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Chapter 3. Hypothesis Development
This paper attempts to investigate the factors that influence the tendency to franchise on entrepreneurs. Our conceptual model is based on resources scarcity and agency theories.
The conceptual model is elaborated as follows.
Resource scarcity theory explains that young and small firms are difficult to raise capital in growth stage and have less experience in either managerial or financial. Firms are likely to adopt franchise when face the requirement to achieve economies of scale and expand at a rate beyond what is possible using only internally generated resources (Lafontaine, 1992; Oxenfeldt & Kelly, 1969). According to resource scarcity theorists, the more resources a firm has, the less it requires franchising to expand, and therefore a negatively associated relationship is hypothesized between size, age, rate of growth, and the proportion of franchising. As a result, this paper assumes the franchise tendency is negatively associated with the franchise speed which is the period of time from firm founded to expand the first franchise store and positively associated with the star-up cost of opening a new outlet (Alon, 2001). From the view points of franchisors, when a firm could sustain longer period before adopting franchising, it’s likely to face less resource scarcity pressure. Resource scarcity theory argues that as the economic system accumulated more resources, the less it requires to franchise. Before franchising their concept, entrepreneurs usually own and manage one or more units. This experience contributes to creating and designing original and proven knowledge to improve their organizational and managerial capabilities. As a result, when franchisees are interested in a higher resource pressure’s franchise brand, franchisees could support
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not only financial resource but also human resource. Therefore, the first hypothesis of this thesis is as follows,
Hypothesis 1. Franchise tendency is negatively associated with franchise speed (FS) of adopting franchise.
Hypothesis 2. Franchise tendency is positively associated with initial investment cost.
Franchisee fee and royalty fee are franchisees’ costs as well. The franchise fee is a one-time charge, up-front fee, the cost of access to the franchise chain brand name and business model (Brickley & Dark, 1987). Royalty fee is a percentage of outlet sales that the franchisor collects for the duration of the relationship. Franchise fee and royalty fee represent important financial resources that allow franchisors to develop renew knowledge (El Akremi, Perrigot, & Piot-Lepetit, 2013). Capital resources enhance franchisors perform in challenging environments and match the changing opportunities.
The higher the resources franchisors collect, the higher the investments in capability of the franchise chain to efficiently exploit and explore its knowledge resources.
Franchisors require incentives to promote the system brand name, franchise and royalty fee provide these incentives. The higher the royalty rate that franchisors receive, the greater return of franchising an outlet relative to the return to owning it directly, and the greater the franchisor's interest in franchising. Higher royalty fee increase franchisors’
profits (Lafontaine, 1992), also provide incentives to maintain the brand by continuous innovation and updates, as well as to franchisee fee franchisors collect.
Following these arguments, we provide the following hypotheses:
Hypothesis 3. Franchise tendency is positively associated with franchise fee.
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Hypothesis 4. Franchise tendency is positively associated with royalty fee.
In addition to resource scarcity theory, franchise is supported by agency theory as well. Franchising, however, presents a two-sided moral hazard problem, wherein franchisees must also monitor the franchisor to prevent free rider (Lafontaine, 1992).
There is a concern by potential franchisees over a franchisor’s potential for opportunistic behavior. Franchisors are responsible for promoting the brand, improving the product, providing service level, policing outlet quality (Combs, 2003). Franchisees are worried about the under effort franchisor made. Therefore, a trade-off exists between the developments of franchisee monitoring capability. Given this trade-off, the greater the allocation of resources to the development of franchisee monitoring capability, the more likely the franchisor is to develop this capability. This capability will lead enhance the franchisors. Therefore lead the franchise tendency higher.
Monitoring experience is acquired from franchisors’ learning experience (Elango, 2007). As firms become mature and have more experience in franchising, we assume firms have better capability in monitoring franchisees. Following Elango (2007), this paper measures monitoring capability if the franchisor had opportunities to develop monitoring skills. Franchisors would have developed the appropriate organization structure and system to monitor franchisees. Therefore, franchisors with more experience in franchising are likely to have greater monitoring capacity to monitor franchisees. And franchisees are more comfortable have business relation with franchisors with higher monitoring experienced.Therefore, we assume that the tendency to adopt franchise is likely to be higher. This argument leads to the following
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hypothesis:
Hypothesis 5. Franchise tendency is positively associated with monitoring capacity.
The agency perspective focuses on the monitoring skills of the franchisor.
According to the agency perspective, firms adopt franchise because they are unable to monitor their managers efficiently (Brickley & Dark, 1987). Agency cost occur when franchisor need to monitoring outlet managers. By converting the outlet manager into an entrepreneur, franchisees’ revenue is the total profit of the outlet deducted certain proportion of royalty fee compared to outlet manager whose revenue did not match outlet performance. Franchising therefore becomes more attractive when it is costly to directly supervise the behavior of outlet managers. Following the augments of agency theory, we argue that monitoring problem is more severe to an international franchisor.
Franchisors operating in international markets face greater risks in monitoring franchisees because of cultural, legal, and political differences. Since international franchisors face unfamiliar local culture, law system, and distant from franchisor headquarter. The international business environment has greater uncertainty than the domestic business environment. Political, governmental, currency, cultural, and macroeconomic differences across nations make international business more uncertain compare to domestic business. Therefore, franchising reduces the need to monitor outlet managers’ effort because franchisees typically make substantial investments in their outlets (Elango, 2007). This argument leads to the following hypothesis:
Hypothesis 6. Franchise tendency is positively associated with
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internationalize.
This paper examines whether performance is a factor that influences entrepreneur’s decision on tendency of franchising. Franchising as an expansion strategy has a positively associated effect on growth and survival (Shane, 1996).
Through investigates for firm growth and survival, Shane (1996) found that franchise model provide a way to overcome moral hazard and adverse selection. He proposed that franchising is a mechanism of minimizing agency problems of growth. An alternative argument is that firms adopt franchising due to the demand of achieve economies of scale and expand quickly beyond using only internally generated resources. Once such economies are achieved, rapid expansion is no longer necessary and mature franchisors would cease franchising and ultimately become primarily company-owned mode to seek maximizing returns. Because firm ownership is presumably more profitable, the franchisor will repurchase its most profitable franchised outlets (Oxenfeldt & Kelly, 1969). Based on above arguments, this paper proposes that:
Hypothesis 7. Franchise tendency is negatively associated with performance.
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