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Pricing Decisions in Franchised Chains: A Look at the Restaurant and Fast-Food Industry

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  • Francine Lafontaine

Abstract

This paper examines empirical issues of pricing and price dispersion within franchised restaurant and fast-food chains. Given the per se illegality of resale price maintenance (RPM) under current U.S. Antitrust laws, and the fact that franchised outlets are independent businesses under the law, franchisors must delegate the power to set prices to franchisees whereas corporate chains can control downstream prices directly. The issue I examine is whether it matters empirically who, between the franchisor or the franchisee, gets to choose downstream prices, and why. After discussing a number of reasons why prices chosen by franchisees may differ from those that a franchisor would pick, I show, using data from all restaurant chains in the metropolitan Pittsburgh and Detroit areas, that there is price dispersion in fast-food franchising. I then show that the amount of price dispersion relates to the amount of franchising in a way that suggests that 1) franchisors are not able to control franchisees' prices indirectly to the same extent that they control company-owned unit prices and 2) the prices in franchised and corporate units are systematically different. Finally, I show that prices are systematically lower in corporate restaurants. This suggests that the reason behind the price differentials is not franchisor opportunism, but more likely double marginalization or, potentially, the existence of positive horizontal externalities among restaurants in a chain.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5247.

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Date of creation: Sep 1995
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Handle: RePEc:nbr:nberwo:5247

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  1. Klein, Benjamin & Murphy, Kevin M, 1988. "Vertical Restraints as Contract Enforcement Mechanisms," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 31(2), pages 265-97, October.
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  3. Richard E. Romano, 1994. "Double Moral Hazard and Resale Price Maintenance," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 455-466, Autumn.
  4. James J. Heckman, 1977. "Dummy Endogenous Variables in a Simultaneous Equation System," NBER Working Papers 0177, National Bureau of Economic Research, Inc.
  5. Klein, Benjamin, 1980. "Transaction Cost Determinants of "Unfair" Contractual Arrangements," American Economic Review, American Economic Association, American Economic Association, vol. 70(2), pages 356-62, May.
  6. Andrea Shepard, 1993. "Contractual Form, Retail Price, and Asset Characteristics in Gasoline Retailing," RAND Journal of Economics, The RAND Corporation, vol. 24(1), pages 58-77, Spring.
  7. Minkler, Alanson P., 1990. "An empirical analysis of a firm's decision to franchise," Economics Letters, Elsevier, Elsevier, vol. 34(1), pages 77-82, September.
  8. Krueger, Alan B, 1991. "Ownership, Agency, and Wages: An Examination of Franchising in the Fast Food Industry," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(1), pages 75-101, February.
  9. Barron, John M & Umbeck, John R, 1984. "The Effects of Different Contractual Arrangements: The Case of Retail Gasoline Markets," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 27(2), pages 313-28, October.
  10. Sass, Tim R & Saurman, David S, 1993. "Mandated Exclusive Territories and Economic Efficiency: An Empirical Analysis of the Malt-Beverage Industry," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 36(1), pages 153-77, April.
  11. Bonanno, Giacomo & Vickers, John, 1988. "Vertical Separation," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 36(3), pages 257-65, March.
  12. Borenstein, Severin & Rose, Nancy L, 1994. "Competition and Price Dispersion in the U.S. Airline Industry," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 102(4), pages 653-83, August.
  13. Pratt, John W & Wise, David A & Zeckhauser, Richard, 1979. "Price Differences in Almost Competitive Markets," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 93(2), pages 189-211, May.
  14. Gallini, Nancy T & Lutz, Nancy A, 1992. "Dual Distribution and Royalty Fees in Franchising," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 8(3), pages 471-501, October.
  15. Smith, Richard L, II, 1982. "Franchise Regulation: An Economic Analysis of State Restrictions on Automobile Distribution," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 25(1), pages 125-57, April.
  16. Lafontaine, F., 1988. "Contract Theory And Franchising: Some Empirical Results," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 88-89-33, Carnegie Mellon University, Tepper School of Business.
  17. Gillian K. Hadfield, 1991. "Credible Spatial Preemption through Franchising," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 531-543, Winter.
  18. Gal-Or, Esther, 1991. "Optimal franchising in oligopolistic markets with uncertain demand," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 9(3), pages 343-364, September.
  19. Graddy, Kathryn, 1997. "Do Fast-Food Chains Price Discriminate on the Race and Income Characteristics of an Area?," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 15(4), pages 391-401, October.
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Citations

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Cited by:
  1. Michael, Steven C., 2000. "The effect of organizational form on quality: the case of franchising," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 43(3), pages 295-318, November.
  2. Gonzalez-Diaz, Manuel & Solis-Rodriguez, Vanesa, 2012. "Why do entrepreneurs use franchising as a financial tool? An agency explanation," Journal of Business Venturing, Elsevier, vol. 27(3), pages 325-341.
  3. Leschewski, Andrea Marie & Weatherspoon, Dave D., 2014. "Fast Food Restaurant Pricing Strategies in Michigan Food Deserts," International Food and Agribusiness Management Review, International Food and Agribusiness Management Association (IAMA), International Food and Agribusiness Management Association (IAMA), vol. 17(A).
  4. Lafontaine, Francine & Slade, Margaret E., 1996. "Retail contracting and costly monitoring: Theory and evidence," European Economic Review, Elsevier, Elsevier, vol. 40(3-5), pages 923-932, April.
  5. Affuso, L., 2000. "Intra-Firm Retail Contracting: Survey Evidence from the UK'," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0022, Faculty of Economics, University of Cambridge.
  6. Arturs Kalnins & Francine Lafontaine, 1996. "The Characteristics of Multi-Unit Ownership in Franchising: Evidence from Fast-Food Restaurants in Texas," NBER Working Papers 5859, National Bureau of Economic Research, Inc.
  7. Itai Ater & Oren Rigbi, 2007. "Price Control In Franchised Chains: The Case Of McDonald's Dollar Menu," Discussion Papers, Stanford Institute for Economic Policy Research 06-022, Stanford Institute for Economic Policy Research.
  8. Zenger, Hans, 2009. "Successive Monopolies with Endogenous Quality," MPRA Paper 15659, University Library of Munich, Germany.
  9. Odile CHANUT & Nadjoua GHARBI & Dominique BONET FERNANDEZ, 2014. "Heterogeneous Institutional environments and Franchise networks Development in Maghreb," Working Papers, Department of Research, Ipag Business School 2014-171, Department of Research, Ipag Business School.
  10. Etienne Pfister & Bruno Deffains & Myriam Doriat-Duban & Stéphane Saussier, 2006. "Institutions and contracts: Franchising," European Journal of Law and Economics, Springer, Springer, vol. 21(1), pages 53-78, January.
  11. Arturs Kalnins, 2006. "Markets: The U.S. Lodging Industry," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 20(4), pages 203-218, Fall.
  12. Tianxi Wang, 2009. "Ownership, Control, and Incentive," Economics Discussion Papers, University of Essex, Department of Economics 676, University of Essex, Department of Economics.

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