underinvestment in traditional fra
nchising. In traditional franchising each franchise underinvests relat
ive to investments in an integrated firm because the benefits that acc
rue to other franchises from its investment (horizontal externalities)
are not accounted for in its investment decision. Ownership of custom
ers is a combination of identifying individual customers with individu
al franchises, monitoring customer transactions across franchises, and
transferring benefits between franchises based on those transactions.
Because ownership of customers rewards franchises for the beneficial
horizontal externalities generated by their investments, the levels of
investment that are chosen by franchises may be increased, although n
ot to the levels that would occur in an integrated firm. As long as IT
costs are covered, the franchisor is always more profitable and, if n
ecessary, the franchisor and franchisees can be jointly more profitabl
e. Consequently, if profits can be redistributed in lump-sum form, the
n the franchisor and franchisees can be individually more profitable.
The analysis applies to all horizontal organizations where ownership o
f customers is feasible and where there are sufficient transactions be
tween units for ownership of customers to be worthwhile.