Academic journal article Journal of Small Business Management

Entrepreneurial Failure: The Case of Franchisees

Academic journal article Journal of Small Business Management

Entrepreneurial Failure: The Case of Franchisees

Article excerpt

The causes of failure are central to entrepreneurship research. This study extends agency and resource-based logic to explain how established franchisors affect franchisee failure. Analysis of 88 restaurant chains shows that franchisors reduce franchisee failure through contract design and by building strategic resources. Thus, franchisors' resource management and contractual policies play a key role in franchisees' survival.


Understanding the causes of business owners' success and failure is a cornerstone of entrepreneurship research (for example, Cooper and Gimeno 1992). Researchers have investigated alternative routes to business ownership, such as de novo startup and acquisition (for example, Westhead and Wright 1998; Cooper and Dunkelberg 1986), but one route to business ownership that has received less research attention is buying a franchise. In franchising, a local entrepreneur-franchisee purchases from a firm (the franchisor) the right to use its brand name and operating system. Franchising is an important vehicle for entrepreneurship; there are approximately 700,000 entrepreneur-franchisees worldwide (Hoy, Stanworth, and Purdy 2000; see also Michael 2003). Franchising is also important to the economy. Taken together, product (for example, gas stations and soda) and business-format (for example, restaurants and copy shops) franchise chains account for over 40 percent of retail sales in the United States (International Franchise Association 2002).

Perhaps because of the importance of franchising in the economy, franchisors have attracted notable research attention (for example, Castrogiovanni and Justis 2002; Combs and Ketchen 1999a). Yet franchisees are an important ingredient in their franchisor's success (Combs and Ketchen 1999a; Shane 1996). Within established franchised chains, franchisees absorb much of the risk of expansion (Minkler 1992) and furnish many of the entrepreneurial innovations franchisors need to adapt to changing market conditions (Kaufmann and Eroglu 1999).

Research on the consequences of franchising for franchisees has been rare (Combs, Michael, and Castrogiovanni 2004). A few important efforts have contrasted survival rates for franchisees with independent businesses (Bates 1998), or focused on why individuals select franchising over independent entrepreneurship (Peterson and Dant 1990) and corporate employment (Kaufmann 1999), but, despite their importance to the success of franchising, there has been almost no effort to understand what factors contribute to franchisee performance. Given that franchisees are an essential ingredient in successful franchise chains and that franchising is so important in today's economy, the lack of understanding about factors affecting franchisee performance represents an important gap in the literature. Knowledge about factors affecting franchisee performance could help franchisors adopt more supportive policies and also help potential franchisees select among competing franchise opportunities.

In this study, we extend agency and resource-based logic to explain how established franchisors affect franchisee failure. From the perspective of agency theory, franchisors grow through franchising rather than company ownership because franchising reduces the agency costs of identifying and motivating qualified outlet managers (Shane 1996; Lafontaine 1992). Franchisors develop policies for managing franchisees in order to further reduce agency costs (Shane 1998). Ideally, some of these policies have benefits for franchisees, such as reducing failure; others reflect a tradeoff between franchisors' efforts to maximize profits while giving franchisees sufficient incentive to stay engaged. Building upon resource-based theory (Barney 1991), we propose that franchisors' investments in strategic resources reduce franchisee failure.

Theory and Hypotheses

Franchising is common among retail and service businesses where production and consumption occur simultaneously (Caves and Murphy 1976). …

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