Growing a Franchise System: Structure and Strategy

The link between structure and strategy decisions is recognized and examined here, using a dynamic, game-theoretic model that addresses the following inter-related decisions faced by a profit-maximizing franchisor: (i) optimal pattern of growth over time, in terms of the proportion of retail outlets owned and operated by franchisees; (ii) optimal franchise contract (the fixed franchise fee and the royalty) offered to franchisees; (iii) optimal price point recommended by the franchisor to all retail outlets and (iv) optimal investments in service at company-owned retail outlets. Analytical, closed-form, equilibrium solutions for four different patterns of growth suggest that how a franchise system expands over time determines if and how different instruments of coordination (the franchise contract and the retail price) are used to create profits and allocate them between the franchisor and franchisees. These instruments of coordination (and service investments) are also influenced by the relative service productivity of owned and franchised outlets, the price-sensitivity of sales, and the ease with which goodwill is created. Numerical analyses reveal that these factors also directly influence the profitability of the different patterns of growth and, therefore, the structure decision.

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