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Real options valuation of franchise territorial exclusivity

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  • Lukito Adi Nugroho
  • David McMillan

Abstract

With the maturity of the franchise system, franchisors have to look for new markets to capitalize constantly. This continuing expansion comes at the expense of the existing franchise establishments, as it could lead to territorial encroachment. One possible solution to mitigate this problem is by offering territorial exclusivity rights (TER) of new potential location to the existing franchisee. Yet, pricing the value of TER is not simple due to contingent claim nature of this rights. Hence, the goal of this paper is to model the TER using real options approach, a financial options valuation method that applies in real business. The real options will be built using Datar–Mathews method and then simulated using hypothetical case data. Results and implications are also discussed.

Suggested Citation

  • Lukito Adi Nugroho & David McMillan, 2017. "Real options valuation of franchise territorial exclusivity," Cogent Business & Management, Taylor & Francis Journals, vol. 4(1), pages 1262490-126, January.
  • Handle: RePEc:taf:oabmxx:v:4:y:2017:i:1:p:1262490
    DOI: 10.1080/23311975.2016.1262490
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    References listed on IDEAS

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    1. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
    2. Mario Cerrato & Kan Kwok Cheung, 2007. "Valuing American Style Options by Least Squares Methods," Money Macro and Finance (MMF) Research Group Conference 2006 49, Money Macro and Finance Research Group.
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    6. Vincent, William Slater, 1998. "Encroachment: legal restrictions on retail franchise expansion," Journal of Business Venturing, Elsevier, vol. 13(1), pages 29-41, January.
    7. Jèôme Barraquand, 1995. "Numerical Valuation of High Dimensional Multivariate European Securities," Management Science, INFORMS, vol. 41(12), pages 1882-1891, December.
    8. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    9. Boyle, Phelim P., 1977. "Options: A Monte Carlo approach," Journal of Financial Economics, Elsevier, vol. 4(3), pages 323-338, May.
    10. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
    11. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
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