The influence of franchise system factors on franchise systems’
competitive advantage in a new industry
A case study of the Dutch coffee bar industry
Master’s Thesis
Roderik de Haan (s1564714)
University of Groningen
Faculty of Economics and Business
MSc Business Administration - Strategy & Innovation
Supervisors
Abstract
This master’s thesis investigates how franchise system factors influence franchise systems’ competitive advantage in a new industry. The various franchise system factors, derived from literature, are: financial requirements for new franchisees, training, location, standardization, systemwide adaptation, growth, competitive positioning, and company-ownership versus franchise-ownership. These franchise system factors are applied to two cases in The Dutch coffee bar industry, which is considered a new industry in terms of the industry life cycle. The two cases selected are very different in terms of competitive advantage in order to find if a possible difference in the franchise system factors can explain this difference in competitive advantage in a new industry. The results from the case study show that the industry life cycle is of influence on how the franchise system factors influence franchise systems’ competitive advantage. For a franchise system to be successful in a new industry it was concluded that new locations should be carefully researched, standardization and systemwide adaptation should be very high, growth through the opening of new locations in new areas is most important in terms of growth, and the franchise system’s locations should be predominantly franchise-owned. Because the case study includes two cases and because of the specificity of the industry studied, the generalizability of this master’s thesis’ findings is limited. Recommendations are made to apply the various franchise system factors to a larger number of franchise systems in various industries to increase generalizability.
1.
Introduction ___________________________________________________ 1
2.
Literature review _______________________________________________ 6
2.1. Theoretical background – Part 1 – General introduction of the main subjects... 6
2.1.1. Competitive advantage ...6
2.1.2. Resources...9
2.1.3. Strategy...11
2.1.4. Structure ...13
2.1.5. Industry life cycle ...14
2.2. Theoretical background – Part 2 – Applying the main subjects to franchise systems ... 18
2.2.1. Introduction ...18
2.2.2. Franchise system factors...20
2.2.2.1. Resources ...20
2.2.2.2. Strategy ...23
2.2.2.3. Structure...29
2.2.3. Industry life cycle ...30
2.2.4. Summary...31
2.2.5. Propositions ...32
3.
Methodology __________________________________________________ 35
3.1. Introduction ... 353.2. General method of inquiry... 35
3.3. Research approach: case study ... 36
3.4. Case study design... 36
3.5. Selection of cases... 38 3.6. Data collection... 38 3.7. Measurement... 39 3.8. Analytic strategy... 42
4.
Results _______________________________________________________ 43
4.1. Introduction ... 434.2. The Dutch coffee bar industry and the ILC... 44
4.3. Case analysis ... 50 4.3.1. Financial requirements...50 4.3.2. Training ...53 4.3.3. Location ...54 4.3.4. Standardization ...55 4.3.5. Systemwide adaptation ...57 4.3.6. Growth ...58 4.3.7. Competitive positioning...62
4.3.8. Company-owned versus franchise-owned ...64
4.3.9. Summary...65
5. Discussion ____________________________________________________ 67
5.1 General discussion ... 671.
Introduction
Differences in how firms become successful exist in every industry. Firms that are more successful in terms of profitability apparently possess something special that allows them to outperform competitors (Bharadwaj, Rajan Varadarajan & Fahy, 1993). Because different types of businesses are organized and managed in different ways, each type of business has different factors that contribute to a firm’s success. Franchising is a business form in which the owner (franchisor) of a product, service, or method obtains distribution of it through dealers (franchisees) in exchange for initial fees and ongoing royalties (Sorenson & Sørenson, 2001). This relationship between franchisor and franchisee is what makes a franchise system different from other organizations such as a hierarchical organization. In general, the franchisee agrees to adhere to several requirements set by the franchisor. Often these requirements are about product mix, operating procedures, and quality. In return, the franchisee is provided with managerial assistance, training, advertising assistance, operating procedures, and site selection (Rubin, 1978). According to Sorenson & Sørenson (2001), franchising is particularly common among chains, including restaurants, hotels, and small business services, in the form of business-format franchising. Examples of franchise systems in different industries can be found in fast food (McDonalds, KFC & Subway), banking (SNS Bank1) and events (World Economics Forum). According to Combs, Michael & Castrogiovanni (2004), two characteristics of franchising distinguish it from other organizational forms. Firstly, franchising usually has an important service component which must be performed near customers. Secondly, franchise contracts typically reflect a unique allocation of responsibilities, profits (and losses), and decision right between the franchisor and franchisee. A major advantage of franchise is the economies of scale that are created by the many geographically dispersed locations (Bradach, 1998). An issue related to this is about the balance franchisors have to find between profiting from these economies of scale through standardization and adapting to local market preferences (Kaufmann & Eroglu, 1998). Also, franchisors have to deal with decision rights. The franchisee acts as an independent business owner and as such expects to have certain freedoms which are related to the decisions they can make. Windsperger (2004) describes decision rights and how these should be distributed between franchisor and franchisee.
Franchise systems are organizations consisting of multiple units operating under a common trademark in diverse locations (Bradach, 1998). Franchise systems generally consist of both
franchise-owned and company-owned locations. Most literature regarding franchising has been conducted, not unlike other fields of study, in the United States. As the franchise organization can be considered a specific type of business there are specific factors that contribute to its success. Therefore, these factors are very relevant to study. Franchise literature, however, generally focuses on specific elements of franchising such as organizational learning (Sorenson & Sørenson, 2001), the plural form of franchising (Bradach, 1997), and growth (Anderson, 1984). Also, the focus of the research is often from the viewpoint of the franchisor and/or franchisee, and not the franchise system as a whole. What contributes to a franchise system’s success is broader than one specific factor or a single viewpoint. There is, however, research that focuses on franchise system success in broader terms. This research, that is conducted on franchise system success includes, among others, an article by Shane & Spell (1998). They discuss “factors for new franchise success” from the franchisee’s perspective. In another article by Lee (1999), a model of antecedents was developed and tested to determine the effect of key factors that determine the quality of the franchisor-franchisee relationship, for example franchisor-franchisee performance. Other literature regarding franchise system performance was conducted by Sorenson & Sørenson (2001), who found that the correct mix of governance structures in a chain affect the success of both the franchisor and franchisees. Of course, it is practically impossible to conduct an all-encompassing study. However, the different fields of study mentioned are interrelated. To study how franchise systems attain a competitive advantage, one has to consider many factors that might influence competitive advantage. Also, an industry’s age is expected to be relevant in this relationship. With regard to industry age, Klepper (1997) states that when an industry matures the firms in the industry will move from a diversification strategy to a low-cost strategy. Thus, franchise systems are likely to achieve competitive advantage in other ways in new industries compared to established industries. Therefore, the industry life cycle (ILC) should be taken into account. Previous research topics on franchise systems and more specific the different stages in their development are often generalized approximations, and rarely consider the dynamics of the ILC. Furthermore, because previous research was primarily on large franchise systems in large industries, the focus was on established systems (Bradach 1998, Winter & Szulanski 2001). As a result, the development of new franchise systems in a new market has had less attention in literature.
The main research question:
How do franchise system factors influence franchise systems’ competitive advantage in a new industry?
Part 1 - General
1. When does a firm hold a competitive advantage?
2. What is the influence of resources, strategy, and structure on competitive advantage and which specific resources influence competitive advantage in the early stages of the industry life cycle?
Part 2 – Franchise systems
3. What sets franchise systems, as a business form, apart from other business forms?
4. Which resources leading to a competitive advantage for firms in general can be applied to how franchise systems achieve competitive advantage and are there factors in literature that apply to franchise systems specifically?
Part 3 – Case study
5. Which franchise system factors influence competitive advantage for the two franchise system cases which are in the early stages of the ILC?
Part 4 – Conclusion
6. What are the differences between the theory and cases with regard to which franchise system factors influence franchise systems’ competitive advantage and how does this influence the theory?
Figure one shows the conceptual model:
Franchise System Factors: - Financial requirements for new
franchisees - Training - Location - Standardization - Systemwide Adaptation - Growth - Competitive positioning - Company-owned versus franchise-owned
Figure 1. The conceptual model
Franchise System’s Competitive Advantage in a
The first part of the conceptual model represents the various franchise system factors that are considered to influence the competitive advantage for franchise systems in general. These franchise system factors are discussed in section 2.2.2. The focus of this master’s thesis is specifically on franchise systems operating in a new industry as can be seen in the second part of the conceptual model. Theory regarding the industry life cycle is discussed to determine when an industry can be considered a new industry.
2.
Literature review
2.1. Theoretical background – Part 1 – General introduction of the main
subjects
In this first part of the literature review, literature is introduced that will help to answer the first two sub questions. This first part serves as a built-up to the second part of this literature review in which the different subjects of the first part are discussed in the light of franchise systems. More specifically, the resources discussed in section 2.1.2., strategy in section 2.1.3., and structure in section 2.1.4. are discussed again in part two of the theoretical background, but then from the perspective of franchise systems.
2.1.1. Competitive advantage
In many industries firms perform differently in terms of profit. Some firms perform below average, others average, and some above average. According to Porter & Millar (1985), firms performing above average possess a competitive advantage over rivals. Competitive advantage occurs when an organization acquires or develops an attribute or combination of attributes that allows it to outperform competitors (Porter, 1980). Also, for firms to have a competitive advantage, the difference(s) between the firm and its competitors must be felt in the marketplace (Coyne, 1986). In other words, besides having skills or resources that competitors do not have, it must also be apparent to a firm’s consumers. Competitive advantage can be measured via financial and broader operational criteria (Venkatraman & Vasudevan Ramanujam, 1986). According to them, examples of financial criteria are: sales growth, profitability, and earnings per share. The broader operational criteria are: market share, product quality, new product introduction, marketing effectiveness, and manufacturing value-added. Measurement of competitive advantage is further discussed in the methodology.
words, a firm’s strategy mobilizes resources in a way that can lead to a competitive advantage of competition (McGee, Thomas & Wilson, 2005). A firm’s ability to distinguish itself from competitors by investing in hard-to-imitate and specific resources is the central idea in the resource-based view (RBV) of the firm (Barney, 1991). In the theory of the RBV, it is assumed that firms within an industry may be heterogeneous with respect to the strategic resources they control. Also, it is assumed that these resources may not be perfectly mobile across different firms. Therefore, heterogeneity may be sustainable over time (Barney, 1991). According to him, not all the resources possessed by a firm hold the potential for sustained competitive advantage (Barney, 1991). To have this potential, a firm’s resource must have four attributes:
1. It must be valuable, in the sense that it exploits opportunities and/or neutralizes threats in a firm’s environment.
2. It must be rare among a firm’s current and potential competition. 3. It must be imperfectly imitable.
4. There cannot be strategically equivalent substitutes for this resource that are valuable but neither rare nor imperfectly imitable.
the competitive advantage. The strategic task for firms is to sustain the rent streams by creating and protecting the competitive advantage and the strategic assets that together underpin them.
There is also criticism on the RBV. Priem and Butler (2001) argue that the static RBV argument has potential limitations for strategic management research. In the sequence of arguments in the RBV there is first a resource that can produce a competitive advantage. Then the heterogeneity of that specific resource is established. Following this is the demonstration of the resource value by asserting that the resource can produce a competitive advantage. Finally, some isolating mechanisms are confirmed, which makes the resource hard to replicate, and thus potentially sustainable. The problem with this argument, according to Priem and Butler (2001), is that this static argument identifies generic characteristics of rent-generating resources without paying much attention to the differing situations or resource comparisons. An example of this problem from an article by Castanias & Helfat (1991) is presented by the authors. In this article, CEOs are argued to have either superior or inferior management skills, but this is not a basis for discriminating among superior and inferior CEOs before performance results are in. Furthermore, the processes through which certain resources provide a competitive advantage remain in a so-called “black box”. In other words, these resources are known to provide sustainable rents through their heterogeneity, but it is unknown how these resources generate a competitive advantage. How resources can generate competitive advantage is an important element of this master’s thesis. To be able to investigate this, first strategy has to be discussed, which in the context of this master’s thesis is about how resources are applied to attain competitive advantage. The focus in this master’s thesis is on competitive advantage and not sustainable competitive advantage because firms in a new industry are also new and therefore it cannot yet be determined whether a competitive advantage is sustainable. Further on in this master’s thesis other factors related to a franchise system’s strategy and structure are discussed that can lead to a competitive advantage. Strategy and structure describe how resources are applied by the franchise systems to achieve competitive advantage. Thus, unlike resources, which are often in the possession of a firm or not at all, these factors can be applied to a different degree by each firm.
2.1.2. Resources
In this section, several resources are introduced that are considered to influence competitive advantage for firms in general. These different resources, found in literature, are divided into the five categories of resources that were described earlier, namely: physical, human, organizational, financial, and legal. The resources will be discussed more thoroughly in the second part of the theoretical background.
A corporate strategy can be successful when it is based on resources that make it possible for a firm to build systemwide advantages that are not easily imitated by competitors. In other words, the resources firms possess can have a significant influence on the competitive advantage they can create.
The physical resources found in literature are: geographic location (Barney, 1991) and raw materials (Barney, 1991). Geographic location is about convenience for customers, affordability, and access to employees. Related to geographic location is spatial preemption, which is about the preemptive identification of ideal locations which is important to be able to give the best service to the customers. Different types of raw material are often exclusively found in certain parts of the world. Accessibility to raw material can lower the cost of the supply chain. For example, steel plants can often be found are near sources of iron ore and coal.
Resources in the category human are: skilled personnel (Wernerfelt, 1984) and training (Barney, 1991). Skilled personnel is about employees who are skilled to a degree that makes it hard for competitors to match the qualities they possess. The qualities can be gained through education and experience. Training can increase a firm’s efficiency and productivity (Argote & Ingram, 2000). Also it can improve service provided by firms.
One financial resource is included, namely: capital (Wernerfelt, 1984). Capital gives firms the opportunity to expand and improve operations.
The last category, legal, includes the following resources: physical technology (Barney, 1991), machinery (Wernerfelt, 1984), and product, process, managerial innovations (Bharadwaj, Varadarajan & Fahy, 1993). Physical technology is considered similar to machinery, which is described in the paragraph on physical resources. Machinery can deter new entrants when the technology is protected through patents, copyright, or secrecy. Product, process, and managerial innovations are resources that can lead to a competitive advantage when they remain proprietary, meaning that competitors do not have access to them.
The different resources discussed above are summarized in table one below:
Category Resource Description
Location Convenience for customers,
affordability, and access to employees
Physical Resources
Machinery Protected through patents, copyright, and/or secrecy
Raw materials Access to these can lead to lower costs
Skilled personnel Gained through education and/or training
Human Resources
Training Can increase a firm’s efficiency and productivity
Brand name Can lead to increase of customers Efficient procedures Lower costs and faster responsiveness
Organizational Resources Scale Cost advantages
Organizational learning
Process of learning about new products, product groups, and improvements of current operations
Financial Resources Capital Expand and improve operations
Physical technology See machinery
Legal Resources Product, process, and managerial innovations
Advantage when it remains proprietary
2.1.3. Strategy
In section 2.1.2. resources were discussed and how these are important in reaching a good competitive position. The RBV describes what resources’ characteristics should be to be able to lead to a competitive advantage, but it does not discuss how these resources can be used to attain a competitive advantage. This section describes generic strategies used by firms which are about how firms use the resources they have to create a competitive advantage.
Strategy in general is a plan of how to achieve a certain goal (McGee, Thomas & Wilson, 2005). The general goal of for-profit firms is to be profitable. Besanko, Dranove & Shanley (2009) state that when a firm earns a higher profit than the average profit of other firms in the same market it has a competitive advantage in that market. Thus, a firm’s strategy describes what firms do with resources and how this leads to a competitive advantage. As stated earlier, competitive advantages arise when an organization acquires or develops a combination of resources that allows it to outperform competitors (Porter, 1985). Thus, a strategy can only be useful when it is distinctive (Pitts & Lei, 2006). Firms build a competitive advantage when they employ activities that give them an edge over competitors in attracting consumers. Through the use of certain resources, which are discussed later on, firms can have a superior product, a superior service, produce at the lowest cost, or focus on a niche of the industry. Porter (1980) identifies three internally consistent generic strategies for creating a defendable position in the long run and to outperform competitors in an industry. These three are designed to be distinctive from rivals. These three generic strategies are overall cost leadership, differentiation, and focus. Firms can sometimes successfully pursue more than one approach as its primary target.
The first strategy, overall cost leadership, is about achieving low cost relative to competitors. A low-cost position can yield above-average returns in an industry despite the presence of strong competitive forces. It is based on locating and leveraging different sources of cost advantages in firms’ value chain of activities. A firm pursuing a cost-leadership strategy still has to pay attention to quality, service and reliability. Otherwise, a firm’s offering can become unacceptable up to a certain point at which consumers will not buy the product or service.
strategy may lead to high profitability when the price premium is higher than the costs of distinguishing the product or service. When potential exists for increased buyer value, there is an opportunity to pursue the differentiation strategy. A company can differentiate itself from competitors at every point where it comes in contact with consumers (MacMillan & McGrath, 1997).
The third strategy, focus, is about concentrating strategy on a particular buyer group, segment of the product line, or geographic market. This strategy can be successful because it enables a firm to serve its narrow strategic target more effectively or efficiently than competitors having a broader strategy. Superior value is created when other less-focused firms cannot specialize or conduct their activities as good as the focused firm. An assumption of the focus strategy is that the firm is able to attract an increasing number of new consumers and/or continues to attract repeat buyers. Repeat buyers are especially important in this strategy because they are knowledgeable about the firm’s products and/or services and are less likely to be price sensitive. Above that, repeat buyers may become very committed with the firm’s product and/or service. There are two ways for a firm to build a focus strategy. It can adopt a cost-based focus or a differentiation-based focus. Thus, the sources for building a competitive advantage for cost and differentiation strategies can also be applied to the focus strategy.
Furthermore, a firm can be “stuck in the middle”, which means a firm fails to develop its strategy in at least one of the three directions. According to Porter (1980), firms that are stuck in the middle compete at a disadvantage because the cost leaders, differentiators, or focusers will have a better strategic position. A firm that is stuck in the middle can only earn attractive profits when the industry structure is highly favorable, or when competitors are also stuck in the middle. In general, stuck in the middle firms have average costs, not much differentiation relative to competitors, an average image and reputation, and a small chance of industry leadership (Thompson, Strickland & Gamble ( 2007).
2.1.4. Structure
Many ways of designing organizational structure exist. Daft (2004) describes several designs, which will be shortly discussed. A functional structure groups activities together by common function from the bottom to the top of an organization. In a divisional structure divisions are organized according to single products, services, product groups, projects or programs, or divisions. A geographical structure can be used when different regions in which an organization operates in have distinct tastes and needs. Then each geographic unit includes all functions required to produce and market products specifically for each region. A matrix structure implements product division and functional structure simultaneously. It is a suitable structure when both technical expertise and product innovation and change are important. Another organizational structure is the horizontal structure in which personnel is organized around core processes.
2.1.5. Industry life cycle
Thus far, several subjects have been discussed that are important to be able to eventually answer the main research question. However, what makes an industry a new industry has not been discussed yet. In this section, this is discussed through the literature that discusses the industry life cycle, which will from hereon forth be referred to as the ILC.
Industries are known to evolve over time. The theory describing this process is about the ILC (Pitts & Lei, 2006). ILC theory has emerged from the notion of the product life cycle (PLC), which was popularized by Dean (1950) and Levitt (1965).
Figure 2. The product life cycle (Kotler & Armstrong, 2012)
Klepper (1997) describes that the ILC, much like the PLC, has emerged from a number of different disciplinary perspectives. Williamson (1975) describes three stages in a new industry’s development: (1) an early exploratory stage, (2) an intermediate development stage, and (3) a mature stage. An industry is defined as a branch of commercial firms concerned with the output of a specified product or service (Oxford Dictionary, 7th ed.). Klepper (1997) distinguishes three stages of evolution in different technological industries. In the first stage, the exploratory or embryonic stage, the market volume is low, uncertainty is high, and the product design is primitive. In this stage, many firms enter and competition based on product innovation is intense. In the second stage, the growth stage, output growth is high, the design of the product begins to stabilize, product innovation declines, and the production process becomes more refined. Entry of firms slows down in this second stage and a so-called shakeout of producers occurs. In stage three, the mature stage, output growth slows down, entry declines further, market share stabilizes, and innovations are less significant.
The evolution of the number of firms is the most studied part of the industry life cycle (Klepper, 1996). Klepper & Grady (1990) establish that the number of firms in new industries follows a distinctive path: first the industry grows in terms of the number of firms, then it declines sharply (the shakeout), and finally it levels off. During the shakeout stage, the number of firms was reduced by a bit more than one-half. Klepper & Simons (1999), found two patterns with regard to entry and exit of firms in industries. First, at the formation of an industry, the number of entrants may rise over time or it may attain a peak at the start of the industry and then decline over time. Eventually, in both cases, the number of entrants eventually becomes small. Although the number declines at a certain point, the remaining firms grow larger and thus the industry continues to grow in terms of revenue.
Figure 3. Industry life cycle in number of firms (Klepper & Simons, 1999)
2.2. Theoretical background – Part 2 – Applying the main subjects to
franchise systems
In this second part of the theoretical background franchising is first introduced, followed by a discussion of the resources presented in part one and whether these can be applied to franchise systems. If this is the case these resources will be from then on be called franchise system factors (F.S.F.). This is followed by the introduction of several factors, which are about strategy or structure, derived specifically from literature on franchising. These will also be referred to as F.S.F. In table two a list of all these F.S.F. is presented. Following this is a discussion of the F.S.F. from the perspective of the ILC and the expected relevance of the various F.S.F. in a new industry. The literature review will be concluded with several propositions.
2.2.1. Introduction
organizational forms. First, franchising often occurs in businesses where there usually is an important service component that must be performed near customers. Second, franchise contracts typically reflect a unique allocation of responsibilities, profits (and losses), and decision rights between the franchisor and franchisee.
In the following section, two theories on the reasons for firms to become franchisors are presented: agency theory and resource scarcity. Literature on these subjects is relevant for this master’s thesis because they also describe advantages of franchising.
Firms choosing to become a franchise system loose a significant degree of control over their units, unlike company ownership, which does not result in loss of control similar to firms choosing to become a franchise system (Gillis & Combs, 2009). The franchise systems apparently consider the advantages to be outweighing the disadvantages. According to Combs, Michael & Castrogiovanni (2004), there are two key theories to explain franchising: agency theory and resource scarcity. Agency theory describes the relationship between the party (the principal) that delegates work to another (the agent). In the case of the franchise system, the franchisees are the agents, and the franchisor can be considered the principal. The situation, in which a franchisor directly owns units, can be problematic because both the franchisor and the, by the franchisor appointed, manager have self-interest which is likely to be different. Eisenhardt (1998) describes this as the agency problem. To resolve the agency problem, the right to make decisions has to be aligned with the profits that result from those decisions (Michael, 1996). This aligns the right to make decisions with the residual claims from those decisions. Because the preferences of both the principal and agent are aligned the conflicts of self-interest between them are reduced (Eisenhardt, 1998).
In the resource scarcity theory, firms choose to become a franchisor when the need to achieve economies of scale pressures them into expanding at a rate not possible when using solely internally generated resources. Through becoming a franchise system, external resources provided by the franchisees, give the franchise systems the possibility to expand faster.
2.2.2. Franchise system factors
Now three different sections on F.S.F. are discussed. First is resources, in which as explained before, the resources from the theoretical background part one will be discussed in the light of franchise systems and whether they can be applied to those. Second, F.S.F. specific to the strategic decisions franchise systems have to make are discussed. Third, a F.S.F. specific to a franchise system’s structure are discussed. If relevant literature is found that will provide the possibility to present propositions with regard to the F.S.F., these propositions will then be introduced separately when these F.S.F. are discussed. The relevant literature that led to the formulation of the propositions is discussed in section 2.2.5.
2.2.2.1. Resources
Like other firms, a franchise system has a competitive advantage when it is implementing a value creating strategy that is not simultaneously being implemented by one of its competitors. Also, like other firms, a franchise system has to distinguish itself from competitors by investing in hard-to-imitate and specific resources, as described before, according to the RBV. The resources discussed in section 2.1.2. are discussed next from the perspective of new franchise systems, which are also new in terms of being unaffiliated to existing companies, in the retailing industry
First, the physical resources are discussed. Geographic location is relevant for firms because it is important for firms to be located there where customers are best reached. Franchise systems, depending on the business they are in, also have certain locations where most potential customers can be reached. Therefore, it is included as a F.S.F. With regard to location, the following proposition is made:
Proposition 1: A successful franchise system in a new industry will carefully consider potential new
locations.
the cooking appliances for grilling hamburgers are available for everyone who can afford them. Based on the preliminary study, the franchise systems in the case study operate in an industry that cannot achieve competitive advantage through machinery. Therefore, it is not considered a F.S.F. Raw material is a relevant factor for firms in general because without these they cannot produce their products. When firms have better access to raw materials than competitors this may be a source of competitive advantage. Therefore, depending on the type of business a franchise system is in, it might be a relevant F.S.F. However, the industry studied in this master’s thesis uses no raw material which has the potential to lead to a competitive advantage and as such as is not considered relevant for the case study.
Second, resources in the human category are discussed. Skilled personnel in terms of a franchise system having personnel that is highly experienced in both franchising and the specific industry of the case study, which will be discussed later on, has not been found to be relevant based on preliminary findings. However, something like customer friendliness and other personnel capabilities could be considered to be part of personnel’s skills. In this master’s thesis, customer friendliness and personnel capabilities are considered to be relevant but are included in the resource training as they are taught during employment. Training can lead to increased efficiency and productivity. For this particular industry, training is also likely to increase the service provided. As such, it is included as a F.S.F.
Third, organizational resources are discussed. A brand is a specific name, symbol or design (or a combination of these) which is used to distinguish a particular seller’s product. A successful brand is, besides having a product which meets the functional requirement of consumers, also of higher quality or more desirable than similar products from competitors (Doyle, 1998). Where a brand is intangible, a brand name can be more accessible and recognizable. Brand names have the advantages of economies of scale in marketing investments and greater recognition. Building a brand name takes a significant effort over a long period. Brand names serve as a proxy for quality, and can create positive images in the minds of consumers (Bharadwaj, Rajan Varadarajan & Fahy, 1993). A franchise specific advantage of brand names is that brand recognition may lead customers of one franchise location who travel to another place to be more prone to visiting another location of the same franchise system. This is also found by Gillis & Combs (2009), who state that strong brand reputation leads to better performance for all franchise systems. For the new franchise system it might be hard to build a strong brand name early on as it is stated to take a significant effort over a long period and therefore it is not included as a F.S.F.
franchise systems in a new industry are still small relatively to large organizations, they can benefit far less from increased efficiency in terms of lowering costs. Furthermore, these new franchise systems will be able to respond fast because they are small. For these reasons, efficient procedures is not considered a relevantF.S.F. to include in the case study.
Organizational learning can have at least two positive effects. First of all, individual workers or worker groups become increasingly efficient. Second, information within an organization may flow more efficiently due to common training and experience, which results in a reduction of transaction costs. According to Winter (1987), organization learning can only be a source of competitive advantage when the learning is tacit and not observable. Furthermore, the underlying knowledge has to be complex. Based on the preliminary study of the industry of the case study, no organizational learning that is tacit and not observable is expected to be found that can lead to a competitive advantage.
Fourth, the one financial resource, financial requirements, is discussed. Capital makes improvement of operations possible, as well as a firm’s capability to research new products. Capital for franchise systems is dependent on the franchisees. Consequently, the number of franchisees is positively related the amount of capital available to franchise systems. Gillis & Combs (2009) found that franchise systems that require a lower initial investment for franchisees fare better in terms of growth and profit. In other words, capital can be considered an indicator of success for a franchise system where financial requirements can influence growth and profit. Thus, with regard to these financial requirements, the following proposition is made:
Proposition 2: A successful franchise system in a new industry will have low financial requirements
for franchisees.
2.2.2.2. Strategy
In the previous section different resources that influence firm performance were discussed to determine whether these can be applied to franchise systems. While some were determined to indeed influence franchise system performance there are also factors found in literature that are specific to franchise systems. This section discusses the F.S.F. that are about strategy.
This literature specific on the subject of franchise system performance often focuses on strategy or structure. These two subjects can also be interrelated. Yin & Zajac (2004), for instance, discuss the issue of strategy-structure fit for franchise systems. They state that franchise-owned locations, which have more flexible and decentralized structure will be more likely to pursue a strategy that emphasizes flexibility and local adaptation. Company-owned locations, on the other hand, are more likely to pursue a strategy that emphasizes predictability and control. Sorenson & Sørenson (2001) state that franchise-owned locations provide better opportunities for firms to learn through experimentation, whereas company-owned locations make it easier to spread this information and enforce standards through company-owned locations. Another important issue in franchise system literature is growth. Shane, Shankhar & Aravindakshan (2006) did research on the use of strategic actions franchisors take to attract partners and grow their franchise system. They found that franchise systems that grow larger lower royalty rates as the systems age, have low up-front franchise fees that rise over time, own a small proportion of outlets and lower that percentage over time, keep franchisees’ initial investment low, and finance their franchisees. This section discusses F.S.F. that are about the strategic decisions franchise systems have to make. The F.S.F. discussed in this section are partly based on the four management challenges by Bradach (1998): adding units, uniformity, local responsiveness, and systemwide adaptation. In his book, Bradach also discusses the issue of company-owned and franchise-owned locations. The paragraph on growth, which is discussed next, is based on the first management challenge, but includes also other ways for franchise systems to grow, which is based on literature by Levy & Weitz (2009).
growth using the retailer’s present format and aiming efforts toward already existing consumers. With market penetration the goal is to increase expenditure by current customers and the frequency by which current customers visit the store. An example of increasing the number of visits is the introduction of a customer card with which customers can get a reduction after a certain amount of money spend. Also, the opening of new stores in geographical areas in which the store is already present is part of growth through market penetration.
The second type, market expansion, is about expanding the existing retail format in new market segments. This can be done through both the opening of new stores in new geographical areas and the addition of new products and product groups. Franchise systems can of course open locations which are owned by franchisees, but the franchisor can also choose to operate a new store themselves. Company-owned and franchise-owned is an issue discussed later on.
With the third type, format development, a retailer develops a new retail format for the same target market. In other words, it is an addition to the current retail format. An example of this type is McCafé by McDonald’s which can be considered a new format but is still related to the current business. Retail format development also includes the opening of in-store shops to target new customers.
Figure 4. Four types of growth (Levy & Wetiz, 2009)
The following proposition is made with regard to growth:
Proposition 3: A successful franchise system in a new industry will have a growth strategy that
emphasizes growth in number of locations as opposed to growth through existing customer through the existing franchise format, growth through new format development, or diversification.
Standardization: The franchisor-franchisee relationship has an inherent contradiction (Cox & Mason, 2007). An important appeal of franchising is the independence of the franchisee. However, critical to the success of the franchise system is the need for providing a standardized product or service across all locations. This contradiction is also discussed by Bradach (1998). In his book he states that a chain must preserve uniformity across different locations, but that a chain must also adapt to local conditions to meet the different needs customers have across the chain’s locations. This section on standardization discusses this.
that diverge from the standardized franchise format due to the advantages of standardization. Consequently, franchisees are limited in taking individual actions regarding local operating procedures such as location, pricing, assortment, hiring labor, and hours of service. However, franchisees may believe their ownership gives them the right to exercise entrepreneurial initiative rather than to conform to franchise system’s norms (Baucus, Baucus & Human, 1996). A reason for franchisees to take entrepreneurial initiative is that they might discover a better way to attend to local consumers. Because not all consumers across the different locations will be same, uniform operating procedures might not optimize the different locations. The adaptation of a franchise format conflicts with the advantage of brand name and consistency (Sorenson & Sørenson, 2001). The inherent contradiction here is the constant tension in the franchise format between the franchisor who wants standardization and the franchisee who wants to adapt to local preferences. In a very standardized system, almost every aspect of franchise unit’s operations is formulated in operating manuals and procedures. A highly standardized franchise system can also result in cost advantages which, as discussed before in section 2.1.3., can give a firm a competitive advantage. In a less standardized system, fewer rules and procedures exist, which gives franchisees the possibility to adapt more easily, without breaking the franchise contract.
Kaufmann & Eroglu (1998) define four format components: product/service deliverables, benefit communicators, system identifiers, and format facilitators. Product/service deliverables are those elements that reflect the unique features of the franchise format. This is sometimes referred to as the concept. Example of these product/service deliverables are the basic menu and the accuracy of work. Where product/service deliverables are format components that are clearly observable to customers, the benefit communicators discussed next are considered to be unobservable to customers. Benefit communicators refer to the elements that make the intangible tangible. They serve as surrogate indicators for those things that are hard to see directly. Clean uniforms are an example that can serve as an indicator of a hygienic work environment. The system identifiers are the set of visual and auditory elements that link a specific retail outlet with a system or chain. This includes system name, trademark, and logo. Format facilitators represent the policies and procedures that form the foundation both for the format’s efficient functioning at individual units or franchise level and the integration of the units into the operation of the total system. Sales reporting procedures and operation manuals are examples.
components into critical elements and non-critical elements. The first are the core elements, which should be standard across all locations without exceptions because they are considered indispensable for the business format franchise system. The second type of element is the peripheral element, which are the elements that may be changed locally if the benefits outweigh the advantages of standardization. Kaufmann & Eroglu (1998) found that economies of scale are not easy to attain when standardization is low. Therefore, large-scale economies in franchising inevitably require standardization of the core and peripheral elements of each format component.
Franchisors have different ways for ensuring certain levels of standardization and thus maintaining uniformity throughout the franchise system. An example of this is the use of mystery shoppers who visit a franchise system’s location and afterwards report on a set of predetermined parameters. These parameters can include the quality of the food and/or drinks, service, and hygiene.
With regard to standardization, the following proposition is made:
Proposition 4: A successful franchise system in a new industry will be high in terms of
standardization.
system perceive the same quality, which they previously experienced at another location. However, new opportunities and/or threats may arise to which a franchise system has to respond.
In the study of adaptive processes, the relation between exploration and exploitation phase is much researched (March, 1991). In the first phase of exploration, the business model is created and refined. The second phase is exploitation in which the business model is stabilized and leveraged through large-scale replication (Winter & Szulanski, 2001). A vital step in this process is the transition from the first phase to the second, in which the task is to create and refine the capabilities that support the more routine replication activities that follow. According to March (1991), adaptive organizations engaging only in exploration are likely to find that they do not reap the benefits from exploration, but that they do pay the costs. Conversely, systems engaging only in exploitation are likely to find themselves trapped in a suboptimal stable equilibrium. Therefore, they argue, maintaining an appropriate balance between exploration and exploitation is a primary factor in system survival and prosperity. In the early life-cycle stage of a system, or exploration phase, it is important to create a concept that is both distinct and associated with a system and not just a specific outlet (Kaufmann & Eroglu, 1998). How franchise systems deal with systemwide adaptation and thus how they find a balance between exploration and exploitation in a new industry is investigated in the case study.
Proposition 5: A successful franchise system in a new industry will be high in terms of systemwide
adaptation.
2.2.2.3. Structure
Company-owned versus franchise-owned: Bradach (1998) argues that franchise systems consisting of both franchise-owned and company-owned locations are better capable of dealing with the challenges franchise systems face. According to his research, the simultaneous use of franchise –and company-owned locations enables faster growth than either one by itself. This plural form of franchising facilitates the growth in number of locations by providing the possibility to escape some of the constraints for each form. With the plural form, both forms are equally effective at maintaining uniformity. Local responsiveness is higher for franchise locations. With regard to systemwide adaptation in the plural form, both forms complemented each other. Bradach’s research focused on large franchise systems. Oxenfeldt & Kelly (1968) state that once a franchise system has grown sufficiently, the emphasis of franchise systems shifts toward operating efficiently and market development, which is best attained through company ownership. The following proposition is made with regard to company-owned locations versus franchise-owned locations:
Proposition 6: A successful franchise system in a new industry will predominantly have
2.2.3. Industry life cycle
The different stages of the ILC, as discussed in section 2.1.5., show that during the different stages there are different forces at play and therefore different strategies need to be applied for firms to be successful. According to Oxenfeldt & Kelly (1968), franchise systems are also subject to changes as they mature. The goals, capabilities, and opportunities faced change from the stage where they are new, through a period of rapid growth, through the stage in which the franchise system becomes established and prosperous, and finally they decline. Lillis, Narayana, & Gilman (1976) look at which competitive advantages normally associated with franchising are relatively important at which stages in the franchise life cycle. They look at how the franchise advantages of (1) rapid access to markets, (2) reduced cost of capital, (3) risk sharing within the channel, and (4) highly motivated franchisees, vary across the life cycle of the franchise system. Although the article by Lillis, Narayana & Gilman is about the life cycle of a franchise system, it does show that certain franchise specific advantages vary across the life cycle of a franchise system. As stated before, firms need different strategies throughout the different stages of the ILC to be successful. Therefore, successful franchise systems in a new industry are likely to apply the F.S.F. in a specific way in a new industry. A few examples are presented in the remainder of this section.
Franchise systems are often started because franchisors aim to penetrate the market as widely and rapidly as possible (Oxenfeldt & Kelly, 1968). Once a franchise system arrives at a point at which desired coverage is attained, the franchisor will move to operating efficiencies and market development. According to the authors, this can be best attained through tight control, which is permitted through company-ownership. Thus, when a new industry emerges, and franchisors become involved in this new industry, they are likely to start of with the focus on growth through franchise-owned locations. Then, as the industry matures, and the franchise systems that were involved in the industry early on grow larger, the franchise systems’ locations will move from being predominantly franchise-owned to be predominantly company-owned.
2.2.4. Summary
In table two, all the F.S.F. that are taken into account for the case study are summarized.
In the second part of the theoretical background, six propositions were introduced. These are discussed next.
Subject Franchise System
Factors
Explanation Resources Financial requirements
for new franchisees
Lower financial requirements lead to higher growth and profits.
Training Can lead to increased efficiency and procedures, as well as better service. Location Suitable location, more customers, higher
performance
Strategy Standardization Degree of freedom allowed for franchisees with regard to franchise concept
Systemwide adaptation Degree of innovation introduced throughout franchise system
Growth
Growth through market penetration, market expansion, format development, and
diversification
Competitive positioning Influences franchise systems’ growth, systemwide adaptation, and standardization.
Structure Company-owned versus
franchise-owned
How competitors differentiate themselves in terms of service, products, and store
2.2.5. Propositions
Based on literature there are several expectations with regard to how several F.S.F. influence the competitive advantage of franchise systems in a new industry. This results in six propositions which are presented at the end of this section. This section is concluded with a summary of all the F.S.F. that have been discussed and are considered to be relevant to take into account for the case study.
Because literature on the F.S.F. and their importance in new industries is very limited, no clear-cut list of F.S.F. that are important in attaining competitive advantage in new industries can be presented. However, based on literature, certain F.S.F. are expected to be important in new industries. This is discussed next.
Duchesneau & Gartner (1988) found that successful firms in emerging industries are more flexible, participative, and adaptive compared to unsuccessful firms. With regard to this, Yin & Zajac (2004) state that franchise-owned locations are more likely to pursue a strategy emphasizing flexibility. Based on this literature by Duchesneau & Gartner and Yin & Zajac it is likely that franchise systems in new industries will prefer to have franchise-owned locations as this provides the flexibility needed. Furthermore, successful firms try to become larger. According to Klepper (1997), an industry will grow when it becomes clear what the industry entails and what customers expect. If these are ways for firms in new industries to become successful, the F.S.F. most important in new industries are those that can help understand customer preferences and make the franchise system flexible, participative, and adaptive. Based on this premise the different F.S.F. can be discussed in the light of their importance in new industries.
important to carefully consider potential new locations. This is also important because an appropriate location is an important factor in a franchise system’s long-term profitability (Kolli & Evans, 1999). If systemwide adaptation is expected to be high, then standardization is expected to be high as well because when a franchise system’s locations are similar, it will be easier to introduce systemwide adaptations. Also, early on, standardization makes the reinforcement and eventually, the solidification of a desired image possible which gives franchisees the exposure to benefit from the cost advantages related to franchising (Kaufmann & Eroglu, 1998). According to them, this solidification of the franchise concept is best attained through standardization.
With regard to the other F.S.F. it is unclear how these are expected to be applied by the case with the competitive advantage in terms of the theory by Duchesneau & Gartner (1988) and Klepper (1997). From the literature review a number of franchise system factors emerged which are considered to influence a franchise system’s competitive advantage. Furthermore, the industry life cycle was discussed. From literature on new industries a few expectation arise on how several franchise system factors will be applied by franchise systems operating in a new industry. These expectations are discussed above and are represented in the following propositions:
Proposition 1: A successful franchise system in a new industry will carefully consider potential new
locations.
Proposition 2: A successful franchise system in a new industry will have low financial requirements
for franchisees.
Proposition 3: A successful franchise system in a new industry will have a growth strategy that
emphasizes growth in number of locations as opposed to growth through existing customer through the existing franchise format, growth through new format development, or diversification.
Proposition 4: A successful franchise system in a new industry will be high in terms of
standardization.
Proposition 5: A successful franchise system in a new industry will be high in terms of systemwide
Proposition 6: A successful franchise system in a new industry will predominantly have
franchise-owned locations (opposed to company-franchise-owned locations).
3.
Methodology
3.1. Introduction
In this section the methodology is discussed. First, the general method of inquiry is discussed. Then the choice for doing a case study as research approach is shortly introduced which is followed by a section on the case study design. Furthermore, the two cases are shortly introduced as well as the reasons for choosing these two. This is followed by a section that discusses data collection. Then, measurement is discussed. The methodology is concluded with a section on the analytic strategy.
The literature discussing the different subjects in the main research question is widely available. However, these different subjects combined and the different theories used to explain them cannot be answered through the sole use of existing literature. This master’s thesis can be considered two-fold. The literature review contains literature that discusses the theory behind the first four sub-questions. These first four sub-questions form the basis for the rest of this master’s thesis. Following this, several franchise system factors are derived from the theory discussed in the literature review. The franchise system factors are applied to two cases, with each case representing a franchise system, in the case study.
3.2. General method of inquiry
3.3. Research approach: case study
To be able to answer the main research question, the results section will contain a case study of two franchise systems. Yin (2009) proposes to apply a case study as a research method when contemporary events are examined, but when the relevant behaviours cannot be manipulated. He also states that the strength of doing a case study is its ability to deal with a variety of evidence – documents, artefacts, interview, and observations. Case study design is discussed next.
3.4. Case study design
Figure 5. Research Design
Differences between theory and cases with regard to franchise system factors explaining competitive advantage. Adapt theory if needed according to these differences. General theory (Theoretical
background part 1)
- When does a firm hold a competitive advantage - Resources -> competitive
advantage, resources early ILC -> competitive advantage
Part 1
Part 2
Apply general theory to franchise systems Franchise system theory (Theoreticalbackground part 2)
- What sets a franchise system a part from other business types? - Resources applied to franchise
systems and franchise specific factors (strategy or structure-based) that influence competitive advantage are discussed.
Apply franchise system factors to two cases.
Comparing theory and cases (Discussion & Conclusion)
- Differences between franchise system factors that influence competitive advantage in theory and cases
- How is theory influenced by cases? (modify theory?) Applying theory from part 2 to two cases (case study)
- Franchise system factors that influence competitive
advantage for the franchise system cases
(cases are in new industry)
Part 3
3.5. Selection of cases
The two franchise systems chosen for the case study are Coffee United and Doppio Espresso. Both were founded and started franchising around the same time (respectively founded in 2005 and 2007, and with a first franchise location in 2007 and 2009). Also, both franchise systems are similar in their aim for nationwide coverage through franchising. They are, however, very much different in how successful they are with regard to their ambitions. Currently, Coffee United has six locations (of which five are franchise locations) and Doppio Espresso has thirteen locations (of which twelve are franchise locations). Doppio Espresso has plans to open four new locations in 2012. Coffee United has no concrete plans with regard to the opening of new locations. In terms of achieving nationwide coverage it is clear that Doppio Espresso is far more successful. Note that they also were founded two years later than Coffee United. Market leader in the Dutch coffee bar industry is the Coffee Company (they prefer company-owned location, but also have franchisees) with 32 locations. In the period 2009-early 2012, Doppio Espresso opened 11 new locations, and Coffee Company opened 8 locations (See appendix H on pages 77-78). Furthermore, Coffee Company took ten years to open their first ten locations. Based on the information presented it is clear that Doppio Espresso has a competitive advantage over Coffee United. In the case study, the F.S.F. will be applied to these two franchise systems to see whether there is a difference in the use of the F.S.F. between the two and how this can explain the difference in competitive advantage for these two in this new industry.
3.6. Data collection
were properly understood. E-mail was used to contact the interviewees for additional information after the interviews.
3.7. Measurement
Before the case study is conducted, the franchise system factors are first made measurable, which is done below.
Capital: With capital, firms can improve current operations and develop new products/activities. The capital available to franchise systems is dependent on the revenue of the locations, because usually a specific percentage of the locations’ revenue flows to the franchisor, which can be used for improvement of current operations, the development of new products/activities, and also marketing. Therefore, the capital available can be calculated by taking the percentage of the total revenue. This percentage, which differs per franchise system, is set by the franchisor and has to be paid by the franchisees over the revenue. This data is collected through the interviews.
Training: Training is measured in the total number of hours and days personnel and franchisees receive training. Training is measured during the start-up of a new location and after a location is opened. This data is collected through the interviews.
Geographic locations: Different types of businesses have different customers. Consequently, there is no clear cut answer to the optimal geographic location. In the Netherlands, central shopping locations are divided in the so-called A, B, and C-locations2. This classification will be used to determine geographic location. Interviewees are asked which type of locations is chosen when determining a new location. The most important indicator for this classification is the number of visitors and peasants.
- A1-location: This is the street with the highest attendance. Often the A1 trajectory is largely between and within the public places (department stores, large clothing stores). A1 sites have an index of 100 to 75.
- B1-location: B1-store locations have an index of 50 to 25. Interestingly, the national operating subsidiary companies here are largely lacking.
- B2-location: B2-locations have expressed index of 25 to 10
- C-location: Locations with a C-mode quality to be the least visited and have an index of 10 to 5.
The so-called ‘busiest point index’ is measured over the full width of the street. This is expressed in terms of an index ranging from 5 (quiet shopping) to 100 (high pressure shopping).
Standardization: Standardization is measured using the four format components as presented by Kaufmann & Eroglu (1994): product/service deliverables, benefit communicators, system identifiers, and system facilitators. The preliminary study found several requirements that are relevant in terms of the four format components. A requirement for product/service deliverables is pricing of the assortment. Requirements with regard to benefit communicators are training of personnel, before and after beginning their job, and training of franchisees, before and after opening the location. Requirements included for the system identifiers are brand name, store interior, and store exterior. System facilitators include the requirements with regard to the purchasing of the assortment. Enforcement of these four format components is measured by the number of times a location is visited by a representative of the franchisor and penalties with regard to non-compliance.
