Disadvantages to Franchising
Underinvestment
Franchisor may fail to build brand. >Cut investment in advertising and create new products Franchisee may fail to maintain outlet. >Cut investment in training and equipment
Conflict over outlet concentration
Franchisors want LOTS of outlets because 1) adding is cheaper, 2) it maximizes franchise fees and royalties, and 3) it builds the brand. More outlets however reduces Franchisee profits
Maximizing Sales vs. Maximizing Profits
Franchisors want more sales, Franchisees want more profit Franchisors prefer high-volume, low margin strategies Franchisees prefer selling lower volumes and higher margins >Disagreements over product >Disagreements over coupon and other promos
Obsolescing Bargain
Over time, value offered by franchisor to the franchisee decreases, although royalty remains the same. The franchisee begins to think royalty is too high
Overall Lessons for Innovation and Changes
Rely on Company over franchising if you want flexibility in changing organizational structure Rely on company over franchising if you frequently introduce new products, and that is important to your business
Overall Lessons of Goal Conflict
Rely on company over franchise if you want high concentration of outlets Rely on company over franchise if the business depends heavily on collective action among operators of different outlets
Overall lessons for Financial returns
Rely on company over franchising if you plan to operate a small chain. A firm must compare the relative margins of company ownership and franchising
Financial Returns
The cost of establishing a franchise system often exceed $500,000. >In large chains, fixed costs are earned through franchise fees and royalties. Small chains may not get anything back from fixed costs. Company owned outlets might provide great returns than franchisees. >100% of profits vs. 5% of sales
Loss of Intellectual Property
Threat of franchisee learning franchisor's secrets Franchisees will keep their knowledge after the agreement ends
Hold Up
"Hold Up" is when franchisors take advantage of franchisees investment in specific assets to extract money from the franchisee. >16% turnover of franchisees each year >Avg. $144k investments in specific assets They may increase royalty rate or threaten to terminate a contract
Transaction Cost Problems
>Free Riding >Hold Up >Under Investment >Loss of intellectual property
Four categories of Disadvantages
>Goal conflict between franchisors and franchisees >Transaction cost problems >Certain types of innovations and changes are more difficult >May lead to lower financial returns
Innovation and Change
>Making changes to organizational structure >Product Innovation
Goal Conflict
>Maximizing sales vs. Maximizing profits >There is conflict over outlet concentrations >There is conflict over collective action >Obsolescing bargain
Free Riding
Free riding is Enjoying benefits without contributing equally to creating those benefits. Any action by a franchisee that hurts the brand name hurts the chain as a whole. Any benefits go directly to the franchisee. Combatting free riding: >Write quality standards into contracts >Audit franchisee behavior >Can dictate the use of some suppliers >Collect advertising fees >Cannot anticipate every possible problem
Making changes to organizational structure
It's relatively easy to change structure among company-owned outlets. However, changing contracts with franchisees is very difficult. Example: hard to force franchisee to computerize All franchisees must be treated the same. Hard to experiment or introduce plans gradually.
Product Innovation
Many franchisees are reluctant to share information with franchisors. It's difficult to get franchisees to adopt new products and programs. Company-owned outlets tend to share ideas amongst themselves better than franchisees.
Conflict over collective action
New policies may hurt certain outlets (Ex: Gift certificates, guaranteed free repair regardless of location) >Irrelevant for a company-owned chain >Huge problem for franchisees
