Present An Economic Analysis Of The Retail Franchise Contract. Why Should Successful Franchisors Leave Rents With Franchisees?

2587 words - 10 pages

Present an economic analysis of the retail franchise contract. Why should successful franchisors leave rents with franchisees? Would you expect the attractiveness of franchising to the franchisor to fall over time?A franchise agreement is defined as a contractual agreement between two independent firms, whereby the franchisee pays the franchisor (owner) for the right to sell the franchisor's product and/or the right to use his trademark at a given place and for a certain period of time (Lafontaine, 1992). The business format of franchising has seen an immense growth over the last 30 years, especially on the retail sector, and it has been a successful organisational form in delivering service products. According to Lafontaine and Shaw (1996), this business phenomenon was responsible for the 35% of all retailing activity in 1986, and it accounted for about 13.5% of GDP in the U.S. Firms rely on expansion by franchising rather than expansion by company-owned outlets due to the advantageous nature of the franchise contract, where the franchisee as a residual claimant has more incentives to monitor than salaried manager.Given this recent popularity, a great deal of academic literature has given a number of alternative explanations about the existence of franchising and the nature of the franchising contracts.This study will focus the nature of the retail franchise contracts, where the franchisee as a residual claimant has more incentives than a company-owned manager. The discussion will present an economic analysis of franchise contracts, and then explain how literature has attempted to explain the existence of share franchise contracts. We will then examine the incentives of well established franchisors that leave rents with franchisees. At a later stage we will look at the franchise life-cycle and give possible explanations for the propensity of firms to franchise over time. Finally, the conclusion will summarize the important findings of the discussion.Economic Analysis of the Franchise ContractFranchise contract has seen an increased popularity in retail markets. Instead of employing and motivating an independent agent to sell a product, companies choose a more flexible and less integrated form of organization that enables them to share their risks and profits with the local franchisee agent (Lafontaine 1996). The Profit Functions below illustrate this contractual relationship.Πe = (1-t) R - Ve - Ce - F Franchisee's Profit functionΠf = t R + F - Cr - Vr Franchisor's Profit FunctionWhere Π denotes the profitR is the revenueF is the Fixed FeeV denotes the variable CostsC denotes the fixed Costst is the proportion of revenue due to the franchisor (royalty rate), ande and r refer to the Franchisee and Franchisor respectivelyAccording to Thompson (1994), literature has suggested that the nature of the franchise contract is encouraging incentive compatibility between franchisor and franchisee. As the functions demonstrate, each party has an...

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