Dual Distribution and the Penrose Effect

Abstract

This paper develops an approach to analyzing an equilibrium in markets where firms can choose dual distribution to sell their products. Dual distribution involves a firm selling its product both through company-owned stores and through independently owned franchises. For a monopoly firm, the use of company-owned stores is assumed to play a number of roles. When the total number of markets is variable, an increase in company-owned stores can signal the quality of the product to potential franchisees, increasing the total number of markets served by the monopolist. Additional company-owned stores may also increase the royalty rate received by the franchisor, as well as increase demand in the local markets. There are limits, however, to the benefits of company ownership, called the “Penrose Effect.” For an equilibrium to exist, the monopoly firm must have no incentive to alter the the number of company-owned stores vis-à-vis franchised stores. The approach taken here yields a number of testable implications, which can form the basis of empirical tests of dual distribution.