AN EXPLANATION OF INTERNATIONAL FRANCHISORS' PREFERENCE FOR MULTI-UNIT FRANCHISING

ABSTRACT Most international franchisors seem to follow multi-unit franchising. But it is often treated as an anomaly from an agency theory perspective. We argue that multi-unit franchising can be explained by agency theory, if we consider the full range of agency problems. These include: shirking, adverse selection, information flow, inefficient risk bearing, free-riding, and quasi-rent appropriation. Although past agency theoretic examinations have mostly focused on single-unit franchising, our analysis shows that in the international context, multi-unit franchising may be more appropriate considering the significant geographic and cultural distance between franchisors and franchisees. INTRODUCTION Franchising has become a very popular means for rapid organizational growth in the U.S over the last four decades. Starting with the fast food industry, franchising has now become pervasive in a variety of industries ranging from auto repair to day care. The rapid diffusion of franchising is also reflected in a surge in the number of academic studies of franchising as well as greater attention in the popular press. A significant number of academic researchers have relied on agency theory to analyze a variety of franchising related issues such as the structure of the franchising agreement, the choice of a specific type of franchising, and financial success of the franchising system (Bates, 1998; Shane, 1996a). The appeal of agency theory stems from the fact that the relationship between the franchisor and the franchisee is essentially an agency relationship. Interestingly enough, most of the theoretical arguments based on agency theory implicitly seem to assume that franchisees are essentially single unit operators (Kaufmann and Dant, 1996: 346). This assumption, however, is surprising given that multi-unit franchising (MUF) seems to be the norm in many industries. For example, using Bureau of the Census data, Bates (1998:114) noted that "among the recently started restaurant franchise units, 84% were units of multi-establishment corporations. " Kaufmann and Dant (1996: 346) note several other examples leading to the conclusion: "It is clear that the typical location-based franchising system (of which the fast-food franchises are the prime and modal example) is populated with multi-unit franchisees. " Interestingly, the prevalence of multi-unit franchises is even more widespread in the context of international franchising (Alon, 2000; Dant and Nasr, 1998). Prior research, by and large, has focused mostly on single-unit franchising (SUF) because of the assumption that agency problems can be best resolved by having owner operators. The moment they become multi-unit systems, individual units are managed by employees, thereby reintroducing the agency problem. This led Kaufmann and Dant (1996) to call the prevalence of MUF "a curious anomaly" in search of a clear theoretical explanation. The objective of this paper is to answer the question: Why do international franchisors prefer MUF over SUF? We argue that there is no need to embark on a search for a new theory to explain this preference. Our position is that MUF is not a theoretical anomaly and that agency theory can adequately explain the preference for MUF among international franchisees. Multi-unit franchising differs from single-unit franchising in one fundamental way. In MUF, the franchisees own, operate, or control more than one outlet (Kaufmann and Dant, 1996). Even within MUF, there are many different types (Alon, 2000). Incremental or sequential MUF occurs when a single-unit franchisee is awarded additional units based upon the performance of existing units. In master franchising, on the other hand, the franchisor grants a franchisee rights to multiple units from the outset (Kaufmann, 1992). Area development agreements are a special type of master franchising which requires the master franchisee to open and operate multiple units within a geographical area according to a pre-specified schedule. …