Transaction costs, corporate hierarchies, and the theory of franchising

This paper provides a managerial-based explanation for franchising that predicts the existence of dual distribution and many commonly observed characteristics of franchise organizations. In this model employee managers working under a promotion-based system are more efficient than franchisees. However, there is necessarily a limit to the number of lower level managers that can be effectively motivated under such a system. In some industries the economies of scale associated with brand names lead to a minimum efficient number of retail/production facilities that is larger than that can be supported by the promotion hierarchy. In these cases the firm's best alternative is to franchise. (C) 1998 Elsevier Science B.V. All rights reserved.