Franchising versus corporate ownership: The effect on price dispersion

Abstract

This paper uses data on the prices charged at fast-food restaurants in the metropolitan Pittsburgh and Detroit areas to assess the effect of franchising on price dispersion within chains in fairly narrowly defined geographical areas. A review of reasons why firms may face more price dispersion under franchising guides the empirical analyses. Results indicate that 1) franchisors do not aim for fully uniform prices even on the corporate side of their chains, 2) the degree of price dispersion is highest for firms with both franchised and company-owned units, as predicted by models implying a systematic price differential between units operated under these different contracting mechanisms, and 3) price dispersion for fully franchised chains is greater than for fully corporate chains. These last two results, combined with evidence from court cases that franchisors sometimes try to control franchisee prices directly, suggest that franchisors indeed lose some amount of control over prices charged to customers when they use franchising as opposed to corporate ownership. Finally, I find a positive effect of the royalty rate on price dispersion. This suggests that double marginalization is behind at least some of the higher prices found in franchised units in the existing literature.