Franchise system growth strategy

by Venkatesh Shankar Coleman Chair in Marketing

Why do some franchisors (corporate entities) such as Pearle Vision and Jazzercise grow larger than others? Is it due to the right decisions on pricing policy, such as the royalty rates franchisors charge the independent business owners, or franchisees, for use of the franchise name and product and the up-front fixed fees? Or is it due to appropriate decisions on the strategic control of the franchise system — from the number and proportion of outlets owned and operated by the franchisor to the initial franchisee investment and how much financing the franchisor can offer? In my recent research with co-authors Scott Shane and Ashwin Aravindaskhan, “Franchise System Growth Strategies: Conceptual and Empirical Analyses,” we examine what growth strategies contribute to the expansion of a franchise system.

We sifted through data on 1,292 business format franchise systems from 152 industries that were established in the United States between 1979 and 1996, analyzing their evolution from inception.

The results show that franchisors that grow larger are most cost effective to their franchisees and exercise appropriate control over their franchisees. Those franchisors that open more outlets typically: Lower royalty rates as the systems age; have low up-front franchise fees and raise them over time; own a small proportion of outlets and lower that percentage over time; keep franchisees’ initial investment low; and, finally, finance their franchisees. These strategic decisions of franchisors increase the value of their brands, reduce franchisee risk, and increase the attraction of new franchisees, thus explaining the growth to a larger franchise system. These findings are novel and counter to previous research that suggested franchisors do not vary their pricing policies much over time.

Our results have useful implications for practitioners. Managers can use the findings to better understand the pricing policy structure — the appropriate mix of franchise fees and royalty rates over time — that drives the growth of a franchise system. We find that franchise system growth is negatively related to the proportion of company-owned outlets, which suggests to managers the merits of minimizing ownership to achieve widespread growth. Finally, franchisors who want to grow larger may be able to use their financial resources to keep their franchisees’ initial investment in the outlets low and to finance franchisees, both of which can drive the expansion of a franchise system.

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