412 ENTREPRENEURSHIP
management professor at Case Western. Boston Market eventually had to halt franchise sales,
close 200 stores, and sell itself to McDonald’s in 2000. Growth without prudent profitability
proved their downfall.^6
Organizational Boundaries
Franchising is a way of setting the boundaries of the organization. Businesses that can expand by
opening individual units always have the choice of establishing a chain through company-owned
units or franchising. In fact, most franchising systems contain a significant number of company-
owned units in addition to the franchised ones. This enables the franchisor to conduct market
experiments, gain knowledge of customer trends and changes, and maintain a solid understand-
ing of procurement and operating costs. Frequently, the franchisor attempts to keep the best loca-
tions as part of the company-owned chain, even repurchasing them from franchisees who have
made them successful.
Franchising is a hybrid form of organization and employs a hybrid mixture of capital and
resources. The franchising agreement defines those boundaries by delimiting the organizational
and financial constraints on the franchisor.^7 Therefore, it expands the organization’s boundaries,
which would otherwise be limited by resources and money.
Additionally, franchising is a way to balance the bureaucratic transaction costs of owning,
monitoring, and controlling all the outlets or units of the venture (as a chain operation) with the
market transaction costs of contracting with the franchisee.
The Agency Problem
The agency problem occurs when ownership and control are separated and the agent or manag-
er substitutes his or her own goals and objectives for those of the owner. Because the franchisee
is the owner/manager of the unit, the problems arising from the separation of ownership and
control are greatly diminished. Because it would be difficult for the franchisor to monitor the
quality and behavior of all the venture’s outlets spread over the globe, the franchisor instead
trusts that owners need much less monitoring than managers. Therefore, franchising is a partial
solution to the agency problem.^8 A study using U.S. Census data on the food and motel indus-
tries found that franchising enables the franchisor to better control the most physically dispersed
outlets and to protect the system’s brand-name capital. The same study also indicated that fran-
chising permits larger local outlets than using non-franchised operations.
However, franchising is only a partial solution because sometimes the owner of a franchise
outlet hires managers to run the business and the agency problem recurs. Also, when franchisees
serve a transient customer base, such as travelers on highways or in airports, they often let qual-
ity slip because they know there is little repeat business.^9 In summary, franchising enables the
owner of a resource that is rare, valuable, imperfectly imitable (by outsiders), and nonsubsti-
tutable to make perfect copies of the resource without lessening its rarity. To do this, the fran-
chisor must grant exclusive local operating rights to the franchisee so that, from the point of view
of the final customer, the product or service is locally rare and somewhat hard to get.^10 The fran-
chisor must build a national reputation. As shown in Chapter 2, reputation is a resource that can
possess the four attributes of sustainable competitive advantage. So what franchisors give up in
the complexity of local organization and the proprietary nature of technology or physical
resources, they attempt to overcome with reputation, high visibility, and a system-wide culture
of high performance.