Why and When Firms Franchise

Abstract

Franchising is a business model decision. The franchise model provides leveraged growth and entrepreneurial flexibility when the firm’s cash flow is uncertain. The theory of franchising provides firm-specific and location-specific conditions that explain when and why some firms franchise and others do not. The firm-specific conditions suggest that when the cash flow appropriability is more uncertain, the firm may choose to franchise the outlets; thus, the rate of franchising will be higher. The location-specific conditions suggest that unless the demand variability is low and the demand externality high, the franchisor will choose to franchise the outlets in the region, not own them. Franchisees possess high-powered entrepreneurial incentives that provide an entrepreneurial surplus. The franchising mechanism provides entrepreneurial leverage to enhance and sustain the firm’s competitive position when the cash flow appropriability is more uncertain and the firm’s economic rent is subject to competitive dissipation.