The Level of Standardization in an International Franchising Context

The Level of Standardization in an International Franchising Context

Master Thesis Faculty Economics & Business MSc BA Small Business & Entrepreneurship

University of Groningen Jesper W. A. Beunk Student ID: 1408925 Supervisor Dr. E. P. M. Croonen

2

Supervisor Dr. M. J. Brand

August 2009

PREFACE

This thesis is the final step in completing my Masters Degree in Business Administration, the specialization Small Business & Entrepreneurship, at the University of Groningen. There are two main purposes for writing this thesis. The first is to provide researchers and academics a useful tool when doing research on the level of standardization or uniformity of franchise systems. The second, is to provide information for (potential) franchisors and franchisees engaging in, or being part of, an international franchising system from a perspective of uniformity.

I especially would like to thank my first thesis supervisor, Dr. E.P.M. Croonen, for her help, advice and dedication. Every time I was stuck her words and advice were my guide in the right direction, which eventually led to a lot of progress. I also would like to thank my second supervisor, Dr. M. J.

Brand.

Finally, I would like to thank the franchisor of Kaldi, who provided me with all the requested information of his company. Besides, I would like to thank him for the time he reserved for having an interview with me. Without his cooperation the process of writing my thesis would be extended by a substantial amount of time. I wish him and his company all the good luck in conquering the Chinese market.

Jesper Beunk

August 2009

Zwolle

TABLE OF CONTENTS

Preface 1

Summary 4

Chapter 1: Introduction 5

1.1 Research Motivation 5

1.2 Research Problem 6

1.3 Definition of Franchising 7

1.4 International Franchising: Direct and Master Franchising 7 1.5 Uniformity and the Level of Standardization: An International Application 8

1.6 Thesis Structure 10

Chapter 2: Theoretical Framework 11

2.1 Theoretical Perspective on Standardization versus Local Adaptation 11 2.1.1 Theories on Standardization versus Local Adaptation 11 2.1.2 An Agency Perspective on Standardization versus

Local Adaptation 11

2.1.3 Dimensions of the Level of Standardization 12

2.2 Concepts Related to the Level of Standardization 12

2.2.1 Uniformity 15

2.2.2 Customization 15

2.2.3 Personalization 15

2.2.4 Centralization 16

2.2.5 Allocation of Rights 16

2.2.6 Control 16

2.2.7 Delegation, Real Authority, and Formal Authority 17

2.2.8 Comparison of the Concepts 20

2.3 The Franchise Contract 21

2.3.1 The Structure of a Franchise Contract 22

2.3.2 Peculiarities of the Franchise Contract 22

2.3.3 The Franchise Contract in an International Context 22

2.4 Operations Manual 23

2.5 The Level of Standardization Measurement Instrument 23

2.5.1 Uniformity Provisions 24

2.5.2 Obligations of Managerial Assistance 25

2.5.3 Provisions on Operations 25

2.5.4 Summarizing: Measuring the Level of Standardization 26

2.6 Factors Influencing the Level of Standardization in an International Context 27

2.6.1 Factors from Literature on International Franchising 28

2.7 Conceptual Model 29

Chapter 3: Methodology 31

3.1 Research 31

3.2 Case Company and Data Collection 31

3.3 Implications Measurement Instrument 31

Chapter 4: Findings 33

4.1 Kaldi’s Uniformity Provisions 33

4.2 Kaldi’s Obligations of Managerial Assistance 36

4.3 Kaldi’s Provisions on Operations 38

4.4 Discussion 41

4.4.1 International Standardization Differences of Kaldi 41

4.4.2 Additional Items 42

4.4.3 Validity of the Measurement Instrument 43

Chapter 5: Conclusion 44

5.1 Answers on the Research Questions 44

5.2 The Improved Level of Standardization Measurement Instrument 44

5.2.1 Adjustment of the Measurement Instrument 44

5.2.2 Reviewing the Determinants of the Level of Standardization 45 5.3 Applicability of the Level of Standardization Measurement Instrument 45 5.4 Research Limitations, Recommendations and Practical Relevance 46

5.4.1 Research Limitations 46

5.4.2 Recommendations for Future Research 46

5.4.3 Practical Relevance 46

References 47

Appendices 50

Appendix A 50

Appendix B 51

Appendix C 52

Appendix D 53

Appendix E 54

SUMMARY

Much research has already been performed with respect to the standardized character of franchising.

However, an instrument to measure the level of standardization has never been proposed. In franchising research the level of standardization is known as the outcome of the trade-off between standardization and local adaptation (figure 1). This thesis develops a measurement instrument for the level of standardization of franchise systems and will be applied in an international franchise context.

On the basis of an extensive literature study the measurement instrument for a franchise system’s level of standardization will be developed and influences on the level of standardization will be discussed.

In order to test the measurement instrument in an international context, franchise contracts and an interview with the franchisor of a Dutch franchise chain are used to come to a standardization score for the countries (The Netherlands and China) the system is operating in. Besides, the determinants causing differences in scores between the two countries will be examined.

The findings of the research show that the level of standardization measurement instrument covers the most important items of the franchise contract of the case company. Moreover, the findings lead to an improvement of the measurement instrument.

Figure 1. A trade-off between standardization and local adaptation. Galleria Vittorio Emanuele in Milan: local adaptation of

the physical layout of McDonalds in a uniform historic design

1. INTRODUCTION

Franchising is a business form essentially consisting of an organization (the franchisor) with a market-tested business package centered on a product or service, entering into a continuing contractual relationship with franchisees, typically self-financed and independently owner-managed small firms, operating under the franchisor’s trade name to produce and/or market goods or services according to a format specified by the franchisor (Curran & Stanworth as cited in Hoy & Stanworth, 2003, p. 10).

Franchising, as a popular form of entrepreneurship, is gaining more popularity around the world.

Statistics of worldwide franchise growth are not available since franchising research is still mainly performed on a national scale. Even an international franchising institution like the International Franchising Association (IFA) only reports about developments within the US.

According to the IFA the amount of franchisors and franchisees still increases in the US. The Dutch franchise association (NFV) also reports an increase in franchise businesses over the last years. While franchising is well established in developed nations, it also works advantageously in transitional economies, such as the Czech Republic, Hungary and Slovenia. These countries are without a history of entrepreneurship, and franchising provides the necessary structure and support that otherwise would be lacking (Hoffman & Preble, 2004). All in all, franchising is a popular business concept for many countries in different economic circumstances all around the world. In appendix A the twenty-five largest franchise systems operating in Europe are listed. They are ranked in the top 500 Franchise Europe list.

1.1 Research Motivation

Franchising is a popular business strategy because of its standardized character. The standardized character takes care that customers know what to expect at every individual franchise store. This expected quality caused by (strict) uniformity of the concept is valuable for the trademark. However, total standardization of the business is not always optimal. A trade-off must be made with local adaptation, to fit the needs of customers in specific areas (Kaufmann & Eroglu, 1998). Thus, on the one hand, franchisors have to protect the core or standards to safeguard the quality of the trademark.

On the other hand, franchisees have to adapt to local conditions in order to optimize the performance of their business.

Already a considerable amount of research about standardization has been performed in the area of domestic franchising. These studies focus on the standardization versus local adaptation trade-off in business format franchising. Besides, it focuses on regional pressures to deviate from franchise formats.

However, studies on the standardization versus local adaptation trade-off in international franchising are relatively scarce. Most of the studies on international franchising focus on the internationalisation path and strategies of franchise chains. The level of standardization is a concept in franchising research which has attracted domestic attention. However, a detailed description of the concept is lacking in the literature. Moreover, there is no research regarding this concept on an international scale. Since franchise chains are expanding abroad more nowadays it is useful to create an international applicable concept.

This study is an initiative to define and operationalize standardization -which is a derivative of

uniformity-, and subsequently measure the level of standardization with the proposed instrument in an

international context. In this research it is important to define the level of standardization and to create

a theoretical framework in order to measure this level. Moreover, the research focuses on the

determinants of this level of standardization. This is relevant since it makes the concept of the level of

standardization more transparent and understandable.

1.2 Research Problem

This section describes the research objective and the research questions.

The research objective is:

To define and operationalize the concept of the level of standardization of franchise systems, and to apply it in an international context to understand how franchisors deal with the standardization and local adaptation trade-off internationally.

The research questions are as follows:

1. Which definitions and measurement instruments of the level of standardization have been used in past literature, and how can they be combined into a internationally applicable standard measurement instrument?

This question is relevant because the level of standardization has not been defined in past literature. Besides, there are many related concepts or derivatives from which it has to be distinguished. Therefore, this field of research is very fuzzy. Furthermore, a proper measurement instrument which can be applied internationally is lacking in the literature.

Finally, there are relatively little empirical studies regarding the level of standardization.

This question will be answered on the basis of past literature in the field of uniformity in franchising.

2. Which factors influence the level of standardization in an international context according to prior research?

In the answer of question 1 components of the level of standardization are indicated.

These components, in turn, are influenced by certain factors. These factors have a positive or a negative effect on the level of standardization. This question is about these determinants. It is important to understand which factors influence a desired level of standardization. Besides, the determination of different levels of standardization between countries within a franchising chain can be done more easily when these influences are indicated. Moreover, the possible differences between the countries will be easier to understand. This question will be answered using international franchising literature and literature regarding the level of standardization versus local adaptation trade-off.

3. What are differences regarding the level of standardization between The Netherlands and China within a particular franchising chain, and how can we explain the differences?

Another country of operation than the domestic country means a different environment and subsequently could imply a different level of standardization as reflected by the franchise contract. This question will be tested empirically. This question is relevant for franchisors and (potential) franchisees when negotiating about the franchise agreement.

The research with respect to this question will be done on the basis of a franchise contract

from The Netherlands and from China. The empirical measurement of the level of

standardization can be applied in different contexts (different countries and franchise

systems).

1.3 Definition of Franchising

As Quinn and Alexander (2002) argue, the term ‘franchising’ may describe a wide variety of business activities, but the contemporary franchise system commonly in use is known as business format franchising. This is the type of franchising under consideration in this research. Grant (1985) defines business format franchising as:

The granting of a license for a predetermined financial return by a franchising company (franchisor) to its franchisees, entitling them to make use of a complete business package, including training, support and the corporate name, thus enabling them to operate their own businesses to the same standards and format as the other units in the franchised chain.

From this definition two important characteristics can be extracted:

• There is a contractual relationship between franchisor and franchisee

• There is one specific format which reflects uniformity to the consumer. Standards of one specific unit are being perceived by consumers to represent the entire chain. So, the franchisor controls the use of the format by the franchisee.

In the remainder of this thesis the definition of Grant (1985) is meant when franchising and business format franchising are mentioned. These terms are used interchangeably.

1.4 International Franchising: Direct and Master Franchising

Since this study crosses the boundaries of countries it useful to provide a thorough definition of international franchising. When international franchising is mentioned the reader must have the following in mind:

International franchising is a foreign market entry mode that involves a relationship between the entrant (franchisor) and a host country entity, in which the former transfers, under contract, a business package (or format), which it has developed and owns, to the latter. For the sake of clarity, this host country entity can be either a domestic franchisee, a foreign franchisee, a master franchisor, or an entity which is partly owned by the franchisor itself (Burton & Cross as cited in Alon & McKee, 1999, p. 77).

Master international franchising is a unique mode of entry (Alon, 2006). Therefore, this section devotes specific attention to this form of franchising. Master franchising has been defined by Kaufmann and Dant (1996) as:

A form of umbrella licensing agreement which differs from the standard unit or location-level franchise in two ways: (1) it provides for the granting of an exclusive territory extending beyond the trade area of a single unit, and (2) it envisions from the outset the introduction of an additional layer of control between story level management and the franchisor.

Thus, there are two main differences between an individual and a master franchisee. The first is that a

master franchisee operates more than one single unit of business compared to a single unit of an

individual franchisee. The second difference is that a master franchisee is the middle layer in the

control chain, under the franchisor and above the franchisees in the master area. In the case of direct

franchising the individual franchisee is under supervision of the franchisor and has no subordinate.

Direct Franchising Master Franchising

Fsee = Franchisee

Master Fsee = Master franchisee

Figure 2. Parties and layers in direct and master franchising.

Next to the differences between the two types of franchising, a few advantages and disadvantages of master franchising in comparison to direct franchising can be in indicated. According to Justis and Judd (1986), and Alon (2006), the advantages of master franchising compared to direct franchising are:

• Speed to market

• Faster system growth rate

• Low capital outlay

• Master franchisor becomes expert on the territory

• Greater closeness with consumer

• Master franchisor knows both the franchisees and consumer The following disadvantages can be indicated:

• Problems associated with a poor choice of master franchisor which is caused by the higher level of independence between partners than is the case with direct franchising (problems like brand name deterioration; appropriation of expertise; less-than-optimal market expansion;

legal entanglements; and the costs of monitoring the master franchisee from afar)

• Territorial limitations

• Long contracts

• Legal problems and lawsuits

• Concentration of power in the master franchisor

• Lower income for headquarter franchisor

1.5 Uniformity and the Level of Standardization: An International Application

Before going into detail about the level of standardization a linguistic aspect must be discussed.

Uniformity is a concept put forward by Bradach (1998). He introduces maintaining uniformity as one of four management challenges facing restaurant franchise chains. Since describing the level of standardization is an essential aspect of this research and the country of origin of this research is The Netherlands, the linguistic aspect of the term uniformity must be clear at first to prevent misconceptions. A table with translations is the way that provides the most clarity (see table 1).

Franchisor

Fsee Fsee Fsee Fsee Fsee

Franchisor

Master Fsee

Fsee Fsee Fsee Fsee Fsee

The Netherlands International

Uniformiteit Uniformity

Mate van Hardheid (Freely translated: hardness

(Croonen, 2007))

Level of Standardization

Table 1. Translation of concepts

This thesis is a research in the area of ‘hardheid’. The English word ‘hardness’ is ambiguously perceived by international researchers and therefore does not cover the Dutch term. There is not a perfect translation for this Dutch concept but the ‘level of standardization’ approaches this term (at least scientifically) the most. The level of standardization ranges from soft franchising to hard franchising. These two main forms are distinguished below (Kneppers-Heynert, 1988):

• Hard franchising: in this form the lines of cooperation are tight and concerns all areas of the conduct of business. The franchise formula as well as the rights and duties of both parties are stated in detail in the franchise contract. There exist strict agreements about purchases (100% purchase obligation), sales, advertisement, style etc.

• Soft franchising: in this form the lines of cooperation are more loose and franchisees enjoy

greater levels of autonomy regarding essential policy decisions, so far as it not harms the

uniform image. The formula is started, exploited and managed together. This is in contrast

to hard franchising where the formula is top-down driven.

1.6 Thesis Structure

This part describes and shows the structure of the thesis in order to provide overview and direction.

Chapter 2 deals with the theoretical framework. The theoretical framework is based on literature regarding (international) franchising, uniformity and franchising contracts. This chapter describes the concept of the level of standardization and the factors influencing the level of standardization in an international context. These descriptions are the answers to the research questions 1 and 2. Besides, the chapter presents the conceptual model. The conceptual model is constructed on the basis of the theoretical framework. It shows where the level of standardization consists of. Chapter 3 describes the research methodology. Subsequently, chapter 4 presents the findings of the research. This chapter provides an answer to research question 3. Finally, chapter 5 deals with the conclusions of the research. Figure 3 presents a picture of the information regarding the thesis structure.

Figure 3. Thesis structure

Chapter 1: Introduction

Chapter 2: Theoretical Framework

RQ 1. Which definitions and measurement instruments of the level of standardization have been used in past literature, and how can they be combined into an international applicable

standard measurement instrument?

RQ 2. Which factors influence the level of standardization in an international context according to prior research?

Chapter 3:

Research Methodology

Chapter 4: Findings

Test of the Measurement Instrument and the Determinants of the Level of Standardization.

RQ 3. What are differences regarding the level of standardization between The Netherlands and China within a particular franchising chain, and how

can we explain the differences?

Chapter 5:

Conclusions

Theoretical Part

Empirical Part

Concluding Part

2. THEORETICAL FRAMEWORK

This chapter first describes the theoretical perspective on the standardization versus local adaptation trade-off in section 2.1. Subsequently, section 2.2 provides a thorough examination of the level of standardization versus local adaptation trade-off and its derivations or synonyms. Thereafter, section 2.3 discusses the franchise contract which comprises the legal obligations of franchisors and franchisees regarding the level of standardization. Closely related to the contract is the franchise manual which I discuss in section 2.4. Then, section 2.5 defines the concept of the level of standardization and how it can be measured. Subsequently, section 2.6 identifies the factors influencing the level of standardization in an international context on the basis of prior research. The core information of sections 2.5 and 2.6 are incorporated in the conceptual model, which section 2.7 discusses.

2.1 Theoretical Perspective on Standardization versus Local Adaptation

This section first describes theories that are used in franchising literature regarding the standardization versus local adaptation trade-off. Thereafter, the second subsection discusses the agency theory in more detail. Finally, the last subsection describes dimensions of the level of standardization.

2.1.1 Theories on Standardization versus Local Adaptation

Theories and concepts of international franchising studies are usually taken from domestic franchising (Dant & Nasr as cited in Pizanti & Lerner, 2003, p. 131). Research regarding domestic franchising to explain why firms franchise is dominated by agency theory and resource scarcity theory. However, several authors have argued that resource shortages are less able to explain franchising than agency theory is able to (Doherty & Quinn, 1999). Next to these two theories the property rights approach and transaction cost theory are other theories used in franchising literature (Kneppers-Heynert, 1988;

Leblebici & Shalley, 1996; Windsperger, 2003) to explain why and how firms franchise. In the property rights theory, rights are divided between franchisor and franchisee. According to this theory the structure of residual decision rights depends on the distribution of intangible (noncontractible) assets. In franchising, intangible knowledge assets refer to the brand name assets and the system- specific know-how of the franchisor and the local market know-how of the franchisee (Windsperger, 2003). Transaction cost theory is one of the most common economic explanations of the emergence of franchising. This is based on the notion that the negotiation, monitoring and control of economic exchanges within and between organizations necessarily incur costs. Businesses seek to minimize these costs wherever possible to maximize efficiency. The franchise business form is an important strategy to reduce transaction costs in many sectors (Stanworth & Curran, 1999).

2.1.2 An Agency Perspective on Standardization versus Local Adaptation

Agency theory hinges on issues related to uniformity and local responsiveness (Bradach, 1998). In terms of this theory, the degree to which adaptation of the various company strategies occurs in different foreign markets entered is contingent on the seriousness of the information asymmetry problem and the potential for moral hazard (Doherty & Quinn, 1999). These concepts are discussed below. Besides, agency theory focuses on the relationship between the principal (franchisor) and the agent (franchisee). Put more specifically, the theory focuses on the contractual and formal aspects of this relationship (Pizanti & Lerner, 2003). Since this study focuses on the level of standardization and aims to measure it internationally on the basis of franchise contracts agency theory is adopted in this study.

Since franchisor and franchisee do not always share the same goals, a main source of risk arises in the relationship when franchisees operate in their own self-interests against the objectives of the franchisor, a problem known as moral hazard (Paik & Choi, 2007). Therefore, franchisors face the need to implement effective mechanisms to control franchisees’ behaviour, which include a formal contract and a monitoring system (Felstead, 1993).

Information asymmetry deals with a large problem in the principal-agent relationship. This problem

degree to which adaptation of the various company strategies occurs in the different foreign markets entered is contingent on the seriousness of the information asymmetry problem and the potential for moral hazard. While research evidence is scant with regard to standardisation/adaptation and the international retail franchise, it may be hypothesized that the seriousness of the information asymmetry problem will be even more acute within this sector due to the higher degree of intangible assets involved (Doherty & Alexander, 2006).

Next to moral hazard and information asymmetry another agency concern, free-riding behaviour, can show up in franchising. Free-riding can be one outcome of the inherent struggle between a franchisee who seeks autonomy in running a business and a franchisor who seeks standardization and control of operations (Dant and Gundlach, 1999). Free-riding is a subset of a phenomenon identified in the management literature as withholding effort, the likelihood an individual will give less than full effort on a job-related task (Kidwell and Bennett as cited in Kidwell et al., 2007, p. 524). A franchisee engaged in a contractual relationship with a franchisor might seek to lower his or her own costs by failing to participate in activities that would be collectively profitable for the overall franchise network (Kidwell et al., 2007).

Agency theory covers issues regarding the contractual relationship between principal and agent. The franchise contract is the primary franchising document placing legally binding obligations and duties on both parties (Felstead, 1993) and protects the financial interests of both sides (Castrogiovanni &

Justis as cited in Pizanti & Lerner, 2003, p. 134). As agency theory contends, the contract also gives franchisees the economic incentive to be responsive to local conditions because they will benefit from the increased profitability of the unit (Cox & Mason, 2007). This indicates an important relationship for this research between the contract and the trade-off between standardization and local adaptation from an agency perspective.

2.1.3 Dimensions of the Level of Standardization

Agency theory and its specifications with respect to the level of standardization have been described in the last section. However, it has not yet been explained that the level of standardization consists of several dimensions. The following areas or dimensions can be distinguished: contractual, formal and actual. The contractual level of standardization concerns the rules and regulations stated in the franchise agreement. Most of the time the operations manual is part of the contract. These are created and agreed on before the franchisee starts doing business. The formal level of standardization comprises the official letters and announcements, the operations manual if it is not part of the franchise contract (which is rarely the case), and other formal communication from higher levels in the franchise system. At last, the actual level of standardization is the way franchisees live up to and behave regarding the standards laid on to franchisees contractually and formally. According to Baucus et al. (as cited in Cox & Mason, 2007, p. 1056) franchisors seek to establish standardization in various ways: the franchise contract, the operating manual, training programmes, monitoring and ownership incentives.

Concluding, in this research I examine contractual agreement(s) and formal communication of the franchisor to determine the level of standardization of a franchise chain. As explained in the last paragraph the level of standardization consists of three dimensions. This study focuses on the contractual and on the formal level. Within the context of agency theory, this study focuses on the dilemma of standardization versus local adaptation; simply stated, the level of standardization.

Information on this level of standardization of a franchise system cannot only be extracted from the contract (which is discussed in section 2.3), but also from the operations manual (discussed in section 2.4). If these documents leave any issue regarding uniformity unclear, the knowledge or observation of a franchisor or franchisee can be useful.

2.2 Concepts Related to the Level of Standardization

According to Stanworth and Curran (1999), franchising does not fit comfortably within the limits of any single academic discipline or area of management practice. Rather, it extends into a multiplicity of fields such as law, marketing, economics, entrepreneurship, human resource management, psychology, sociology, and organizational theory. The issue of standardization versus adaptation trade-off was already part of marketing research before it was introduced in franchising (Ozsomer, Bodur &

Cavusgil, 1991; Szymanski, Bharadwaj & Varadarajan, 1993; Papavassiliou & Stathakopoulus, 1997).

These studies focused solely on the trade-off between standardization and adaptation of marketing strategies. Today, it is widely recognized that standardization and uniformity are cornerstones of franchising (Cox & Mason, 2007).

Much has been written on the topic of standardization in business format franchising (Streed &

Cliquet, 2008). However, a consistent well grounded definition has never been put forward. Moreover, in the franchising literature other comparable concepts are used as well. Synonyms or comparable concepts such as uniformity, customization, centralization, delegation, personalization and allocation of rights dominate the franchising literature. However, these concepts cover each other partly but all have slightly different meanings and are used in different contexts. Besides, in some studies different measurement instruments of these related concepts are being proposed.

The terms extracted from the studied literature are summed up in table 2. All the terms mentioned are

related to the level of standardization. The cited literature is categorized by author in alphabetical

order since the studies are too diverse to categorize them in another way. The next part of this section

describes each concept and examines measurement instruments and determinants used in related

research. Subsequently, the measurement instruments and determinants of the relevant concepts are

summarized in table 3 and 4. Finally, this section concludes with comparing the concepts, and

indicating which parts of the discussed literature I will use in this thesis.

Table 2. Uniformity Literature Spectrum

Field of tension Article author(s) Paper/book type

←--- Level of Delegation ---→ (Azevedo & Silva, 2004) Empirical

←--- Level of Real Authority ---→ (Azevedo & Silva, 2004) Empirical [effective control over decisions exercised by the franchisors]

←--- Level of Formal Authority ---→ (Azevedo & Silva, 2004) Empirical

←--- Uniformity ---→ (Bradach, 1998) Empirical Control ←---→ Autonomy (Cochet et al., 2008) Empirical [counterbalance of franchise chains]

Standardization ←---→ Adaptation (Cox & Mason, 2007) Empirical Standardization ←---→ Autonomy (Dant & Gundlach, 1999) Empirical Control ←---→ Autonomy (Doherty & Alexander, 2006) Empirical [the methods of control international franchisors use with respect to their

franchisees in the international franchise business]

[contractual control] (Felstead, 1993) Conceptual Uniformity ←---→ Local Responsiveness (Kaufmann, 1989) Empirical Standardization ←---→ Adaptation (Kaufmann & Eroglu, 1998) Conceptual Standardization ←---→ Autonomy (Kidwell et al., 2007) Empirical

←--- Customization ---→ (Lafontaine & Oxley, 2004) Empirical

[of franchising contracts]

←--- Allocation of Rights ---→ (Leblebici & Shalley, 1996) Conceptual Control ←---→ Autonomy (Paik & Choi, 2007) Conceptual [similarities and differences between domestic (US) and international franchises] (Pizanti & Lerner, 2003) Conceptual [examining control and autonomy in the franchisor-franchisee relationship]

Standardization/Centralization ←---→ Adaptation (Sorensen & Sørensen, 2001) Empirical

←--- Personalization ---→ (Streed, 2008) Conceptual [of franchise services through relationships]

Standardization ←---→ Localization/Customization (Streed & Cliquet, 2008) Empirical

←--- Degree of Centralization ---→ (Windsperger, 2003) Empirical [of decision making (decision rights) in franchising networks]

Table 2. Literature spectrum of uniformity

Table 2 thus provides an overview of the concepts and terms used by different authors. All the concepts are comparable, though not the same. The definitions and tensions of these concepts can be found in appendix B.

The following subsections describe the concepts (uniformity, customization, centralization, control,

delegation, real authority, formal authority, personalization and the allocation of rights) and its most

important studies. The discussion of every concept starts with defining or describing it. The last part of

each subsection describes the measurement instrument used in research of the particular concept, if

there is one, and if it is closely related to the level of standardization. If there is a measurement

instrument discussed for the concept, the last part also contains its determinants.

2.2.1 Uniformity

Before defining uniformity a critical note must be made regarding the concept of uniformity, put forward by Bradach (1998) in his book ‘’Franchise Organizations’’. He proposes four management challenges of which uniformity is one. Two other challenges are directly linked to the concept of uniformity: local responsiveness and systemwide adaptation. Firstly, local responsiveness because every franchise unit must be responsive to local conditions and alter the uniform format in order to fit the local market. Secondly, if systemwide adaptations are being implemented, a new standard of uniformity will be established. Concluding, these three management challenges are explained and deal with the concept of uniformity, however no clear definition is stated. Bradach (1998) should have better indicated the second management challenge as maintaining uniformity instead of uniformity on itself. Moreover, in his book uniformity is only mentioned quantitatively and not qualitatively: the term uniformity is used, but what it implies and what it consists of is not described.

If one critically searches for a definition of uniformity in literature in which the concept is mentioned, none can be found. Besides the absence of a definition, a measurement instrument and determinants of uniformity have never been proposed in prior research.

In extant literature it is discussed what the role of uniformity is, how it could be created, several ways how it could be maintained etc. Moreover, authors write about uniformity in an adjectival way.

Uniform quality, a uniform image, external uniformity etc. are typifications or contexts in which uniformity is used. But what is uniformity actually? According to Kaufmann and Eroglu (1998) there are two abilities central to creating a uniform image: (1) clearly articulate the franchising concept and (2) communicate it consistently across time and space. They more or less define the concept as the collection of unique elements that build and maintain a distinct image among consumers. In franchising uniformity of offering and uniformity of contract are distinguished (Lafontaine & Oxley, 2004). On the one hand, uniformity of offering comprises both the unity of the product in a broad sense (the franchising chain as such: regulated exterior and interior of the establishment, clothing, services offered etc.), and the unity of the product in a narrow sense (product or service) (Kneppers- Heynert, 1988). On the other hand, uniformity of contract takes place when a franchisor offers one single contract to all its franchisees.

Measurement: not available.

Determinants: not available.

2.2.2 Customization

Customization, as used by Lafontaine and Oxley (2004), is the degree to which contracts are customized to the wishes of the firms. These researchers use a franchise guide and a magazine to compare fees and royalty rates of US and Canadian franchisors operating in Mexico. Here, customization is comparable with franchise contract uniformity. However, often customization is used in a different context. Streed (2008) uses customization in a more marketing like context, in which it designates how products (in production) and services (by actions of employees and front line personnel) are customized. In this way customization is related to uniformity of offering and is not related to contract uniformity as Lafontaine and Oxley (2004) intended.

Measurement: not available.

Determinants: not available.

2.2.3 Personalization

Another term also put forward by Streed (2008) is the personalization of services. Although, it is a pure marketing concept and has little overlap with franchising. Services are personalized by adapting them to the wishes of the individual customer. The degree of personalization of services can vary among franchises and thus is related to uniformity.

Measurement: personalization is measured by general marketing measurement instruments such as

SERVQUAL (service quality) and SERVPERF (service performance). Since these are pure marketing

instruments an explanation and a discussion of determinants of personalization is beyond the scope of

this study.

Concluding, personalization is only related to the level of standardization from the perspective of the customer. For example, the design of the exterior and interior of a unit is not covered by the concept personalization.

Determinants: not relevant.

2.2.4 Centralization

In Windsperger’s (2003) research, the degree of centralization of decision making in franchising networks is determined by applying the property rights theory. From the franchisor’s perspective: the higher the specific assets, the more decision rights and subsequently the higher the degree of centralization of the franchise network. So, the more centralization the better the franchisor is able to protect uniformity of offering. This uniformity of offering is dealt with in the contract.

Measurement: based on a questionnaire Windsperger (2003) measures a number of variables on a one to five or a one to seven scale, except the control variables. The questions were asked to franchisors.

Table 3 shows the measurement instrument of this study.

Determinants: the main determinants of centralization are the knowledge assets of both the franchisor and the franchisee (table 4). On the one hand, franchisor’s knowledge assets consists of training days (initial and annual) and advertising fees. On the other hand, franchisees’ knowledge assets comprise local marketing, human resource, quality control and innovation. Based on the property rights approach, residual decision rights in franchising networks must be allocated according to the distribution of intangible knowledge assets between the franchisor and franchisee: the more important the franchisor’s system-specific assets for the generation of residual surplus, the more residual decision rights are assigned to the franchisor, and the higher the degree of centralization of te franchising network (Windsperger, 2003).

2.2.5 Allocation of Rights

Regarding the franchise contract, property rights are divided between franchisor and franchisee in order to fulfil the need to control resources as well as the need to be independent and flexible. As Rubin argues, the structure of the contract is such as to give each party property rights in those aspects of the operation under his control (as cited in Hoy & Stanworth, 2003, p. 59). Below it is explained why this is the case.

The main item in the transaction between a franchisor and franchisee is the trademark. This is a valuable asset since consumers know the price and quality standards related to this trademark. Since franchisors make certain that quality standards are maintained, consumers know exactly what to expect. The result is an externality problem. If a franchisee of a chain offers lower quality of services or products, she gains revenue. Revenue is extracted because consumers assume that this particular franchisee offers the same quality as others in the chain. The amount of this revenue equals the amount of savings which stems from reduced quality savings. The franchisee only suffers partly for the costs related to the decrease in quality; the burden of all costs is carried by the whole chain. So, consumers will have less faith in the trademark and all franchisees will loss in the end.

Measurement: Leblebici and Shalley (1996) develop four types of rights. Moreover, they divided the franchise contract into seven contract categories (table 3). On the basis of thirty franchise contracts they estimate the presence of these four rights in the agreements. The rights are measured against governance mechanisms, monitoring intensity and contract length. The presence is being reflected and scored with a percentage. It is just a simple score which reflects the percentage coverage of the rights regarding all the contracts. If every contract out of the sample contains a certain type of right the score is 100 percent. Since the rights in the contracts are being scored on their presence, determinants are not relevant in this research.

Determinants: not relevant.

2.2.6 Control

Control (in relation to autonomy) deals with the franchisor supervising and keeping the actions of its

franchisees within boundaries in order to establish consistency between units with respect to

measurable factors. According to Rubin, control by the franchisor may extend over products sold,

price, hours of operation, conditions of the plant, inventory, insurance, personnel, and accounting and

auditing (as cited in Hoy & Stanworth, 2003, p. 51). Control and autonomy are two extremes of the same continuum. They are a subject of the division of power between franchisor and franchisee.

Measurement: both Felstead (1993), and Paik and Choi (2007) developed a measurement instrument regarding control in franchising. The latter research focuses on key activities of control and autonomy, whereas the former is specifically dealing with contractual control. The measurement instruments of both researches can be found in table 3.

Determinants: there are no determinants since Felstead (1993) only examines contracts on the basis of six elements of contractual control and finds out if a franchise is soft or hard. However, Paik and Choi (2007) do indicate five driving forces that influence the perception of dependence and the desire for autonomy on the part of the franchisees: success of the franchisee, franchisee ownership format, level of experience of the franchisee, competition level in the market, and growth stage of a franchise.

Higher levels of success decrease the desire for autonomy of franchisees. With respect to the ownership format multi-unit franchisees have more flexibility than their single-unit counterparts.

Besides, master franchisees expressed no desire for a lower level of autonomy (Paik & Choi, 2007).

The level of experience of the franchisee and the growth stage are positively related to autonomy.

Finally, the higher the competition level in the market lead to a lower desire for autonomy. Table 4 sums up these determinants and their influence on the desire for autonomy.

2.2.7 Delegation, Real Authority, and Formal Authority

Azevedo and Silva (2004) discuss three terms related to the level of standardization in one article:

delegation, real authority, and formal authority. Real and formal authority are part of the level of delegation. These researchers investigate the allocation of formal and real authority in franchise chains. The level of real authority is the effective control over decisions. Formal authority is the right to decide.

Aghion and Tirole (as cited in Azevedo & Silva, 2004) argue that besides allocating formal rights by means of a contract, the parties choose how much effort they want to spend in monitoring and measuring information, which is relevant in determining the effectiveness of their formal rights. This is the issue of allocation or real authority.

Measurement: Azevedo and Silva (2004) measure a number of variables (table 3) with respect to their influence on the level of delegation. In order to indicate a relationship between terms it can be said that the level of delegation is part of authority. Streed and Cliquet (2008), in turn, argue that uniformity could be maintained by authority.

Determinants: there are three main determinants of real and formal authority: tasks prescribed in the franchisees’ manual, proportion of company-owned outlets, and monitoring intensity. They are described in more detail in table 4.

From an agency theory perspective the following can be described: in their model (Aghion & Tirole as

cited in Azevedo & Silva, 2004), a principal contracts an agent to perform some task (the selection of

projects that may be implemented by both). The separation of formal and real authority derives from

asymmetric costs in collecting information about the quality of each project. If the principal delegates

to the agent the right to choose a project, the agent will make more effort collecting information about

the projects, thus saving on information costs that would be incurred by the principal. On the other

hand, the agent is likely to choose a project that would not be the principal’s choice. Based on this

trade-off, the principal decided its own effort in acquiring information, and, as a consequence,

determines the allocation of real authority to the agent.

As was described above some of the studies outlined in table 2 proposed or developed measurement instruments to measure the concepts under investigation. Because the measurement of the level of standardization is an important part of this thesis, the following table provides oversight of the instruments (if present) related to some of the concepts in table 2.

Table 3. Measurement Instruments of the Concepts

Degree of Centralization (Windsperger, 2003)

Allocation of Rights (Leblebici & Shalley, 1996)

Control (Felstead, 1993).

Control vs. Autonomy (Paik & Choi, 2007)

Level of Delegation:

Level of Real Authority Level of Formal Authority

(Azevedo & Silva, 2004)

With respect to the decision rights the franchisors were asked to rate franchisee’s influence on the decisions mentioned below on a seven-point scale.

(1) Procurement decision (2) Product decision

(3) Accounting system decision (4) Resale price decision (5) Advertising decision (6) Employees’ training decision (7) Investment and financial decision (8) Recruiting decision

These authors subdivided franchise contracts in seven contract categories:

(1) General contract provisions (2) Provisions of uniformity

(3) Obligations of managerial assistance (4) Employee conduct provisions (5) Provisions on operations (6) Termination of the contract

(7) Relationship between the parties after termination

The seven groups are categorized in two main classes. The ‘formation and terminations’

provisions: 1,6, and 7. The ‘operations and conduct’ provisions: 2, 3, 4, and 5.

Six key elements of contractual control: (1) non-exclusivity, (2) performance targets, (3) stake in intangible business assets, (4) operations manual, (5) post-termination restrictions and (6) monitoring of output quality.

Felstead assesses contracts individually on these six key components with a score of 0 indicating the component’s absence, 1 its presence and, where appropriate, 2 indicating its presence in a stronger form. The scores for each contract are then added together producing an index of contractual control ranging from 0-9.

Index of contractual control

‘Soft’ franchising (0-3)

‘Medium’ franchising (4-6)

‘Hard’ franchising (7-9)

Seven key activities that involve control and autonomy in the franchise system are identified:

(1) location selection, (2) adaptation to local market, (3) franchise agreement, (4) marketing, (5) monitoring mechanism, (6) supplier selection, and (7) training.

Based on in-depth interviews with franchisor representatives and franchisees the researchers determine if the degree of autonomy accorded is higher for franchisees in the US compared to franchisees in Europe (Iceland, Ireland, the UK, Belgium, and The Netherlands).

Departing from three variables (tasks prescribed in the franchisee’s manual, proportion of company-owned outlets, monitoring intensity), the authors constructed a delegation index, with equal weight for each variable, ranging from ‘0’ (no delegation) to ‘1’ (complete delegation).

Table 3. Measurement instruments of concepts outlined in table 2 (if present)

Next to measuring it is also important and useful to know what the determinants of the concepts are.

This explains the reasons behind why a certain score or level is being measured. The next table shows

the determinants of the concepts outlined in table 3.

Table 4. Determinants of the Concepts of Table 3

Degree of Centralization (Windsperger, 2003)

Allocation of Rights (Leblebici & Shalley, 1996) Control

(Felstead, 1993).

Control vs. Autonomy (Paik & Choi, 2007)

Level of Delegation:

Level of Real Authority Level of Formal Authority

(Azevedo & Silva, 2004)

Three groups of variables are important for testing how residual decision rights in franchising networks are allocated according to the distribution of intangible knowledge assets between the franchisor and franchisee: (1) knowledge assets, (2) decision rights, and (3) control variables.

The first group can be considered as main determinants of centralization.

(1a) Franchisor’s intangible knowledge assets - Training days (initial and annual) - Advertising fees

(1b) Franchisee’s knowledge assets - Local marketing

- Human resource - Quality control - Innovation

Regarding these determinants, the more important the franchisor’s intangible knowledge assets for the generation of residual surplus relative to the franchisees’, the more residual decision rights must be assigned to the franchisor. More decision rights for the franchisor, in turn, implies a higher degree of centralization.

Not relevant

Not relevant

There are five driving forces that influence the perception of dependence and the desire for autonomy on the part of the franchisees:

(1) success of the franchisee (+ leads to higher desire for autonomy)

(2) franchisee ownership format (multi-units have more flexibility than single-units) (3) level of experience of the franchisee (+ leads to higher desire for autonomy) (4) competition level in the market (+ leads to a lower desire for autonomy) (5) growth stage of a franchise. (+ leads to higher desire for autonomy) Determinants of the allocation of real and formal authority are:

(1) tasks prescribed in the franchisee’s manual. The more comprehensive the tasks prescribed, the lower the level of formal authority allocated to franchisees.

(2) proportion of company-owned outlets. The greater the proportion of company-owned outlets, the lower the formal authority allocated to franchisees in the whole chain. In addition, as vertical integration changes information structure, the real authority, for a given formal distribution of decision rights, will be lower.

(3) monitoring intensity. The more frequently the franchisor inspects the franchised units, the lower will be the real authority allocated to franchisees.

The following variables are used to measure the effect on the level of delegation: experience before franchising, externalities, number of outlets, domestic, years of franchising experience, franchisee investment, no. employees per outlet, geographic dispersion, R&D outlet.

Table 4. Determinants of the concepts of table 3.

The next section compares and distinguishes the concepts in order to provide an overview and

indicates which parts of the literature from the discussed concepts are relevant and, thus, being

adopted or used in the remainder of this thesis.

2.2.8 Comparison of the Concepts

The concepts just discussed are compared below and an overview of them is presented in table 5. The concepts of uniformity (of offering) and the level of standardization are connected tightly and are often used interchangeably in franchising literature. The main difference is that standardization versus local adaptation is usually presented as a trade-off and uniformity is not.

Customization as Lafontaine and Oxley (2004) used it, deals with adapting the franchise contract to the wishes of the franchisee in general and not only on standardization versus adaptation related issues. They took the concept directly from marketing, however they did not use it in a marketing context. The term customization can be used in research when something (contract, strategy, behaviour etc.) can be adapted to the wishes of the customer (or franchisor/ franchisee/ managers/

employees etc). The level of standardization deals with uniformity considerations in operations and the contract accordingly, whereas customization only focuses on the degree of adaptation of the franchise contract to the wishes of the parties involved.

Personalization of services is a marketing concept regarding the level of standardization from the perspective of the customer. The level of standardization is a broader concept. It concerns the perspectives of both parties in a franchise agreement. Thus, the term personalization can be used in research where services are being adapted to the needs of the customer. Here, he or she is the most important party under consideration.

Centralization, control, delegation, real authority, formal authority and the allocation of rights are all concepts of power. Additionally, centralization and allocation of rights in franchising research are both subject to the property rights theory. These concepts can be used in research when the level is determined by adopting this particular theory. Since this study is not based on the property rights theory, the terms centralization and allocation of rights are not used. Centralization is appropriate in research if one studies the level of standardization on the basis of decisions by the franchisor and franchisee. The distribution of intangible knowledge assets plays an important role. The adoption of the allocation of rights as a term is applicable to franchising research on the basis of contracts from a property rights perspective.

Control, and the level of real and formal authority deal with the trade-off of control versus autonomy

which is another than standardization versus local adaptation. In the former there is a certain division

of power whereas in the latter the freedom of movement of the franchisee granted by the franchisor is

determined. Control, as a concept, can be adopted in franchising research which focuses purely on

power. Formal and real authority are concepts that can be used to measure the level of delegation.

Table 5

Concept/Author Theory Concept Specific Important Characteristic(s)

Measurement of the Concept

Instruments Available

Uniformity - No Distinction between uniformity of

(Bradach, 1998) contract and offering

No measurement instr. available

Customization Agency theory No Marketing term

(Lafontaine & Comparable to the concept of

Oxley, 2004) uniformity of contract

Personalization Marketing literature No Pure marketing term

(Streed, 2008) Used as a synonym for for individual

adaptation

Centralization Property rights No Concept of power

(Windsperger, 2003)

Allocation of Rights Property rights Yes Concept of power

(Leblebici &

Shalley, 1996)

Control Agency theory Yes Concept of power

(Felstead, 1993) Exchange theory (Paik & Choi, 2007) Marketing channel

literature

Delegation Agency theory Yes Concept of power

Real Authority ,, ,, ,,

Formal Authority ,, ,, ,,

(Azevedo & Silva, 2004)

Level of Standardization Agency theory Yes Deals with (uniformity of)

operations

(based on Kaufmann

& Eroglu, 1998)

Table 5. Theory, availability of measurement instruments and characteristics of the concepts

2.3 The Franchise Contract

A franchise agreement is a contract between two (legal) firms, the franchisor and the franchisee. The franchisor is a parent company that has developed some product or service for sale; the franchisee is a firm that is set up to market this product or service in a particular location. The franchisee pays a certain sum of money for the right to market this product (Rubin, 1978). The franchise fee is the lump sum that the franchisee has to pay the franchisor once, in order to do business in the name of the trademark. Besides, the franchisee pays royalties to the franchisor (usually on a monthly basis) which is often a certain percentage of its sales. However, in turn, he has the assurance (or at least should have) the he is going to sell a product well known by consumers (Rosboch, 2005).

The franchisor and franchisee both have responsibilities they must carry out in order to take part in the

franchise concept. Together they sign a contract when doing business with each other in which the

responsibilities are laid down. Franchisors have a contractual -or at least an implied obligation- to

maintain their system’s brand image and standing through advertising and promotion, and through the

control of other participants in the franchise system. Next to paying a fee and royalties the franchisee

will also be expected to maintain the standards of the franchise outlined by the franchisor in the

Franchise contracts are relational because they bring together and maintain the relationship between franchisor and franchisee in the form of rights and obligations. The contracts are incomplete because the contracts are neither employment nor discrete spot market or futures contracts (Rubin, 1978).

Besides, the franchise agreement usually has the character of a standard contract. This is an agreement which is full of uniform conditions or standard stipulations (Kneppers-Heynert, 1988).

2.3.1 The Structure of a Franchise Contract

The franchise contract has a more or less standardized structure. As was briefly introduced in table 3 Leblebici and Shalley (1996) identified and selected seven major contract categories:

1. general contract provisions such as the nature of franchise, territory of franchise, protection from competition, degree of franchisee participation in the business;

2. provisions of uniformity that include items such as physical layout, product lines, hours of operation;

3. obligations of the franchisor that include various types of managerial assistance provided to the franchisee such as site selection, and training programs;

4. employee conduct provisions that specify the rights of the franchisee and the franchisor with respect to the employees of the franchisee;

5. provisions on operations that specify how the service should be provided;

6. termination of the contract;

7. relationship between the two parties after termination.

The categories of number 1,6 and 7 are ‘formation and termination’ provisions. Number 2,3,4 and 5 are the ‘operations and conduct’ provisions (Leblebici & Shalley, 1996).

2.3.2 Peculiarities of the Franchise Contract

Next to the structure of the contract, a few important aspects must be mentioned. The following three aspects of franchise contracts can be indicated (Kneppers-Heynert, 1988):

1. It is not always possible to formulate the obligations precisely.

2. Distractions of regulated behaviour are difficult to ascertain.

3. There is a free-riding potential, because franchisees may show opportunistic behaviour.

The first aspect requires more nuance. Even though obligations are not watertight, vague formulations can also be formed on purpose. The provisions applying to the franchisee tend to say that ‘the franchisee will do such and such at a given place, in a specific amount of time, and in a particular manner. On the other hand, franchisor provisions are inclined to be more vague and are hedged in limiting phrases (Felstead, 1993)’. These kind of formulations restrict the franchisee in its freedom of movement and makes it easy for franchisors to refrain from duties and obligations.

2.3.3 The Franchise Contract in an International Context

So far, this section has described the franchise contract in general. However, this study has an international focus. Therefore, the contract also has to be placed in an international context. Within the domestic context, most contracts between franchisee and franchisor are standardized (Lafontaine &

Kaufmann as cited in Fladmoe-Lindquist, 1996, p. 424). However, in the international environment, franchising contracts vary substantially (Abell as cited in Fladmoe-Lindquist, 1996, p. 424).

Lafontaine and Oxley (2004) agree on this issue and state that if there exists a context where one might expect a franchisor to diverge from a practice of offering a single uniform contract across all franchisees, foreign expansion is surely it.

Concluding, the franchise agreement is the primary franchise document placing legally binding obligations and duties on both parties. Therefore, the contract plays a major role in determining the relationship between franchisor and franchisee (Felstead, 1993) and the level of standardization accordingly. The contract comprises categories dealing specifically with this level of standardization.

With respect to this level of standardization the formation and termination areas of the contract

discussed on the last page are irrelevant. These provisions are not relevant since they do not represent

issues that involve distractions from the level of standardization of individual franchise units. The

provisions on operations deal with the freedom of movement the franchisee has in implementing the