BUSI 423 Week 3 Discussion Board Forum 2 Thread Example

Discussion Board Forum 2 Thread: Why Companies Choose to Franchise

BUSI 423 Franchising, Discussion Board Forum 2 Thread

Thread by [Student Name]

The forum prompt and the restaurant chain are composites; the Franchise Bible and the research cited are real, and the structure follows Liberty's public course guide for BUSI 423.

The first two weeks looked at franchising from the buyer's side. This week's question turns it around: why would a successful company let other people own its units and keep most of the profits? Grossman and Katz (2017) describe franchising as a way to expand a proven concept faster than a company could on its own. Research offers two more specific explanations, and I think the best answer combines them.

The first is agency theory. A company that owns a unit must hire a manager, and a manager who earns a salary has less reason than an owner to control waste, train staff carefully or work long hours. Supervising that manager costs money, and it costs more the farther the unit is from headquarters. A franchisee, by contrast, keeps the unit's profit after royalties, so the incentive to run it well is built in. Brickley and Dark (1987) found evidence consistent with this view: in their study of franchise chains, units located farther from monitoring headquarters were more likely to be franchised than units nearby.

The second explanation is capital scarcity. A young chain may simply lack the money to open units itself, so it uses franchisees' capital to grow. Some scholars dismissed this explanation, arguing that a sound company could raise money in other ways. Combs and Ketchen (1999), however, studied restaurant chains and found that resource scarcity helped explain franchising beyond what agency theory alone predicted. Agency theory explains which units a chain franchises; capital scarcity helps explain how many it franchises, especially when the chain is young.

Consider a composite sandwich chain with thirty company-owned stores in one state, planning twenty new units. Its stores near headquarters are easy to supervise and profitable, so it has good reason to keep them. New markets three states away would be expensive to monitor, and opening twenty units at once would require more capital than the company can borrow. Franchising the distant units solves both problems. Many chains reach exactly this kind of mixed system, owning some units and franchising others, in part because company stores let the franchisor test new products and keep operating knowledge in-house.

The two explanations also predict how a chain's mix should change over time. If capital scarcity were the only reason, a chain would buy back its franchised units once it could afford them. If agency costs matter, it would keep franchising distant units even when rich, because hired managers there would still be hard to supervise. Many mature chains continue to franchise a large share of their units long after money stops being scarce, which suggests that incentives, not just capital, keep franchising attractive.

This matters for the prospective franchisee as well. A franchisor that franchises only to raise capital may lose interest in its franchisees once it is large enough to finance its own growth, while one that franchises because owner-operators run units better has a lasting reason to support them. Asking a franchisor why it franchises, and watching how its mix of company and franchised units changes over time, tells a buyer a great deal about the relationship to expect.

References

Brickley, J. A., & Dark, F. H. (1987). The choice of organizational form: The case of franchising. Journal of Financial Economics, 18(2), 401-420. https://doi.org/10.1016/0304-405X(87)90046-8

Combs, J. G., & Ketchen, D. J., Jr. (1999). Can capital scarcity help agency theory explain franchising? Revisiting the capital scarcity hypothesis. Academy of Management Journal, 42(2), 196-207. https://doi.org/10.2307/257092

Grossman, R., & Katz, M. J. (2017). Franchise bible: How to buy a franchise or franchise your own business (8th ed.). Entrepreneur Press.