24
Paper to be presented at EMNet-Conference on
“Economics and Management of Franchising Networks
Vienna, Austria June 26-28, 2003
The Nature of the Franchising Relationship
and its organizational Consequences[1]
Délila Allam
Université de Paris 1 Panthéon-Sorbonne
Matisse/CNRS
Maison des Sciences économiques
106-112 boulevard de l’Hôpital
75647 Paris cedex 13 - France
Tél: 00331- 44078317
e-mail:
Abstract:
The paper analyses the nature of the franchising relationship and its organizational consequences on the franchising networks by privileging the transaction cost economics. This analytical approach considers that the governance structure chosen to manage the franchising relationship is a hybrid form between the market and the hierarchy. We will try to bring operational dimension to this theorical proposal from the definition of franchising relationship given by the European Court of Justice. But there are two possible interpretations of this economic cooperation. The first one leads us to see the franchisee as simple duplicating the franchisor’s sucess. Then the franchisee has to be monitored to make sure that he correctly follows the instruction, then the franchisor controls every stage in the entrepreneurial function. This is what we call a “fordist interpretation”. The second interpretation of the franchising relationship is based on the dual aspect of a single figure: the entrepreneur. It involves two independant entrepreneurs entering into a relationship in order to divide up this entrepreneurial function and its inherent risks. This is where the organization of the network comes in it facilitates the sharing knowledge and communication and maintains its overall cohesion. The network produces a collective economic value. This is what we call this the “entrepreneurial interpretation”. Finally, each representation does not implement the same organization of the network.
Keywords: franchising network, entrepreneurial function and information and control systems.
I - Introduction
The New Institutional Economics (NIE) includes three levels of analysis which offer the advantage of a synthetic representation of the institutional economic and behavioural context within which economic cooperations take place. This representation allows, in particular, to identify the relevant levels – institutional, economic, behavioral – and their effects on the factors determining the organizational forms chosen by the economic actors to govern their relationship. In this paper, we only focus on the governance structures (the second level) even if neither of them are established independently of the legal system which refers to institutional environment (North, 1990). From a more theorical point of view, this institutional level is assimilated with formal (the legal and political rules) and informal (the professional pratices) contraints. The influence of the first level is essential, but here we consider that it is fixed at a certain moment in time and is thus assimilated with institutional parameters. This precisely means, that the contractual decisions of economic agents are reduced and that institutional rules are considered as contraints in their relationship. As such, they cannot be negociated by the two parties.
The aim of this paper is to examine the nature of the franchising relationship by privileging its legal definition given by The European Court of Justice and its consequences on the management and the manner to organize the franchising network. I will show that the network is a central asset which contributes to the value of this economic cooperation. Nevertheless, a too strict contractual conception of the franchising relationship often fails to improve our understanding of this collective asset (the network). My approach is based on the transaction cost economics on account of its capacity to mix better organizational and contractual dimensions of the economic phenomena. It emphasises a comparative analysis of feasible governance structures and it always recognizes their imperfect character. Hence, it is never a question of comparing observed empirical forms to an ideal form and concluding that the former is inefficient due to its differences with the latter. The methodological roots of this approach is positioned as a reaction to that of “the nirvana economy”. There are no ideal forms of organization but it considers only existing and implemented forms of organization. The second methodological orientation consists in effectuating a finer study of observable phenomena at cost of a loss generality. In fact, one always proceeds with an trade-off between the exhaustiveness of the knowledge about an economic phenomenon and the precision of this knowledge which cannot be obtained without reducing the scope of observation. Consequently, it is not a question of defining the nature of the franchising relationship in comparison with an ideal form of organization – which is impossible to create and which has never been empirically observed. Thus, the starting point of the research is based on the real pratices of franchisors and franchisees. These real observations come from two empirical investigations effectuated in 1999 and in 2001 using a panel of representative french franchising. In the early stage of the first study, I sent mailing survey destined to the whole of french franchising population (393 in all)[2]. I sought to obtain a characterisation of the french franchising networks in view of the transaction costs economics. The objective of the questionnaire was three-fold. The first part of the questionnaire aimed to obtain precise information concerning the human assets (seniority, mode of recruitment and training of the franchisees…), concerning the information sharing and the decision-making process as well as the contractual clauses chosen to protect the value of the specific assets implied in the transaction. But it was necessary to identify the economic environment in which each network is operating, as well as its capacities for adaptation. The second part of the questionnaire looked to learn the precise characteristics of the economic environment of each network (the degree of uncertainty and its various origins) the adaptation of the network to its environment (in terms of costs, initiatives left to the franchisees, franchisees opportunism and the evolution of contract). At last, the third part of the questionnaire sought to evaluate the distribution of decision-making power among the parties, the mechanisms to control the franchisees, the existence and the origins of eventual disagreements as well as the possible existence of contract breaches. I do not relate in detail this empirical knowledge, but with help of this one, I would like to suggest a more theorical understanding about the nature of the franchising relationship based on existing and observable forms of networks as the transaction costs economics recommends to do it.
The paper is organized as follows. Section II describes the theorical framework to examine the franchising relationship as hybrid form. The european legal definition of this economic cooperation shows that it is possible to formulate two interpretations of it. I identify its main characteristics and I then clarify the concept of hybrid form to give it a concrete and more operational dimension. Section III examines organizational consequences of each interpretation. In fact, in according with the interpretation adopted, the organization of the network will be different. The decision-making powers, information or control sytems are more or less centralized. Section IV concludes with few remarks.
II - The franchising relationship is a hybrid organization
The objective of this first section is to examine three main characteristics of the franchising relationship. To do that, I will study them in two subsections. On one hand, I will present the theorical framework coming from the transaction cost economics analysis, by justifing its pertinence in apprehending the theorical nature of the franchising relationship (subsection A). On the other hand, from the European Court of Justice definition of this cooperation inter-firms we identify two possible interpretations of the franchising relationship. The first one concerns what I call the “fordist interpretation” and the second one is relative to what I name “the entrepreneurial interpretation” (subsection B).
A - The transaction costs economics and the theorical nature of the franchising relationship
The analytical origins of the transaction costs approach are found in the research perspectives pioneered by R. Coase, in 1937, with his article “The Nature of the Firm”. Coase’s main proposal states that the distinctive mark of the firm is the elimination of price mechanisms. The firm is a mode of coordination providing an alternative to the market form. Effectively, the market, considered as the single mode of coordination for economic activities, was an important obstacle to understanding the existence of firm except as a function of production. Coase’s work gave rise to the concept of transaction costs which was, up until that time, ignored by economists. It wasn’t until the early 70’s that Coase‘s proposal was again examined. It was Williamson (1975, 1985) who treaded the question with much perseverance. In his book - Markets and Hierarchies (1975) - he explicity exposes the trade-off between the choice of market and that of firm coordination. He offered criteria allowing the differenciation of economic cooperations piloted in an efficient manner by the market from economic cooperations for which mediation of market was too costly and which thus required the coordination by a firm[3]. Several empirical works (Williamson & Masten, 1995) verified this theory. Later, at the end of the 80’s, empirical observations gave rise to strong fondations for the recognition of a third mode of coordination. The trade-off between “make or buy” decisions was too restrictive to understand better the empirical and economic reality. This one was also characterised by the existence of hybrid forms which proved to be relatively stable over time, contrary to early theorical assertations. Numerous empirical works confirmed its analytical pertinence (Willamson & Masten, 1995). It is particularly important as all forms of inter-firm cooperation fall into this third category coordination. Such as the franchising relationship is neither a market coordination nor a vertical integration (a firm coordination) it’s a hybrid form. But so speaking, this proposition is too general and can not improve our understanding of its peculiar nature. In such case, I should more presicely know what is a hybrid form which only points out a generic mode of coordination.
As we have just mentionned, every “governance structure” is a distinctive mode of coordination of economic relations. In fact, there is one main mechanism of coordination by governance structure: coordination by price, by contrat and by command in the firm case. The franchising relationship is a form of cooperation which is coordinated by contractual negociations. The division of property rights between the partners will be interpreted as a mechanism distributing the decisional and control powers among the contracting parties. This contractual coordination is distinguished from the two previous governance structures by its capacities for adaptation, its incentives properties and its conditions for resolving conflicts (Williamson, 1991). Its specific characteristics are translated by the contractual clauses negociated by the partners. Consequently, its economic efficiency comes from its properties which allow savings in terms of transaction costs when the partners have made specific investments. But as the economic agents have limited decision-making capacities (hypothesis of limited rationality) and that there is an asymmetrical distribution of information (hypothesis of opportunism) the contract will necessarily be incomplete. Indeed, adaptation needs are not clearly known in the initial negociation and so the organizational device to fulfil them have not integrated into the contract. The revision of certain initial decisions can lead to new negociations sometimes quite costly.
The incompleteness of contract will thus carry mechanisms of adaptation taking into consideration the evolution of the transaction‘s economic environment (hypothesis of uncertainty). The contractual link between franchisor and franchisees is an authority relationship and constitutes one of these mechanisms of adaptation. It represents a transfer of decision-making power between the agents and, more exactly, it confers on one of parties the right to control the behavior of the other party (Hadfield, 1990). This assignment of certain decision-making rights reduces the costs of adaptation to post-contractual situations in order to preserve the continuation of the cooperation.
Lastly, the franchising relationship reflects the willingness of the parties to protect their specific assets as much as possible and confers on the economic cooperation a great part of its value. These assets thus create an additional source of value for the cooperation since it produces an almost constant source of quasi-rent which would be lacking in case of its absence. This quasi-rent corresponds to the positive differential of value which would have be to given up if the cooperation did not take place or was interrupted before its end. Specific assets have no value outside of the franchising relationship and confirm the link of dependence between the parties. It would intuitively be correct to think that this dependence is a priori on one-sided: only the franchisee loses the amount of this quasi-rent if he moves into other activities. He is effectively obliged to stop using the know-how at the end of the contract. Whereas, on the other side, for franchisor, the valorisation of the know-how depends on the personal competences of the franchisee who must make use of it in a concrete manner. Thus, the capacity for learning and the cognitive resources of the franchisee participate in the actual valorisation of this asset. The quality of the reception of the know-how by the franchisee - which is not available elsewhere and which has never before been tested by him - represents another condition to create the quasi-rent. What’s more, the transmission of the know-how does not only concern a formal, technical expertise, but also an organizational expertise. Now, contrary to the preceding, this expertise is more tacit, thus more difficult to share, and more difficult to write in the handbook furnished to the franchisee at the signing of the contract.
Therefore, the clauses of the franchising contract constitute negociated restrictions affecting the rights of the parties. Those are relative to right of use (usus), right of benefit (fructus), and rights of transformation (abusus) of assets connected with the transaction and finally, as pertaining to the possibility of reselling the three preceding rights (contractual freedom). Furthermore, the franchising contract is a “sui generis” agreement. In other words, the french law does not impose a model for this economic cooperation. This is an enormous advantage which offers a great flexibility allowing the contracts to cover a very wide variety of economic situations. The franchising contract is proposed by the franchisor and the jurists call it “adhesion contract”.