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Adoption, Transfers, and Incentives in a Franchise Network with Positive Externalities

Author

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  • Barrie R. Nault

    (University of Alberta)

  • Albert S. Dexter

    (University of British Columbia)

Abstract

We study franchise arrangements that allow franchisees with exclusive territories to own their customers. This permits franchisees to benefit from positive externalities in the franchise network through interfranchise transfers based on the purchases by their customers at other franchises on the network. Using the structure of a single franchisor and many franchisees, we show that, in general, interfranchise transfers between franchisees and incentives for franchisee investment in the expansion of their customer base are critical both to the size and to the benefits derived from the franchise network. Specifically, we find that when individual franchisees make investments in marketing effort to increase their customer base, the franchisor's setting of the interfranchise transfer trades off the positive effects on network size with the negative effects of removing franchisee incentive for investment. This result is due to the fact that interfranchise transfers encourage adoption, but discourage full investment in marketing effort. As compared to first-best franchisee investment, use of the royalty and the inter-franchise transfer directly dissipates franchisee profits, and indirectly dissipates franchisee profits through less than universal adoption, thereby causing franchisees to underinvest. As compared to traditional franchise systems, however, use of the interfranchise transfer results in franchises making greater investments than they otherwise would.

Suggested Citation

  • Barrie R. Nault & Albert S. Dexter, 1994. "Adoption, Transfers, and Incentives in a Franchise Network with Positive Externalities," Marketing Science, INFORMS, vol. 13(4), pages 412-423.
    • Handle: RePEc:inm:ormksc:v:13:y:1994:i:4:p:412-423
    DOI: 10.1287/mksc.13.4.412
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    Cited by:

    1. Sharma, Amalesh & Soni, Mauli & Borah, Sourav Bikash & Saboo, Alok R., 2020. "Identifying the drivers of luxury brand sales in emerging markets: An exploratory study," Journal of Business Research, Elsevier, vol. 111(C), pages 25-40.
    2. Barrie R. Nault & Rajeev K. Tyagi, 2001. "Implementable Mechanisms to Coordinate Horizontal Alliances," Management Science, INFORMS, vol. 47(6), pages 787-799, June.
    3. Barrie R. Nault, 1998. "Information Technology and Organization Design: Locating Decisions and Information," Management Science, INFORMS, vol. 44(10), pages 1321-1335, October.
    4. Daisuke Nikae & Takeshi Ikeda, 2005. "The economic theory of quasi-exclusive territory," Industrial Organization 0508002, University Library of Munich, Germany.
    5. Amiya Basu & Tridib Mazumdar & S. P. Raj, 2003. "Indirect Network Externality Effects on Product Attributes," Marketing Science, INFORMS, vol. 22(2), pages 209-221, April.
    6. Ma, Shuzhong & Chai, Yuxi & Jia, Fu, 2022. "Mitigating transaction risk for cross-border e-commerce firms: A multiagent-based simulation study," International Business Review, Elsevier, vol. 31(4).
    7. Robert J. Kauffman & James McAndrews & Yu-Ming Wang, 2000. "Opening the “Black Box” of Network Externalities in Network Adoption," Information Systems Research, INFORMS, vol. 11(1), pages 61-82, March.
    8. Hsu, Liwu & Kaufmann, Patrick & Srinivasan, Shuba, 2017. "How Do Franchise Ownership Structure and Strategic Investment Emphasis Influence Stock Returns and Risks?," Journal of Retailing, Elsevier, vol. 93(3), pages 350-368.

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    Keywords

    channels of distribution; pricing research;

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