The objective of this study is to examine two questions central to research on franchising. First, is there a systematic performance differential between franchise outlets and similar independent businesses? Second, if as expected, franchise outlets can be shown to outperform independent businesses, is that differential performance the result of franchises' economies of scale?
A review of the literature reveals a scarcity of empirical studies on the relative performance of franchise outlets and independent businesses. The notable exception is a study, by Bracker and Pearson (1986) that found no performance differential between franchise outlets and independent businesses in the dry cleaning industry. The results of the Bracker and Pearson study appear to be contra-intuitive. The evidence suggests that franchising, which constitutes approximately 40 percent of all retail trade, is supplanting independent businesses in the economy of the United States (Trutko, Trutko, and Kostecka 1993; Hoy 1994; Tikoo 1996). Employing Darwinian logic (see, for example, Hannan and Freeman 1977), it appears reasonable to assume that the relative decline in independent businesses is the result of some performance advantage held by franchise outlets. Given the paucity of evidence in opposition to the strength of franchising in the economy, the question begs revisiting: Do franchise outlets outperform independent businesses?
One frequent explanation for the success of the franchise form of organization is the franchiser's ability to attain sufficient size to achieve economies of scale (Stephenson and House 1971; Schmalensee 1978; Eaton and Lipsey 1979; Hadfield 1991; Carney and Gedajlovic 1991). Economies of scale, or decreasing unit cost as a function of increasing unit volume, appear to be a likely source of differential performance favoring franchise outlets over independent businesses. No study has investigated the role of economies of scale in franchise performance. However, the prevalence of scale as an explanation for franchising suggests that an empirical test of the effect of scale on franchise performance is warranted.
The definition of franchising employed in this study is intended to be non-specific with regard to type of franchise or franchiser motivation (Castrogiovanni, Bennett, and Combs 1995). Franchising is considered to be a contractual arrangement in which a franchisee owns and operates a retail business employing the franchiser's brand name. Under this agreement, the franchisee commonly purchases various inputs and goods from the franchiser, often for resale. In turn, the franchiser charges fees and royalties for the use of the brand name and typically provides such inputs as training and advertising. Further, the contractual arrangement grants the franchiser the fight to set and enforce performance standards on the franchisee (Milgrom and Roberts 1992).
There are four popular explanations for the growth of the franchise form of organization. These explanations include the raising of scarce capital (Norton 1988a); the monitoring of managerial incentives (Norton 1988b); optimal market coverage (Julian and Castrogiovanni 1995); and the attainment of economies of scale (Carney and Gedajlovic 1991). These explanations for the success of the franchise form of organization are not in conflict. Rather they are intertwined and complementary aspects of the same phenomena. The ability to raise scarce capital through the sale of the franchise contract is a precursor to external growth. The sale of the franchise contract creates the franchisee as manager. The vested interest of the franchisee as owner-manager provides the economic incentive to manage in the best interests of the franchise. This alignment of franchiser and franchisee interests is the means through which superior internal growth rates are attained. In turn, optimal market coverage is the result of superior external and internal growth rates. …