What Are the Implications of Managing the Franchise Side of a Chain Organization - Coursework Example

What are the implications of managing the franchise side of a chain organization? The modern globalization has led to expansion and management of thebusinesses in the new model of franchise chain organization. There is marked change in the wide network of franchising, worldwide expansion of businesses have taken place in United States. “During the 1990’s in the United states franchising became the most popular method of expanding commercial retail stores quickly with limited capital risk”(Bradach 1998) (Montagu, 2001). Franchising is characterized by locally owned outlets which deliver services according to a standardized model. Franchising has been recognized as a successful business model leading to accelerated expansion of the new store with local control of the franchise owners assuring lesser financial risks with rewards associated with local ownership which requires lower level of supervision and economies of scale. “The most widely accepted definition of a franchise refers to a contractual relationship between a franchisee (usually taking form of a small business) and a franchisor (usually a larger business) in which the former agrees to produce or market a product or service in accordance with the blueprint devised by the franchisor”(Stanworth et al. 1995) Management Structures: Franchising is primarily defined in terms of the legal business agreement between two partners, the franchisor and the franchisee. The franchisor, who has previously established a market-tested business package of products or services, enters into a continuing contractual relationship with a number of franchisees, typically small business owners, who must operate their businesses according to the franchisors specified format (Curran and Stanworth, 1983). The franchisor provides a proven method of operation, support, and advice on the setting up of the new franchisees, and also guarantees continuing support to the franchisee. In return, the franchisee pays a lump sum entrant fee and other charges for regular services (that is, royalty on sales, advertising fees, marketing levy) (Fulop and Forward, 1997). Franchising has been adopted a growth strategy for many firms in business with the advent of globalization. It is a different from other form of business. A franchise is a hybrid form of business characterized by complex contractual arrangements (Eisenhardt, 1989). Though many franchises operate between hybrid and the hierarchy (centralized or organizational) firm and incorporate both the franchised units as well as the company owned outlets (Brickley and Dark, 1987) In a hybrid operation, the franchisor monitors and controls the franchisee within the limits specified in the franchise agreement. In contrast, the franchisor operates company-owned outlets through his or her authority over a centralized bureaucracy or as a hierarchical organization. The resource scarcity theory and the agency theory explained the theory of franchising around the hybrid and hierarchy forms of franchise organization. Support for the agency theory as a rationale behind franchising was substantial. Research found that the franchisee motivation as an agent was perceived to be the most important strategy of the franchise firms (Oxenfelt and Kelly, 1968-69) while the capital advantage of franchising, which was proposed by the resource scarcity theory, had a low acknowledgement by the franchisors (Lillis, Narayana and Gilman, 1976). The franchisees high motivation was probably derived from the nature of the franchise relationship. Franchising involves an exchange relationship between franchisor and franchisee which was sometimes described as a partnership or strategic alliance (Stanworth and Kaufmann, 1996). The franchisee is simply managing an outlet featuring the corporate strategy of the franchisor and to a certain extent possesses a degree of autonomy in managing the outlet (Dant and Gundlach, 1998). Unlike the company-owned manager, the franchisee enjoys more dependency in running the day-to-day business Franchisee and Franchisor: The franchisor and the franchisee are bound by the contractual arrangement that is intended to align the goals and incentive of both parties (Brickley and Dark, 1987). The goal is to achieve congruence between the franchisor and the franchisee. The goal congruence refers to an agreement as related the business goals between the franchisor and the franchisee. In the principal and agency relationship, it is anticipated that franchise goal congruence would exist as the franchisor and the franchisee possess the common intention of successful franchise operation. With agency efficiency, the goal congruence between the franchisor and the franchisee should be higher than the goal congruence between the employer and the employee. Franchise goal congruence resulted from high motivation and a willingness of the franchisee to take part in a franchise arrangement. Hybrid and Heirarchy: The level of goal congruence between the hybrid and the hierarchy forms of franchise organization differs, with the franchisor and the franchisee displaying a higher level of goal congruence when compared to the franchisor and the company-owned manager. The agency theory suggested that franchising was favourably employed as a means to reduce high employee monitoring costs (Brickley and Dark, 1987). Research has shown that the franchise firms that operated both company owned and franchised outlets had a higher use of company-owned outlets in metropolitan areas and in locations with low repeat business, where the costs of monitoring the franchisee were greater than monitoring the company-owned employee (Brickley and Dark, 1987; Lafontaine, 1992; Norton, 1988b). Therefore, it is argued that agency efficiency will take place, when there is the difference in a level of control used between the hybrid and the hierarchy forms of franchise arrangement. The franchisor should adopt a higher level of control or use a higher level of centralization for those outlets managed by the company-owned manager. In contrast, with the agency efficiency, the lower level of control should be found in the franchised outlets. The franchisees are claimed to have better local market knowledge because they are either a local owner or have an accumulation of local experience through employees (Lal, 1990). The combination of both sources makes the franchise business arrangement more competitive than other forms of business. Better local information or local knowledge is mainly possessed by the agents, who are actively involved in daily activities within the local vicinity, but not the principal. Information asymmetry is defined as information about local knowledge possessed by the agents (the franchisee and the company-owned manager) but not the principal (franchisor) (Jaworski and MacInnis, 1989). This information can be used to influence competitive advantage of the franchise firms in which the franchisor provides a large scale advantage and the franchisee and perhaps the company-owned manager contribute the local knowledge to the niche market advantage. Agency Theory: The agency theory postulated that the franchisee was recruited in order to promote greater agent efficiency (Shane, 1998) and the franchisees incentives which act as a behavioral control mechanism would promote franchisee motivation to act for the franchise firms best interest (Shane, 1998). Therefore, it is likely that the level of local information which the franchisee shares with the franchisor should be higher than the company-owned manager counterpart. The agency theory of franchising is that monitoring costs for the central corporation to assure quality will be high compared to the localized benefits. Sales occur through the local outlets, and therefore depend to a great extent on local effort in addition to price and advertising. Because local effort is difficult to monitor in the context of service delivery it is often more efficient to localize incentives and align managers’ goals with organizational goals. Franchising is one of the methods of accomplishing this. (Montagu, 2001) Most of franchises succeed or fail depending on the merit of the local operation management and partly upon the appropriateness of their brand to the market they serve. As franchises grow, it becomes increasingly difficult to permit deviation from the standardized characteristics of outlets as monitoring variable criterion is expensive and because a diffuse brand will be less valuable because its association in the minds of the consumers will be muddied. This trend towards strict standardization is particularly true in the sectors where service is critical to the brand such as in hospitality and food services. Standardization and monitoring are important because of an inherent cost in franchising which stems from the incentive for franchises to become free riders on the brand. While brand equity from advertising or reputation helps the franchise as a whole, the individual franchisor has an incentive to provide low cost, low quality service. There is as strong reason for the franchisor to allow brand positioning and advertising to reach beyond the core franchised services as it will increase the benefits for member franchisees. The greater the benefits accrued to the franchisees by the program, the faster the franchise will be to increase the outlets and the more leverage the program will have to assure compliance with quality standards. Greater benefits will also allow a franchise organization to select the best providers as members. The criteria for incentives to providers are that they be sufficient to assure compliance with the practice standards and attract new franchisees (Montagu, 2001). There are number of reasons why standardization of services is critical to franchises. The clarity of a brand is a reflection of its immediate association for the consumers. Inconsistency in advertising or in services can weaken the brand by clouding associations. It is very important that within the branded set of services the goal of a franchise is to remove as much variability as possible. The poor performance of an individual outlet can effect the reputation of the larger group. A franchise or a chain of any sort must have a regular set of criteria upon which to judge the performance of members. In profit sector, with business format franchises particular emphasis is placed on the monitoring process indicators as well as outputs. It is important to make sure that service standards are upheld and products are maintained with good advertising promotion. This is done to ensure that at each affiliate service quality, pricing, and financial management are all being properly managed. The evaluation is focused on quality assurance method: like certifications, codes of conduct, regulations to assure board accountability, funding sources and financial stability. Franchisee Vs Company Owned: A company that has undertaken the mission of implementing an integrated supply chain management strategy has to deal with one of the greatest challenges, which it faces is the significant change in internal culture that is required to make the supply chain redesign successful. It is not an easy thing, to re-condition people to accept change, especially in organizations where a certain mindset has prevailed for many years. However difficult it may be to accomplish, change can be implemented successfully when directed by a strong and knowledgeable leader, who understands the tools available for achieving positive change, as well as their role in initiating and sustaining these changes. (Handfield, 2004) The agency theory proposes that firms use franchising as a business mechanism to reduce agency problems initiating from the opportunistic behaviour of their own employees. This would encourage them to take advantage of the highly motivated serf-driven agents as franchisees by using effective compensation as a basis to encourage the high franchisee motivation. The agency theory explained that franchise firms could increase their level of efficiency with the likelihood of reducing the level of monitoring and control employing the franchisees as agents. The franchisees, who were self-motivated, would be more satisfied with the franchise relationships and would be likely to display better performance outcomes for the franchise firms when compared to the company employed agents. Franchisees were found to be non-economically dissatisfied with the franchise relationship while the company-owned managers reported a higher level of non-economic satisfaction with the employer-employee relationship in their organizations. Although some past literature proposing that the franchise arrangement offers the franchisees a certain degree of entrepreneurship in which the franchisees can exercise their initiative, risk taking, authority, independence and adaptation to the franchise outlets (Jule,Baucus and Baucus,1996). In addition, the franchisees also tend to receive more support, guidance, and ongoing training given by the franchisors than the company owned managers (Forward and Fulop, 1993). Franchisees and the franchisors are bound by the franchise contracts, which typically guide the franchise relationship rather than values and norms. Franchisees may be non-economically dissatisfied with the relationship when they view their roles as an alliance partner in which they should be given the fight to exercise their entrepreneurial initiative to their franchise outlets rather than limit their initiatives within the franchise contract or conform their activities to the organizational norm. Nonetheless, it will be easier for the company-owned managers, who are organizational employed personnel, to conform to the organizational norms which are considered to be a common practice in the employee-employer relationship leading to their level of non-economic satisfaction being significantly higher than the franchisees level. The significant difference of the economic satisfaction between the franchisees and the company-employed managers was not supported. Although, the mean on economic satisfaction between the franchisee and the company-employed manager was insignificantly different, the mean of the company-owned managers was slightly higher. The expectation of the monetary rewards of the franchisees is slightly higher than the company-owned managers resulting in the lower level of the franchisees economic satisfaction. The employee compensation was found to be slightly greater for the company-owned outlets than franchised outlets. Hence, the results contradicted the agency theory, which predicted that the franchisees should be more economically satisfied as their economic rewards depended on the performance of the franchise outlets, while the economic rewards of the company-owned manager are fixed (Brickley and Dark, 1987; Lafontaine, 1992). The level of the economic compensation of the franchisees also reflects the financial performance of the franchise units in which case the results showed no significant difference between the franchisees and the company-owned managers. According to the agency theory, the franchise outlet was anticipated to contribute better financial performance to the organization than the company-owned outlet. The lower level of monitoring and control of an agent was also proposed by the agency theory as a dominant factor for firms to employ franchising strategy. It is anticipated that the company-owned outlet should operate under a higher level of control or be more centralized than the franchise outlet, as the franchise outlet requires less monitoring and control resulting from agency efficiency (Baucus, Baucus and Human, 1996). There are practical implications for businesses with administrative constraints which are considering using franchising as a quick fix for their expansion or growth strategy. Franchising may not be an effective strategy to reduce the administrative cost of monitoring and control. The franchisees have a higher expectation, demand more return and may not be highly motivated when compared to the company-owned employees. As a result, businesses may have to pay more for administrative monitoring when engaged in franchising. Although franchising strategy may offer other competitive advantages to businesses (that is, capital resource as suggested by the resource scarcity theory), it should not be viewed as a substitute for agent efficiency as the company employed manager may be able to contribute to the success of the firms with less cost and less expectation. Uniformity and Conformity: Franchising is highly guided in operation by the agency theory which states that the objective and explanation for franchising is primarily monitoring costs for the central corporation and to assure that quality will be high compared to the localized benefits. The theory requires uniform standardization fo the product and the services through advertising and brand representation. This calls for uniformity of the franchisee with the franchisor or the corporation. But the sales occur through local outlets, and therefore depend to great extent on local effort in addition to the price and advertising. Because local effort is difficult to monitor in the context of service delivery it is often more efficient to localize incentives and align manager’s goals with organizational goals. This calls for conformity and franchising is one method of accomplishing this dual uniformity with conformity. Franchisees and the franchisors are bound by the franchise contracts, which typically guide the franchise relationship rather than values and norms. Franchisees may be non-economically dissatisfied with the relationship when they view their roles as an alliance partner in whom they should be given the fight to exercise their entrepreneurial initiative to their franchise outlets rather than limit their initiatives within the franchise contract or conform their activities to the organizational norm. Management of the Franchisee: The Agency Theory contends that an organization is the nexus of the contracts, which adapts to environmental factors such as major market changes. The contractual relationships are not suited to effecting large or frequent adaptations. Though it is impertinent that franchise systems do adapt to product market changes, but it is not clear how they manage such changes via contractual means. The hybrid nature of the franchise requires multidisciplinary approach to management and control. The contract is the tool to unify the objectives of the franchisor and the franchisee to common goal congruence. The market for franchises is competitively organized. The contractual agreements play a very critical role in mature franchise systems. The contractual agreement is to support and guide the franchisee unit to maintain standardization of the product and the services. (Carney and Gedajlovic, 1991) However, the relationship between the franchisors and the franchisees is not only an economic contract, an exchange relationship specified by the written agreement, but also social interaction, which may require an exchange of values and norms, formal and informal that may not be specified in the franchise contract. The successful principal and agent relationship may also be built towards the collaborative perspective, in which collaboration, trust, and corporation and ethical integration exist between the two parties (Shaw, Gupta, and Delery, 2000). The ownership of the units through contractual agreement is the potential for controlled and guided growth for the franchisee with the incentive for expansion and economic advantage for the main franchisor. The franchisee should also be more economically satisfied. Economic satisfaction occurs when the franchisee has a positive response to economic rewards that flow from the relationship with the franchisor. Generally, franchisor and franchisee share in the investment of and profits from the franchise outlet. The personal investment encourages the franchisee to put an effort into beneficial activities and day-to-day outlet operation (Caves and Murphy, 1976). The level of the economic compensation of the franchisees also reflects the financial performance of the franchise units. As a result, franchising offers greater agency efficiency. Therefore, the franchisee possesses higher motivation to work harder, as they are more economically satisfied, Franchising occurs when the firms need to enhance the capital and human resources and at the same time create agency efficiency or human capital strength in the participating firms. Franchising is then employed as an entry and growth strategy for firms, resulting in a rapid adoption of this business practice. The main advantage of the business model franchising is the potential for fast, low risk, expansion through local ownership backed by recognized brand with well established attributes desired by the consumer. As Aaker(1991) writes: “the key to obtaining high perceived quality is to deliver high quality, to identify those quality dimensions that are important, to understand what signals quality to buyer, and to communicate the quality message in a credible manner” The service at each franchise or outlet must be backed by the mass media communication to associate both the services and the brand name with the desired attributes. Beyond the individual outlet qualities, mass advertising will always be critical to the success of the franchise, and central to the value of the brand (Sen,1995) (Montagu, 2001) For the past four decades, the agency theory has been popularly used to explain the origin of franchising. This theory is also deemed to be a popular rationale for the spread of the franchise business practice worldwide. Works Cited Montagu, Dominic (2001 Dec. 19). Franchising Health Services in Developing Countries. Retrieved July 3, 2007, Web site: www.janani.org/pdf/Franchising.pdf (Montagu, 2001) Shane, Scott A. (1998).Making New Franchise Systems Work. Strategic Management Journal. 19, 697-707. (Shane, 1998) Lafontaine, Francine (1992).Agency Theory and Franchising: Some Empirical Results. The RAND Journal of Economics. Vol.23No.2, 263-83. (Lafontaine, 263-83) Horsky and Sen, Dan and Subrata K. (1980).Interfaces Between Marketing and Economics: An Overview. The Journal of Business . Vol.53No.3, S5-S12. ( Horsky and Sen, 1980) Sen, Kabir C. (1993).The Use of Initial Fees and Royalties in Business-Format Franchising. Managerial and Decision Economics. Vol.14, 175-190. (Sen, 1993) Carney and Gedajlovic, Mick and Eric (1991).Vertical Integration in Franchise Systems: Agency Theory and Resource Explanations. Strategic Management Journal. Vol.12, 607-629. (Carney and Gedajlovic, 1991) Brickley, James A. (1990).Incentive Conflicts and Contractual Restraints: Evidence from Franchising. Journal of Law and Economics. 745-770. (Brickley, 1990) Handfield, Rob (2004). Leading Change in Supply Chain Management. Retrieved July 3, 2007, from SCRC Web site: scm.ncsu.edu/public/hot/hot040526.html (Handfield, 2004) Brickley James A and H Frederick Dark, 1987. "The Choice of Organisational Form: The Case of Franchising". Journal of Financial Economics, Vol 18, pp 401-420. (Brickley and Dark,1987) Curran James and John Stanworth, 1983. "Franchising in the Modern Economy: Towards a Theoretical Understanding". International Small Business Journal, Vol 2, p. 826. (Curran and Stanworth,1983) Gassenheimer Jule, David Baucus, and Melissa Baucus, 1996. "Cooperative Arrangements Among Entrepreneurs: An Analysis of Opportunism and Communication in Franchise Structures". Journal of Business Research, Vol 36, pp 67-79. (Jule,Baucus and Baucus,1996) Oxenfelt Alfred R and O Anthony Kelly, 1968-1969. "Will Successful Systems Ultimately Become Wholly-owned Chain?" Journal of Retailing, Vol 44, pp 69-83. (Oxenfelt and Kelly,1968-1969) Fulop Christina and Jim Forward, 1997. "Insights into Franchising: A Review of Empirical and Theoretical Perspectives". Service Industries Journal, Vol 17, pp 603-625. (Fulop and Forward,1997) Jaworski BJ and DJ MacInnis, 1989. "Marketing Jobs and Management Controls: Toward a Framework". Journal of Marketing Research, Vol 26, November, pp 406-419. (Jaworski and MacInnis,1989) Lal Rajiv, 1990. "Improving Channel Coordination Through Franchising". Marketing Science, Vol 9, pp 299-318. (Lal,1990) Shaw Jason D, Gupta Nina, and E John Delery, 2000. "Empirical Organisational-level Examinations of Agency and Collaborative Predictions of Performance-contingent Compensation". Strategic Management Journal, Vol 21 No 5, p. 611. (Shaw, Gupta, and Delery, 2000). Caves Richard E and F II William Murphy, 1976. "Franchising: Firms, Markets and Intangible Assets". Southern Economic Journal, Vol 42, pp 572-586. (Caves and Murphy, 1976). Read More