30
Paper to be presented at the EMNet-conference on
“Economics and Management of Franchising Networks”
Vienna, Austria June 26-June 28, 2003
www.univie.ac.at/EMNET
Understanding Exploration and Exploitation in Franchising Relationships
Evelien Croonen[1]
Faculty of Management and Organisation
University
Groningen
PO Box 800
9700 AV Groningen
Phone: +31 (0) 50 363 8180
Telefax: +31 (0) 50 363 7110
E-mail:
Abstract
The objective of this paper is to present and illustrate a framework for understanding how and why franchise partners deal with the paradox of exploration and exploitation in franchising relationships through time. We focus on two levels of analysis: the strategic characteristics of the franchise formula and the level of relationships between the franchiser and the franchisees that are part of this formula.
We argue that franchise formulas, as any other organizational form, have to balance exploration and exploitation in order to survive and prosper in their environment. We distinguish the following five strategic characteristics of franchise formulas that reflect their exploration and exploitation objectives: the positioning of the formula, the “hardness” of the formula, the formula’s entrepreneurial orientation, the degree of strategic participation of franchisees and the formula’s growth objectives.
On the relationship level, we see the franchising relationship between the franchiser and its franchisees as a specific form of strategic alliance. We distinguish the following variables in understanding both franchise partner’s response strategies towards each other: the degree of strategic compatibility between the franchise partners (depending on the above five strategic formula characteristics), the degree of operational compatibility, the evaluation of available alternatives, and switching costs. Both franchise partners’ response strategies can vary according to two dimensions: constructive versus destructive and active versus passive.
І. Introduction
The objective of this paper is to present and illustrate a framework for understanding how and why franchise partners deal with the paradox of exploration and exploitation in franchising relationships through time. Within this framework we distinguish two levels of analysis. First, we focus on five strategic characteristics of franchise formulas that consist of the franchiser, its franchised units and sometimes also its company-owned units (Elango & Fried, 1997). Second, we focus on the franchising relationships between the franchiser that administers a certain franchise formula and the franchisees that are part of this formula.
We aim to overcome several limitations of franchising research by viewing franchising relationships as a specific form of alliance in which both franchiser and franchisee are “intelligent” partners that interact and adjust to each other through time. The franchising relationship is still too often seen as a static, top-down relationship in which the focus is on efficiency-aspects, such as monitoring and control of franchisees. However, we argue that franchise formulas and the relationships within it have to deal with March’s (1991) paradox of exploitation and exploration in organizational adaptation. According to March, exploitation includes aspects such as refinement, choice, production, efficiency, selection, implementation, and execution. Exploration includes issues such as search, variation, risk taking, experimentation, play, flexibility, discovery, and innovation. March argues that firms must try to find an appropriate balance between exploitation and exploration in order to survive and prosper in their environment. However, there has been little attention for the way franchise partners in franchise formulas deal with this paradox of exploitation and exploration.
In sum, our framework distinguishes five strategic characteristics of franchise formulas that reflect different types of exploitation and exploration. These are the positioning of the formula in the market, the degree of “hardness” of the formula, the formula’s entrepreneurial orientation, the room for strategic participation of franchisees and the formula’s growth objectives. These characteristics influence the degree of strategic compatibility between franchise partners: the franchiser of a certain formula and a specific franchisee that is part of this formula. Next to this strategic compatibility, the partners’ operational compatibility, available alternatives and switching costs influence both franchise partners’ response strategies towards each other in the relationship.
We illustrate our framework with some examples of a Dutch drugstore formula (the DA-formula) in the beginning of the 90’s[i]. Before the 90’s, the druggists from the DA-formula operated under the DA-name, they jointly purchased goods and did some promotion activities together with the support of a central organization (the Druggists Association). After a process of complex changes at this central organization, in 1992, a new organization called Dynaretail was formed that was going to perform the retailing and supporting activities for the DA-druggists in a more centralized and structured manner. In short, from 1992 Dynaretail wanted to change the characteristics of the DA-formula, which resulted in many destructive response strategies of the DA-druggists (and about 100 of 1000 DA-druggists stepping out of the DA-formula).
This paper has the following structure. In section II, we first point at some characteristics of franchise formulas and franchising relationships as specific form of alliance, and we distinguish three possible levels of analysis. Section III elaborates on the limitations of franchising research we briefly mentioned above. We discuss our framework for understanding exploration and exploitation in franchising relationships in section IV. In section V, we conclude with a methodological note on how to conduct research on franchising as a dynamic phenomenon.
II. The franchising relationship
Franchising is often divided in “trade name franchising” and “business format franchising”. In trade name franchising, the owner of a trade name (the franchiser) allows another firm (the franchisee) to operate under this name for the purpose of producing or distributing a product or service, in return for fees (Caves & Murphy, 1976). Compared to trade name franchising, business format franchising entails a more integrated and intense relationship. Next to the right to use the trade name, the franchiser also provides a proven method of operating (the business format) and support. According to Kaufmann & Eroglu (1998) a business format consists of four elements (based on the fast-food sector, but it can be applied to other sectors).
First, the product/service deliverables are the unique differentiating features of the business format that define a competitive niche in the market. In the drugstore sector, this is for example the composition of the drugstore’s assortment. Second, the benefit communicators are elements of the business format that make intangible benefits more tangible. In drugstores these are for example the distribution of free perfume samples to customers or the possibility to have your face made up by a cosmetician in the store. Third, the system identifiers are the set of visual and auditory elements that link a specific retail outlet with a system or chain. These are the trade name, color schemes, architectural features, characters and uniforms etc. Finally, the format facilitators are the policies and procedures that form the foundation both for the format’s efficient functioning of the individual franchised units and of the franchise system as a whole. On the store level these are elements like specification of equipment, layout and design. On the system level these are elements like financial reporting requirements, royalty payment procedures, and data collection.
Both trade name franchising and business format franchising relationships are established in a contract and the franchisee is an independent business owner that runs the business at his or her own risk and retains the rights to the establishment’s earnings (Rubin, 1978). We focus on business format franchising because this entails a closer relationship between the franchiser and its franchisees that is more interesting from a strategic point of view.
The business format is central to business format franchising: the franchisee becomes part of a franchise formula with a certain uniform identity towards customers. As we mentioned before, this formula consists of the franchiser, its franchised units, and sometimes also its company-owned units. Ideally, all these units operate under the same business format with a uniform presentation towards customers. This sharing of a common identity sends a message to customers, so customers know what to expect when they visit a unit of a certain chain. For example, customers generally know what to expect when visiting a McDonald’s restaurant (Kneppers-Heijnert, 1988). This relates to another important aspect of business format franchising. The franchiser supervises the use of the business format by the franchisees in order to enhance this uniform presentation towards customers and to preserve a uniform quality of the provided goods and/or services to customers (Kneppers-Heijnert, 1988).
We distinguish three possible levels of analysis in franchising (see Fig. 1):
· Level 1: The level of the corporation (1a) and the level of the franchiser (1b). We distinguish level 1a because a franchiser can in itself be part of a larger corporation. We distinguish level 1b because one franchiser can administer different franchise formulas that each has its own strategic characteristics. We do not explicitly take these levels 1a and 1b into account, but we recognize that these levels are part of the context of franchising relationships and can therefore influence strategic interactions between the franchiser at the level of a specific formula and the franchisees that are part of this formula.
· Level 2: The level of the franchise formula with specific strategic characteristics. A franchise formula consists of the franchiser, its franchised units and sometimes also its company-owned units (the O’s in Fig.1 stand for company-owned units). On this level, our framework focuses on five strategic characteristics of franchise formulas.
· Level 3: The level of the relationships between the franchiser of a certain formula and the franchisees that are part of this formula. On this level, our framework includes the response strategies of both franchise partners that are influenced by the strategic compatibility, operational compatibility, availability and attractiveness of alternatives, and the costs of switching to the next best alternative.
ІIІ. Towards a less simplistic understanding of franchising relationships
For some researchers (and also some practitioners), franchising at the level of the franchisee is the anti-thesis of strategy and entrepreneurship because the franchisee operates under the established business format of its franchiser and has little influence on strategic decision-making with respect to the franchise formula. This idea has often led to too simplifying assumptions in franchising research. We aim to provide a less simplistic understanding of franchising relationships as specific form of alliance. In this section, we briefly discuss the most important limitations of current alliance and franchising research (see also Table 1).
Table 1: Towards a “less simplistic” approach of franchising relationships
From: / To:Single-faceted perspectives / Multifaceted perspectives
Both exploitative and explorative aspects
Static relationships / Dynamic relationships
Interaction through partner’s response strategies
Top-down relationships / “Two-sided” relationships
Franchisees can contribute to exploration
Homogeneous franchisee group / Heterogeneous franchisee group
Franchisees (franchisee types) can differ in their objectives (of exploration and exploitation)
A. Single-faceted perspectives à multifaceted perspectives
Osborn & Hagedoorn (1997) point out that several perspectives have been adopted to understand the formation, evolution, operation and outcomes of different forms of alliances. Each of these perspectives has its own strengths and limitations. Franchising relationships are often studied from a resource-based or an agency perspective (cf. Carney & Gedajlovic, 1991). From a resource-based perspective, the franchisee is seen as a source of capital and labor for the franchiser. From an agency perspective, franchising reduces agency costs because the franchisee owns specific assets (for example, store equipment that is specific to the business format) and will therefore be motivated to perform effectively within the franchise system. So, the literature largely focuses on March’s “exploitative” aspects such as efficiency, monitoring and control of franchisees, and not on March’s “explorative” aspects such as innovation, play and search within the franchise system (March, 1991). However, according to many authors, in today’s environment of rapid technological and market changes, shortening product life cycles and changing customer tastes, the strategic management of innovation has become more important (Stanworth, et al. 1996). Moreover, Jacobs (1999) points out that the traditional forms of innovation -product innovation and process innovation- have become more and more intertwined and have gained new meanings. So, product innovation not only refers to new products; it also concerns new business concepts or formats (like McDonald’s or Benetton).
We have already argued in section II that the business format or shared identity is central to business format franchising relationships. However, such a standardized and uniform identity may seem inappropriate in the current environment with rapid technological and market changes, shortening product (and concept!) life cycles, and changing customers’ tastes. Therefore, it is surprising that only few researchers explicitly refer to this paradox of exploitation and exploration in franchise systems. In section IV, we argue that franchisers and franchisees have to deal with different types of exploration and exploitation in the franchise system. By studying both explorative and exploitative aspects we adopt a multifaceted perspective of franchising relationships.
B. Static relationships à dynamic relationships
Next to a focus on “exploitative” aspects of franchising relationships, the use of certain perspectives has probably also caused a focus on “static” aspects of franchising. In alliance research in general, there is also lack of research in the “dynamics” or processes of alliances (Ring & Van de Ven, 1994). However, processes in alliances influence the partner’s perceptions of the alliance and their motivation to continue or terminate the relationship over time. Also, with respect to franchising relationships, Elango & Fried (1997) acknowledge that there is lack of research in the “dynamics” of franchising relationships. Franchising researchers often focus on one important governance decision for franchisers: the share of company-owned and franchised units in their franchise formulas. However, there has been little attention for the way franchise partners interact and respond to each other in a dynamic environment. Through time the needs and offers of the franchise partners can change and may change the partner’s motivations to continue or to break up the franchising relationship, which is reflected in their response strategies towards each other.
C. Top-down relationships à “two-sided” relationships
As we already argued, for some people (both researchers and practitioners), franchising is the antithesis of entrepreneurship and strategic thinking. Some authors even refer to the franchisee as a “strategic non-entity” because the franchisee has no influence on strategic planning and decision-making within the franchise system (e.g. English, 1993). In the literature, the franchising relationship is often viewed as a top-down relationship in which the franchiser has all the influence. Therefore, Elango & Fried (1997) propose to view the franchisee more as an “intelligent player” with its own specific contributions and needs in the franchising relationship. Also, Hoy & Shane (1998), Bradach (1998) and Sorenson & Sørensen (2001) argue that many franchisers rely on franchisee experimentation to generate the innovations that keep their organizations healthy and competitive. Or put differently, also the franchisee contributes to the renewal or exploration of the franchise formula.