Apr 5, 2019 - Blog by |

Problem: As discussed in more detail below, although it is possible to achieve some measure of success in furthering the short-run goals of franchisees through the formation of franchise associations, achievement of the long-run goals of franchisees will nevertheless remain elusive, as they have for the last 25 years. Until franchisee associations develop the ability to understand and use more correct, accurate and dynamic theories underlying franchise market forces, they will be nothing more than temporary dues-collection entities. To explain this pervasive misunderstanding more fully, below I briefly posit the existence of two prototypical market models. (Of course, the markets as defined below are not pure nor are they complete; I defined and created the two crossbreed models below only for illustrative purposes).

Franchise Model with Inherent Conflicts and Distorted Incentives (“Conflicts Model”)

The Conflicts Model is one that I argued previously covers the franchise context. To create this model for illustrative purposes I’ve chosen and combined certain elements of both the neoclassical and transaction cost economics (“TCE”) theories to identify myriad “inherent conflicts” in the franchise market (and between stakeholders). Again, the neoclassical model shows, inter alia, that there is an underlying inherent conflict between the two major stakeholders since they maximize different variables, sales and profits. The implication of this inherent conflict is that franchisors and franchisees, in naturally seeking to achieve and maximize different market goals, will calculate different optimization levels of the same market variables. I gave the example of how this shakes out in an encroachment/territorial development context, by pointing out that differing optimal levels for the franchisor and franchisees would result in a market too saturated from the franchisees’ point of view.

And, regarding TCE theories, there are various qualitatively different inherent conflicts between effort and information levels that cause structural (or inherent) conflicts between the two stakeholders, including moral hazards, free riding, adverse selection and the extraction of quasi-rents. TCE theories also go to explain certain of the penalties normally included in franchise agreements, leading to the rich and interesting process of economic hostage taking. Analytically, it might be argued that these TCE conflicts are more like failures of certain behavioral assumptions underlying the neoclassical model rather than inherent conflicts, but many of these conflicts arise out of the assumption that the parties are opportunistic and not omniscient and interested only in maximizing profits through the augmentation of output.

Free Market — Pure Competition Strain (“Conflict-Free Market Model”)

In contrast to the Conflicts Model above, the view of the “market” hypothesized by franchisors (at least in public, through some IFA submissions to government agencies and some postings by franchisor-side advocates on the Forum, for instance) appears to be one in which few or no theoretical defects exist. This view of the market posits equally capable parties – franchisees and franchisors – who approach each other (in an externality-free market); negotiate over the terms of a contract; adequately seek to learn about each other and the other parties’ skills, benefits and weaknesses before signing the agreement; and then, after evaluating the relevant information (all of which is assumed to be readily available for those who seek it), the parties decide, in a rational manner, whether to proceed with a deal. It also assumes that after a contract is signed, no problems will arise that have not been accounted for, considered and addressed ahead of time, as the parties both begin and end their relationship with “equal” power and assessment abilities. (In other words, this version frequently ignores the problems created by intertemporal, versus spot, relationships, thus eradicating the possibility of contract distress or failure due to future unanticipated events). It also assumes that each party will proceed in good faith after execution of the contract as “neither party has any true market incentive to harm the other party.” Some applications of the Conflict-Free Market Model (intentionally and unintentionally) deny the existence of the neoclassical maximization conflict identified above.

Final Thought: Future articles and writings will demonstrate how the failure of leadership of many franchisee associations (including the umbrella franchisee organization in California) to understand the differences between the two above market models has doomed, and will continue to stultify, any meaningful movement forward in the franchisee movement.

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