MAY 2006
Franchisors Manage to Maintain Brand Value
Illustration by Stuart Bradford
by Theresa Johnston
Companies that invest heavily in advertising to build their brand’s reputation will protect that image by owning a higher percentage of their own franchise outlets, say researchers. Moreover, most firms decide within the first decade what proportion of franchise outlets for a given brand they will own and stick to that number.
“What’s really clear from this research is that franchising firms tend to choose a targeted percentage of outlets that they want to operate themselves, and they stick with that,” said Kathryn Shaw, the Ernest C. Arbuckle Professor of Economics. Percentage of company ownership drops dramatically for franchises in the first eight years, but then tends to level out.
Shaw and co-researcher Francine Lafontaine of the University of Michigan examined more than 1,000 franchisors between 1980 and 1997 and found what Shaw called a “very, very strong relationship” between advertising expenditures and company ownership.
Across industries, about 15 percent of franchise outlets are company owned. But this varies considerably by industry and by individual firms. Specifically, franchisors with aggressively advertised brands—such as Hertz or Pizza Hut—tend to have much higher rates of company ownership. For example, among car rental agencies, Hertz is 66 percent company owned, compared with Dollar at 2 percent. Pizza Hut is 50 percent company owned, compared with Shakey’s Pizza Restaurant at 7 percent.
Kathryn Shaw
“If your brand value is very high, you’ve put a lot of media expenditures into trade name value, and you therefore want more company-owned outlets so you can better control quality,” said Shaw.
By owning their own franchise outlets, firms are guarding against free riders—outlets not owned by the company that might be tempted to sacrifice quality and rely on the strong brand to attract customers. For example, the franchise owner of a fast-food outlet located on a highway—which traditionally would have very little repeat business—has very little incentive to pay attention to serving customers who are unlikely ever to visit again. In contrast, a franchisee located in a small town would be more inclined to provide higher quality of service to generate repeat business, said Shaw.
At issue is the art of correctly aligning incentives to maximize shareholder value.
One franchisee who chose to ignore franchisor policies about product quality and cleanliness was Raymond Dayan, the owner of the French franchise license for McDonald’s. By 1982, Dayan had 12 restaurants in Paris but blatantly ignored the company’s strict specifications on food products, including the quantity and quality of ingredients. In addition, he held food so long and served it so cold that McDonald’s managers sent to inspect the stores found it difficult to eat. Although these shortcuts allowed Dayan to save on costs, the reputation of the chain suffered. Ultimately, McDonald’s, with the court’s support, terminated his license.
— Alice LaPlante
“Targeting Managerial Control: Evidence from Franchising,” Francine Lafontaine and Kathryn L. Shaw, The RAND Journal of Economics, Spring 2005.
