The Relationship between Initial and Ongoing Fees in Franchising: A Meta-Analysis

Author(s): Farhad Sadeh and Manish Kacker
Web Index: 2016-03
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Abstract

Franchisors typically create and appropriate value through the growth of agent (franchisee) networks and extraction of economic profits (for the rights granted to franchisees) through revenue sharing contracts. Mechanisms and rationales for revenue sharing have been the subject of many theoretical and empirical studies on contracting. Franchising is a popular form of retailing in a wide range of product and service markets, plays a significant role in many developed economies and is a rapidly growing form of retailing in a number of emerging markets – therefore it is a suitable context for research on revenue sharing contracts. There is an extensive body of research that examines factors influencing the fee structure of franchise contracts and the relationship between the different components (fixed initial fees and ongoing fees that are typically expressed as a percentage of franchisee revenues) of this fee structure. There are two competing perspectives on the latter – one school of thought views the fixed and ongoing fees as being negatively related, since they are considered as twin parts of a mechanism deployed by a franchisor to share risk and extract franchisee profits, ensuring that franchisees just receive a normal profit on their investment; the other school of thought (based on arguments drawn from property rights theory, a combination of signaling, screening and transaction cost theory, brand effects rationales, allocation of channel functions and the implementation of the equity principle,and the existence of positive franchisee rents) posits that the two components are not related or are positively related. The divergence in these perspectives calls for a comprehensive empirical examination of the relationship between initial and ongoing fees in franchise contracts. However, to the best of our knowledge, there is no integrative quantitative review or meta-analysis on this topic. In this study, we conduct a meta-analysis to aggregate results from empirical studies, synthesize insights from prior research and test our hypotheses. Results from our meta-analysis (based on 26 studies with different samples and a total sample size of 22,676) reveal a small but significant positive correlation between royalty rates and franchise fees.

Valuation Insight

Value creation facilitated by franchising. In retailing, franchises allow for efficient revenue sharing. The paper conducts a meta analysis of the relationship in franchising contracts between fixed and ongoing fees, finding that fixed and ongoing fees have a small, but significantly positive correlation.

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