Adoption, Transfers and Incentives in a Franchise Network with Positive Externalities
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AbstractFranchising arrangements that allow franchisees with exclusive territories to own their customers are studied. This permits franchisees to benefit from positive externalities in the franchise network through inter-franchise transfers based on the purchases by their customers at other franchises on the network. Using the structure of a single franchisor and many franchisees, its is shown that interfranchise transfers between franchisees and incentives for franchisee investment in the expansion of their customer base are critical both to the size and to the benefits derived from the franchise network. Specifically, it is found that when individual franchisees make investments in marketing effort to increase their customer base, the franchisor's setting of the inter-franchise transfer trades off the positive effects on network size with the negative effects of removing franchisee incentive for investment. This result is due to the fact that inter-franchise transfers encourage investment, use of the royalty and inter-franchise transfer directly dissipates franchisee profits, and indirectly dissipates franchisee profits through less than universal adoption, thereby causing franchisees to under invest. As compared to traditional franchise systems, however, use of the inter-franchise transfer results in franchises making greater investments than they otherwise would.
*INFORMS: unless published under the open access option, the publisher will provide a specific copy of the paper that can be posted to a web page https://www.informs.org/Find-Research-Publications/INFORMS-Journals/Rights-Permissions#work. Article deposited according to Publisher's Policy 05/25/2015