Improving Channel Coordination through Franchising

In this paper, we explore the role of franchising arrangements in improving the coordination between channel members. In particular we focus on two elements of the franchising contract, namely, the royalty structure and the monitoring technology. We begin with a simply analysis where a manufacturer distributes its product through a retailer and the retail demand is affected by the retail price and the service provided by the retailer. In this context we show that neither royalty payments nor monitoring are needed for full coordination. We then extend the model to allow for free riding by frnachises and show still unnecessary to coordinate the activities of the franchisor and franchisees. Finally, we show that in environments where factors affecting retail sales are controlled by both the franchisor and the franchisee, royalty payments provide the necessary incentives for the franchisor while monitoring systems are sued to ensure that franchises also behave in the best interest of the channel. In this way our general results are found to be consistent with those in Norton (1988), who concludes from an empirical analysis of three industries that the incidence of franchising is positively related to principal-agent incentives and the brand name effect. We also study the interactive affects of these decisions and hypothesize conditions under which one is more likely to observe large royalties or more intense monitoring by the franchisor.