Rajiv P. Dant and Patrick J. Kaufmann

In addition to representing a huge portion of retail activity in the U.S. and the world, franchising offers a particularly vivid example of a set of important and familiar questions involved in industrial organization. Should a company use a sales force or manufactures' reps? Should a company outsource or should it build internal capacity? Should a function be organized as a tightly controlled entity or a loosely controlled one? Or most generally, should a company make or buy? Embedded in these questions is the recognition that if a company does maintain control over the function, it must expend fixed resources. If it disengages the function, it loses some level of control.

In the franchising context this question takes on the following form: Should an entrepreneur give up direct control of a retail unit to a franchisee or should the entrepreneur acquire and spend the resources necessary to operate the unit as a company owned store? In this context, the question is complicated by the intangible nature of the assets. Will a new entrepreneur with few tangible assets be able to attract the resources needed to retain direct control as the chain expands? Or even if the entrepreneur wants to give up control, will he or she be able to convince a prospective franchisee of the value of the intangible assets granted by the franchise? And finally, what happens as the firm matures and resources and willing franchisees become increasingly available?

In this study, we examine this final question. To do so we compare two competing theories: the resource acquisition theory and the signaling theory. The former suggests that retailing entrepreneurs desiring to expand their system would prefer to operate their outlets as company owned stores, but due to the inaccessibility of resources, are forced to accept franchisees. In time, however, as the system matures, the franchisor will generate sufficient resources to allow it to execute on its strategic tendency toward more company ownership in the chain, either through opening new company owned outlets or reacquiring existing franchised outlets, a shift referred to in the literature as ownership redirection. Signaling theory has the opposite assumptions and predictions. Under that theory, entrepreneurs seeing the incentive benefits from franchise ownership, would prefer to have franchisees run their outlets. However, due to the difficulty in convincing prospective franchisees of the value of their concept, they are forced to own and operate a sufficient number of their systems' outlets to act as a credible signal of their belief and conviction in the value of business concept. In time, however, as prospective franchisees are able to directly observe the value of the concept through demonstrated results and acceptance within the market, the importance of the franchisor's ownership signal diminishes. Franchisors might then be expected to divest themselves of company owned outlets and open only new franchised outlets.

The primary goal of this paper is to test these two theories against one another in the context of the U.S. fast food industry, a retail segment in which franchising is not only prevalent but dominant. However, we also examine a third theoretical perspective. The latter perspective, referred to as tapered integration or plural forms, suggests that there are strategic reasons for not limiting the choice to the ideal or pure forms of only franchising or only company ownership. Rather, there are synergistic advantages that can be derived from maintaining a mix of ownership within a system. Thus, franchisors that recognize these benefits might be expected to eschew tendencies toward either only franchising or only company ownership, and instead settle into a strategy of maintaining a mixed steady state even as the system matures.

Findings generally support a resource acquisition model where increases in age, size and resources are associated with a tendency toward converting previously franchised units to company ownership. There was no support for the signaling model. In regard to the tapered integration perspective, evidence suggests that franchisors categorize the various benefits of maintaining a mix of company owned and franchised outlets as falling into two clear factors, insight and control. However, these were not significantly associated with a tendency to maintain the status quo. Since franchisors nevertheless recognize these benefits, this lack of statistical significance could be due to low variance on the factor measures.