Factors Influencing the Adoption of Plural Forms of Distribution in Vertically Contracted Marketing Networks

 

Abstract

The body of franchising research that deals with the choice of organisational form examines the motivational incentives that influence entrepreneurs to choose franchising expansion rather than expansion through company owned units.  Although, many past conceptual, exploratory and explanatory studies advocate the benefits of hybrid organisational arrangements, in practice, few firms pursue a pure franchising strategy.  While this may be partially explained by studies linking plural or chain organisations (simultaneous use of franchised and company owned units) with the promotion of standardisation and system-wide adaptability to competition, it contrasts with recent research showing that franchising strategies are an optimal method of maximising system performance.  Given this apparent disparity in the literature, together with what is observed in practice, further investigation into the reasons why franchisors encourage the growth of plural governance structures is warranted.  This research aims to build theory through the presentation of a set of general propositions explaining the choice of plural governance structures as a function of local market innovation, organisational learning and system-level adaptation, the maintenance of operational standards through mutual benchmarking and the provision of experienced prospective franchisees, necessary for future system growth. Overall, the qualitative findings drawn from a sample of franchisors within the retail and services industries clarified and confirmed the appropriateness of the general propositions in preparation for quantitative testing in the near future.

KEYWORDS:  Marketing, franchising, plural governance, mutual learning.

Introduction

Much of the literature examining organisational choice supports the view that franchising represents an efficient method for firms to acquire capital necessary to achieve economies of scale associated with large-scale operations, whilst minimising monitoring expenses through improving the alignment of their incentives structures (for example, Caves & Murphy 1976; Dant 1995; Jambulingam & Nevin 1999; Rubin 1978).  However, in practice few firms pursue a pure franchising strategy (Sorenson 1999).  Instead, franchise networks are most often characterised by plural forms of distribution (Bradach 1997).  This is anathema to previous research that generally endorses the use of one governance structure as a method of maximising system performance (for example, Brickley & Dark 1987; Norton 1988; Shane 1996a).  A possible explanation of plural governance structures may be that they balance the competing demands of system standardisation and system-wide adaptation to competition (Bradach 1997).  In particular, franchisees may possess the operational freedom necessary to gather new information and exploit opportunities within their local markets (Stanworth 1995), while company owned units may provide the franchisor with a means by which to benchmark best practices and maintain consistency across other units within the system (Bradach 1994).  However, recent empirical research suggests that systems pursuing a franchising strategy are more likely to have higher growth rates than systems maintaining a mix of franchised and company-owned units (Sorenson & Sorenson 2000).  Thus, there does not appear to be consensus in the literature.  In addition, no examinations of the factors driving a franchisor’s choice of governance structure has been examined within the Australian franchising sector.

 

This paper examines the relatively unexplored issues surrounding the antecedents to the adoption of plural forms of franchise organisation.  Although plural distribution arrangements are prevalent within many franchising systems within the Australian franchising sector (Frazer and Weaven 2002), they has received little attention in the Australian franchising or management literatures.  In the next section of this paper, the research problem is defined within the context of existing literature.  Then, the methodology used to conduct the study and the results are described.  Finally, implications for theory and practice are considered.

 

Literature review

Advantages of franchising

Two distinct and competing theories used to explain the success of franchising as an organisational form are resource constraints and agency variants.  Resource constraints or resource-scarcity theories endorse the choice of franchising as a method of extending capital, labour and managerial limitations on future growth (Combs & Castrogiovanni 1994; Norton 1988; Oxenfeldt & Kelly 1968).  An implied tenet of this theory is that a firm’s commitment to franchising diminishes as it matures and no longer needs to extend its resources (Oxenfeldt & Kelly 1968). As a result, many systems would be characterised by a plural form of distribution (Bradach 1997).  However, the capital redirection hypothesis has received limited empirical support (Dant, Paswan & Stanworth 1996; Rubin 1978).  Although the resource-constraints theory has received recent support in the literature (Combs & Ketchen 1999), majority support appears to rest with the incentives rationale for franchising adoption.

 

Agency theory views franchising as a method of aligning the incentives of principals (franchisors) and agents (franchisees and/or employee managers) thus minimising costs associated with the management of geographically dispersed units (Dant 1995; Shane 1996b).  Franchisees, as semi-independent owner operators of a system unit, are assumed to be more highly motivated to follow decisions and policies necessary to realise the franchisor’s goals than employee managers (Achrol 1996; Wattel 1968).  That is, franchising maximises the joint utility of the principal and agent, because franchisee remuneration is tied to unit performance (Bergen, Dutta & Walker 1992; Shane 1996a).  The alternative expansion through company ownership does not offer the same degree of incentives alignment in the agency relationship.  This is due to an employee’s propensity to misrepresent his or her skills and effort levels (Alchian & Demetz 1972; Kaufmann & Dant 1996). 

 

Recent research suggests that firms may encourage franchising as it fosters the generation of new ideas, local market innovation and adaptation to changes in the marketplace (Darr, Argote & Epple 1005; Lashley & Morrison 2001).  Although franchisees exist in a state of ‘controlled independence’ (Felstead 1991, p.39), they often have the operational freedom to experiment with new ideas, the results of which may be disseminated throughout the entire network (Baum & Ingram 1997; Stanworth & Curran 1999). 

 

Advantages of company ownership

Company owned units are typically managed by salaried employees who have less incentive to innovate and adapt to changes in local market conditions (Weaven 2004).  However, these units are beneficial in promoting consistency across units within the chain.  Franchisors use hierarchical controls to ensure quality control, image uniformity and cost minimisation (Kaufmann & Eroglu 1998).  Through controlling product quality and service delivery, franchisors are able to maintain and reinforce brand value, ensuring that there is no service variation between units (Jain 1989).  In addition, unit consistency makes it easier for franchisors to attribute differences in unit-level performance to moral hazard employee effects, thus minimising agency-related expenses (Kaufmann & Eroglu 1999).  Also, recent research suggests that it is easier to disseminate accumulated knowledge throughout company owned units as they are directly controlled by the principal franchisor (Sorenson & Sorenson 2000).

 

Advantages of the plural form

Early research assumed that franchising was a transitional organisational arrangement and that firms in a growth stage of their development would be inclined to convert franchised units to company ownership, providing that they had sufficient access to needed resources (Oxenfeldt & Kelly 1968).   However, this hypothesis has received varying levels of support in the literature (for example, Caves & Murphy 1976; Hunt 1973; Thomas, O’Hara & Musgrave 1990).  Research suggests that plural or chain organisations are successful in managing the competing demands of local market innovation and adaptation, and the maintenance of system-wide standards (Bradach 1997).  However, recent empirical research concludes that a pure franchising strategy is preferable to a mix of company-owned and franchised units (Sorenson & Sorenson 2000).  Thus, there does not appear to be agreement within the literature.  In addition, little is known about factors determining the adoption of a plural governance strategy in Australia.  Thus this research addresses gaps in the literature by examining the following research question.

What are the reasons that justify the choice of a plural governance structure in vertically contracted marketing networks?

 

In the next section, the antecedents to the adoption of plural governance structures are examined.

 

 

Antecedents to the choice of the plural form in franchise Organisations

 

Local market innovation, organisational learning and system-level adaptation

As stated above, franchisors aim to manage the tension between system standardisation and control while encouraging local market flexibility, creativity and adaptation (Stanworth, et al 1996).  Research suggests that franchisees are able to engage in exploratory or experimental learning that results in the acquisition of new knowledge that ‘initiate[s] or renew[s] the fit between organisations and the rigours of markets’ (Stanworth & Curran 1999, p. 335).  However, a pure franchising strategy may result in a decentralised governance structure that may impede the dissemination of new information to other units within the system, thus minimising the potential for system-wide adaptation to competition.   Hence, franchisors may view plural forms of distribution as necessary to encourage both experimentation and dissemination of new knowledge throughout members of the network.  Thus it is posited that:

P1:  Plural forms of distribution are a more efficient method of encouraging local market innovation, organisational learning and resultant system wide adaptation to competition, than non-plural forms.

 

Maintenance of operational standards through mutual benchmarking

Research suggests that franchisees have sufficient levels of independence that allow them to engage in exploratory learning (Ozanne & Hunt 1971; Walker 1971) while, company-owned units are proficient in optimising existing routines and processes (Sorenson & Sorenson 2000).  Previous research indicates that franchisors rarely rely upon contractual provisions to coerce franchisee cooperation (Stanworth 1995).  Instead, they are likely to use company-owned store performance as a benchmark for other units operating within the franchise system (Bradach 1998).  This should allow an informal method of ensuring unit-level compliance among member franchisees.  In addition, chain managers may use franchisee performance output to set appropriate benchmarks for company-owned units (Sorenson & Sorenson 2000).  Thus, franchisors may perceive plural organisational arrangements as a means of maximising their control over unit performance and sales growth.  Thus, it is postulated that:

P2:  Plural forms of distribution are more efficient methods of ensuring unit level compliance through mutual learning and benchmarking, than non-plural forms.

Provision of experienced prospective franchisees

In a sectoral level study of franchising in Australia franchisors nominated that the limited availability of potential franchisees, represented the greatest threat to future system growth (Frazer & Weaven 2002).  Apart from encouraging existing franchisees to expand sequentially, there is some anecdotal evidence that some franchisors encourage company employees to purchase franchise territories (Meij 2002).  Company employees are familiar with the system and are less likely to engage in behaviours that will damage the system brand (Arrow 1985).  Thus it is posited that:

P3: Plural forms of distribution are beneficial in providing a pool of potential franchisees that are familiar with system operating procedures and standards.

 

Methodology

Recent research in the franchising discipline recommends the use of qualitative methods when little is known about the area under investigation (Kaufmann 1996).  To this end, this exploratory research incorporated a series of convergent interviews, which were held with an heterogenous sample of franchisors from the retail and services sectors in Australia (denoted by letters ranging from ‘A’ to ‘G’ to protect the anonymity of respondents).  This process was used to gain an in-depth understanding of the issues and aid in theoretical development (Eisenhardt 1989; Parke 1993). 

 

Convergent interviewing is a technique that collects, analyses, and interprets information through the use of a limited number of interviews with selected experts in the field.  This process involves a series of in-depth interviews that allows questions to be refined and developed after each interview with the aim of converging issues in a particular area.  That is, this research encourages a ‘series of successive approximations’ (Dick 1990, p.3) leading to a consensus through the development and use of probe questions about important information where interviewee agreement or disagreement is tested. 

 

Respondents were initially asked to talk about their '…experiences with plural franchising systems (that is, franchise systems incorporating both company owned and independent franchise units)'.  In keeping with expert recommendation (for example, Dick 1990), probe questions were only used throughout the interviews to test areas of agreement or clarify areas of disagreement.

 

Table 1 presents demographic data from the seven franchisor interviewees.  Company ownership ranged from one to 33 units, or from one to 41 percent of total unit holdings. 

Table 1 Demographic statistics on franchise systems in the convergent interview sample

Franchisor

Industry type

Sales 2002-2003 $

Total units

Company units

Franchise units

Average unit sales volume $

A

Personal and other services

3 230 000

85

2

83

57 600

B

Retail trade food

78 938 000

73

30

43

1 081 342

C

Retail - non food

24 000 000

100

3

97

240 000

D

Personal services

1 176 000

12

7

5

98 000

E

Retail trade-non food

1 326 000

13

1

12

228 000

F

Retail trade – food

117,000,000

174

2

172

672 414

G

Retail trade - food

130 578 000

310

33

277

421 219

 

Results

All propositions were supported, albeit to differing extents.  Most franchisor respondents agreed that a plural governance structure was necessary to aid in the creation and dissemination of new knowledge throughout the chain.  For instance, respondent F stated that:

            'We develop and test new products through our company owned operations.  These couple            of stores are important in testing and adopting new methods of service.  Franchisees can    see and copy these processes in their store...its more efficient because we've already been    through the problems and we can show them [franchisees] exactly how things should        work.

 

Five respondents nominated that franchisees were entrepreneurs who generated innovative products and processes at the local market level, which was necessary in maintaining existing brand equity and market share.  For example, respondent A stated that:

            'On the whole our franchisees have a lot of flexibility within their territory…not only in     local advertising, but also in finding cheaper and quicker methods of service delivery.            Some of our best ideas, like our new water diagnostic system, came directly from one of our franchisees who was friendly with a manufacturer in Taiwan'.

 

Nearly all of the franchisors self-identified the linkage between local market innovation and system-wide adaptation to competition.  In particular, company ownership was viewed as important in influencing franchisees to maintain uniformity and adopt system-wide adaptations, which appears consistent with previous overseas findings (Bradach 1997).  For instance respondent C said that he maintained three company owned units to promote

            '…best practice in micro merchandising and visual merchandising in franchisee stores',     while respondent B suggested that company ownership was necessary in '…ensuring     system compliance…and new staff training initiatives'. 

 

Thus proposition 1 received strong support. 

 

The second proposition posited that plural organisational arrangements encouraged unit level compliance through mutual benchmarking between member units.  This proposition received moderate support.  More than half of the respondents agreed that their decision to keep company units was predicated on a need to refine operating procedures, pricing and test the introduction of new products or services.  In particular, these interviewees believed that franchisees were more willing to accept re-branding and signage changes, and new product introductions once these changes had been made within company flagship stores.  For example, respondent C stated:

            'You have to bring franchisees to the company store and show them things in operation.    Unless they see how and why things are set-up…they will be unlikely to make necessary     changes for the good of the company brand'. 

 

In addition, four franchisors self-identified the importance of benchmarking franchisee and company-owned unit performance so as to maximise unit-level efficiencies. For example, respondent F said that

            'They [franchisees] compare the productivity of their unit with our [company owned]       units.  We [franchisor] use this to leverage our control over their performance and    sometimes they use this to improve the productivity of company stores'.

 

Overall, proposition 3 received strong support.  Nearly all franchisors agreed that it was difficult to attract suitable franchisee candidates, which appears in consistent with previous findings (Frazer & Weaven 2002).  Most interviewees agreed that they preferred to encourage existing employees to acquire units within the system once they had a proven track record of performance in managing company owned units.  For example, respondent A stated that:

            'We offer employees…the opportunity of owning their own franchise because they have a working knowledge of the industry and the system.  There's less risk associated with            converting over employees'.

 

While most respondents offered employee managers the opportunity to purchase a franchise within the system, they were generally required to undertake additional training, and usually only granted territories in which they had prior operational experience.

 

Conclusion and recommendations

Generally, the qualitative findings of this research confirmed the proposed theoretical relationships between identified constructs.  However, this research was exploratory and requires future empirical verification.  In particular, this study will form the basis for a large-scale empirical analysis of plural systems of governance in franchising systems in the near future. 

 

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