by Scott Shane, Venkatesh Shankar, and Ashwin Aravindakshan
This article was published in Management Science, 52 (May 2006), 773-787.
Why do some franchisors (corporate entities) such as Pearle Vision and Jazzercise grow larger than others? Is it due to effective pricing policy decisions, such as the royalty rates franchisors charge the franchisees for use of the franchise name and product and the up-front fixed fees? Or is it due to appropriate decisions related to strategic control of the franchise system, including the number and proportion of outlets owned and operated by the franchisor, the initial franchisee investment and how much financing the franchisor can offer? This paper examines what partnering strategies contribute to the expansion of a franchise system. We analyzed the evolution of franchise systems from their inception using data on 1,292 business format franchise systems from 152 industries that were established in theUnited Statesbetween 1979 and 1996. Our results show that franchisors that open more outlets typically: Lower royalty rates as their systems age; have low up-front franchise fees and raise them over time; own a small proportion of outlets and lower that percentage over time; keep franchisees’ initial investment low; and, finally, finance their franchisees. These strategic decisions increase the value of the franchise brands, reduce franchisee risk, and increase the attraction of new franchisees, thus explaining the growth to a larger franchise system. We also find that franchise system growth is negatively related to the proportion of company-owned outlets, which highlights the merits of minimizing ownership to achieve widespread growth. Hence, franchisors who want to grow larger may be able to use their financial resources to keep their franchisees’ initial investment in the outlets low and to finance franchisees, both of which can drive the expansion of a franchise system.