Franchise Agreements and Joint Ventures

Introduction

There are several types of strategies, which an organization can adopt for its growth and expansion purposes. Two of such strategies are known as franchising and joint-ventures. Franchising refers to the type of business organization in which restricted rights are purchased for selling services or goods under a particular trade name within a precise geographical area. The franchisor is the one who sells these rights, is entitled to an initial fee coupled with a percentage royalty, to be paid to the franchisee, who has been authorized to use the companies registered name and logo. The continuing growth of franchising has encouraged firms representing different industries to enter into such agreements. (Khalid, 2007) [1] .

A franchise is not strictly a form of legal structure for a business but it is legal contract between two firms. (Stimpson, 2005) [2] Examples could be Telenor in telecommunication industry, Nike in clothing industry and McDonalds in foodstuff industry. Whilst on the other hand if we talk about joint-ventures; it refers to the situation when two businesses agree to work closely together on a particular project and create a separate division to do so. The reasons for joint venture are costs and risks of a new business venture are shared, different companies might have different strengths and experiences and lastly company might have their major markets in different countries and they could exploit it more effectively. (Stimpson, 2005).

There are numerous factors why a company should go for these expansion strategies but choosing of the strategy depends on many dependant and independent variable such as market position of the firm, financial standing of the firm and nature of the product or service that the firm is offering. If a person wants independence, but it is better at carrying out or improving someone else’s idea than their own, franchising might be the ideal solution, franchising has grown steadily. Primarily there are two types of franchises; one is dealer franchises and it is used by petrol companies, breweries, and vehicle and computer producers. Company agrees that the other businesses can sell their product a written agreement is done between the two covering the aspects like stock levels, market share and territory of the franchisee. Second type is known as brand franchising and it is designed to allow an inexperienced franchisee to set up from the scratch. The franchisor will already have a reputation of the product or service and the intention is that a consumer will know they are buying same product whether they are in London, Sydney or New York. It is important that franchisee is monitored to make sure that the standard is maintained. (Hall, 2000). [3]

Factors impacting franchisee compliance

Franchising involves an organizing firm selling a proven business format that entitles a semi-autonomous franchisee to the rights to market n sell goods or services under the organizer’s brand name. Although the franchisor and franchisee are legally distinct organizations (Mendelsohn, 1995) [4] the economic rewards from, and responsibilities to, the franchise system are interdependent between the parties (Kumar, 1995) [5] . In this business system, economic rewards are generally maximized where the interests of franchisors and franchisees are most effectively aligned through both the relationship agreement (the franchise contract) and also through voluntary participant behaviors. Nevertheless, it is the franchisor that generally specifies the responsibilities of each relational partner, and how the assets and economic rewards are distributed within the relationship, setting the stage for potential disagreement and tension between the parties over the course of the franchise relationship.

Financial interdependence between two entrepreneurially motivated partners, combined with the asymmetrical exercise of power within the relationship (such that franchisors often focus more carefully upon preserving their rights rather than tending to their obligations to franchisees can lead to frustrating conditions for franchisees. This frustration is exacerbated because franchisees invest their own capital into an enterprise they initially do not fully understand, and which has meticulous operational constraints (enforced through formal legal contracts) that serve to discourage some forms of entrepreneurial aspirations. As a system characterized by mutual interdependence but asymmetrical control, the success of franchising is heavily contingent upon significant manifestations of trust between the franchisor and franchisee (Pizanti, 2003) [6] . In practical terms, the franchisor relies upon the franchisee to perform at expected levels and within rigidly specified guidelines, while the franchisee relies upon the franchisor for both promotional support (brand equity) and also managerial support (training and process design). This mutual reliance between franchisor and franchisee can make interpersonal and inter-organizational roles and relationships more ambiguous, leading to disagreement over issues of control.

When franchisees feel they can no longer trust the franchisor, they may come to believe that their contractual obligations are no longer aligned with their own economic or entrepreneurial interests. These beliefs can lead to diminished efforts to comply with franchise regulations, or even acts of contractual defiance. Franchisors thus need to maintain the trust and goodwill of their franchisees because a disgruntled franchisee that neglects or subverts operational policies will weaken the brand identity of the franchise (Baucus, 1996) [7] . Leading to both diminished system sales and later recruitment difficulties. Growth and expansion objectives will compound the gravity of this issue.

Ownership trends and system evolution in franchises

The reason why retailers franchise outlets instead of owning and operating them directly has been a question of importance and interest in the franchising literature. According to existing theories, the reasons why franchise fall into two major categories: Resource constraints and incentive issues. We will observe the essential arguments that relate these factors to the use of franchising, and obtain predictions as to why and how changes in these over time are likely to affect franchisers’ choices. The resource limitation argument was first put forward by Oxenfeldt (1969) [8] He says that franchisers use franchising to attain access to some resources which franchisees own. Oxenfeldt and Kelly recommended that the resources that are provided by franchisees may be human capital, financial capital, or managerial talent. Likewise, Norton in 1988 [9] argued that the franchiser’s need for human capital and managerial talent as a reason for franchising, while Minkler (1990) [10] focused on the franchisee’s capability to entertain local market expertise.

Underlying this resource limitation argument is the assumption that most retailers prefer to own their outlets; it is only because that option is not available to them that they choose to franchise. If we suppose such a preference, the next step is to decide if and when such ownership is probable. New niche retailers with exclusive concepts find market preemption and fast expansion to be key element of their marketing strategy (Gilman, 1990) [11] but rapid growth requires major increases in human and financial capital, expertise in unfamiliar markets, resources to which any other organization may not have easy access. As noted by Norton (1988), franchising is one way for firms to obtain access to these resources. For example, while managers with the talent to manage new outlets is often complicated to develop from within, especially while early in an organization’s history, franchisees mostly offer ready sources of such human capital.

Rubin (1978) [12] , has expressed that, due to differences in risk, selling shares in the entire chain is better solution to the capital crisis than franchising which amounts to selling shares at individual outlets. Consequently he notes that the scarcity of financial capital observed by a new chain should not cause retailer to franchise its outlets, but instead to raise funds from investors. According to him, if a firm decides to franchise, it has reasons other than availability of capital. According to (Rubin, 1978) franchising may be a less costly source of capital if there are incentive related issues at the outlet point. She emphasizes that if managers lack incentives to put forth effort, investors with a portfolio of shares from every outlets are likely to demand higher rates of return, even if their investment is not very risky. Thus, capital may be more proficiently obtained from franchisees than from investors.

Whether franchising is originally the most capable source of capital or not, financial and human capital limitations are usually relaxed. When this happens, the resource constraints dispute predicts that the percentage of company-owned outlets will enlarge as the franchiser moves toward a fully company-owned chain. Only the marginal outlets, e.g., those situated far from company headquarters, or facing low demand, will stay in the hands of franchisees. Though latest outlets will be opened as company-owned units from the outset, changes in the possession of existing outlets may be hampered by lengthy and long franchise agreements and the complexity in negotiating reacquisition’s prior to termination.

Cultural differences created by joint-ventures

National culture has a cognitive element which indicates to the fact that it’s the collective programming of the mind that differentiates the members of one sort of people from those of another sort” (Hofstede, 1988) [13] . It also has a normative aspect because society’s values and norms are elements of a culture’s individuality. Culture differences can thus be closely associated by a boost in normative and cognitive institutional individuality. Increases in national culture differences are closely associated with increased unfamiliarity, both in respect of the MNE’s awareness of the host country, as a result increasing the need for an associate that understands the local surroundings and environment (Eden, 2004) [14] .

Berkema (1966) [15] argued that equity joint ventures incur ‘double-layered acculturation,’ which requires adaptation not only to the local surroundings but also to the culture of the companion or partner. Nevertheless, empirical evidence suggests they are favored to wholly owned subsidiaries for entering into nations and countries that are culturally far-off. This dilemma can be resolute by recognizing the fact that national culture differences boosts unfamiliarity, which typically is impermanent. Though a joint venture enables a firm to develop internationally with potentially lesser investment risk than other higher-control modes of entry, parent firms that are associated with joint ventures overseas could tackle disadvantages, due to their operation in foreign countries (Zaheer, 1995) [16] . From the perception of organizational learning, the benefits that can be extracted from multinational diversity may not surpass the costs incurred from national cultural differences. Apart from diversification benefits, national cultural differences also help in reducing the capability of firms to learn how to function efficiently with a joint venture partner in the foreign land. As a consequence, we should expect national culture differences to highlight troubles of transferring tacit information and knowledge from a joint venture to the parent firm, and thus, minimizing the benefits to the parent firm.

Joint-ventures Partnering strategies and performance

A joint venture is referred to a ban entity that is formed when two or more firms pool in a segment of their resources to create a jointly owned organization (Barringer, 2000) [17] . The importance of joint ventures is increasing as an internationalization strategy has resulted in extensive research on the antecedents and aftermaths of international joint ventures, particularly amongst strategy and international business researchers. Consistent with the conventional focus of strategy and international business research on large. (Mcdougall, 1996) [18] Many of these empirical studies have emphasized on international joint ventures recognized by large firms to the exclusion of SMEs’ international joint ventures. The empirical conclusion on the relationships between partnering strategies and joint ventures performance based on samples of international joint ventures established by large firms do not essentially relate to joint ventures established by small and medium enterprises because of the fact that it has been well argued and acknowledged that smaller businesses and larger businesses have different nature and are different species (Shuman, 1986) [19] .

Resource-based point view of the firm emphasizes the significance of firms’ resource endowments .If compared to large firms, small and medium enterprises have inadequate financial and managerial resources; furthermore, small and medium enterprises are generally owned and managed by founders, whereas on the other hand large firms are managed by expert professionals. As a consequence, the decision-making in SMEs (short medium enterprise) is relatively centralized (Carrier, 1994) [20] . Furthermore, many of the researches on joint ventures performance focus on joint ventures reliability and longevity (which is sometimes also called survival) perhaps due to the complexity in attaining profitability information. Firm performance is a multidimensional construct and a strategy may have differential effects on different magnitudes of firm performance (Delios, 2001) [21] . Joint venture durability and profitability are two noteworthy proportions of joint venture performance, and it is imperative to comprehend the differential affect and influence that partnering strategies have on both.

International joint ventures are principally important for small and medium enterprises in their internationalization development. By meaning, small and medium enterprises have more limitations and constraints in resources and abilities as compared to large firms. As an outcome, SMEs are subject to liability of smallness. Aldrich (1986) [22] which is reflected in SMEs’ difficulties in securing and obtaining significant resources such as capital and staff, and their susceptibility to environmental changes. Such disadvantages compel constraints on the growth and expansion of small and medium enterprises in both; domestic market or international markets. Furthermore, the liability of smallness can negatively affect the future of SMEs’ subsidiaries. For SMEs’ overseas subsidiaries, the burden of smallness inflates the liabilities of newness and freshness. The liability of newness can be looked upon in the series of operational challenges facing the establishment and startup, such as recruiting, financing, procuring and marketing. More prominently, the liability of newness raises the aspect of legitimacy which directly affects the key solution to all the above mentioned operational challenges. The legitimizing process could be costly and time-consuming, considerably increasing the challenges that new subsidiaries have to face. This process can be more complicated for SMEs’ new subsidiaries due to the fact that they cannot leverage their SME parents’ public awareness as opposed to the new subsidiaries by large firms who are recognized and more well-known. (Eisenhardt, 1990) [23] .

Resources of particular interest to SMEs in their international growth and expansion are knowledge about the local firms and markets, firm repute and financial capital. Joint venture partners’ knowledge about the local markets can assist reducing of the the liability of foreignness confronted by SMEs’ foreign subsidiaries (Henisz, 2000) [24] , joint venture partners’ knowledge about the local markets usually depends on the partners’ understanding and experience in the local markets. Joint venture partners’ status provides approval and endorsement to SMEs’ foreign subsidiaries and therefore helps diminish their liabilities of newness. Joint ventures partners’ financial status can minimize the financial limitations of SMEs’ foreign subsidiaries and can help trim down their liabilities of smallness. Joint venture partners’ reputation and financial capital are connected closely with the size of the partners

Potential gains to firms by joint venture

Vertical joint ventures create major gains to both suppliers and purchasers. Overall, the outcome propose that joint ventures present an opportunity for both partners to acquire synergistic gains, with the relationship-based nature of this organizational form providing a productive arrangement for joint activity (Hall, 2000). The efficiency of joint operation can be seen by the fact that the mutual wealth gains are significantly larger than the gains from asset sales, but less than from mergers, which imparts full integration of the assets of the two firms with decisions made by a joined management team in quest of maximizing the value of the collective entity (Stimpson, 2005). In joint ventures wealth gains are distributed between both partners, but in case of mergers and asset sales, all of the gains accumulate to targets (sellers). A partner can also relate valuable knowledge gained from a joint venture to the projects it operates apart from or independently of the venture. Therefore, a joint venture allows a firm to have a chance in a productive activity and gain learning externalities that can augment the value of it’s separately managed and operated assets, while maintaining the choice to end the venture by dissolving it or selling to the partner or a third party. A joint venture is shaped by a consensus between different teams of managers that involves shared ownership of assets and a relationship-based cooperative approach about objectives and goals. Whilst In a merger, a single management team has direct control of all resource allocation decisions, which allows it to seize any synergies among the assets of the two firms so as to maximize the combined entity’s value. Nonetheless, a merger can cause substantial turnover of personnel and disrupt business activities. Such integration difficulties can dissolve a noteworthy portion of the potential gains from a merger. Mergers can also reflect agency troubles at acquirers (Hall, 2000).

Joint ventures normally have a 50/50 ownership formation. This type of ownership requires both partners to be in agreement on major decisions and reinforces the need for a continuing joint relationship between the partners, unlike in the case asset sales or mergers where a complete transfer of authority and control obviates any need for an ongoing relationship between the parties.

Previous theoretical research, including Darrough (1989) [25] , critically analyzes governance aspects in joint ventures, and illustrates how they are different from mergers and asset sales. Darrough (1989) emphasizes on two-party agreements and predict that a 50/50 ownership formation induces both parties to undertake plenty ex ante investments to facilitate cooperative behavior and ease the likelihood of stalemate, which increases the value of a 50/50 structure. Therefore, we test whether benefits from a joint venture are related to its ownership formation, and compare the benefits to mergers and asset sales.

Because sole possession of an asset is shifted to joint control, such a venture can be seen as a alternate for an asset sale that transfers complete ownership of an asset to a buyer in return for a financial payment (Eden, 2004). McConel (1985) [26] reported optimistic and constructive excess returns to firms that indulge in joint ventures and argue that these valuation effects reflect synergistic gains. In this view, each firm contributes resources to a mutually owned entity and has the potential to gain synergistic advantages of the joint venture that can be applied to its own activities, encompassing benefits from organizational skills or technological knowledge learned through its contribution in a joint venture. As the venture’s operations develop, a partner can apply relevant skills and knowledge that it gains to assets it operates apart from the joint venture.

Vertical joint ventures refers to a form of partial vertical integration in which a supplier and purchaser share the profits from cooperative and combined activity, and can be viewed as a replacement for a contractual or market-based agreement between a purchaser and supplier (Johnson, 2000) [27] . Studies allow us to determine whether purchasers and suppliers share the gains in vertical joint ventures or whether the distribution of gains to the partners differentiates from non-vertical joint ventures. Cross-industry joint ventures reflect those that are neither horizontal nor vertical. Two firms that operate in different industries may look for advantage of complementary competencies by indulging in a joint venture to develop a new product. Such a joint venture can also present an opportunity for a firm to gain access to the complementary skills and expertise of another firm, which can be applied to assets operated apart from the joint venture. A cross-industry joint venture can also symbolize diversification into a business different from a firm’s chief operations, a substitute to diversification by acquisition. Since previous empirical work finds focused firms more highly valued than diversified firms (Lang, 1994) [28] .

Factors affecting the choice of organization

Given all the advantages and disadvantages of both forms of organization it’s not an easy decision to make for an organization. Organization has to consider various factors before making the choice (Hall, 2000). First factor is of age; many businesses change their legal status as they become older. Most businesses when they start out are relatively small as sole traders. Over time as needs change, a sole trader may a form of partnership. Alternatively, a sole trader may invite owners to contribute in the business, form a private limited company and issue shares. Second factor is the need for finance; which states that an alteration in legal status may be forced on a business. Frequently small businesses wish to grow but lack funds (Khalid, 2007). Additional finance can also be raised if the business changes status. Another factor is of limited liability; which refers to the fact that owners can protect their own personal financial position if the business is a limited company. Sole traders and partners have unlimited liability. They may, therefore be placed in a position where they have to use their own money to meet businesses debts. Another factor which contributes to the decision is of degree of control; which refers that the owners may consider retaining control of their business to be important (Stimpson, 2005). This is why many owners chose to remain as sole traders. Once a new partner becomes a part of business the degree of control starts to diminish because now it is being shared with new owners. Though, it is possible to keep some control over limited company by holding majority of the shares. The last factor is of the nature of the business; the type of business activity may influence the choice of legal status. (Carrier, 1994).

Conclusion

This essay represents advances in international business transactions. Specifically, it sheds light on the particular causes of hazards to entrepreneurial cooperation that may indulge in franchising or joint ventures. These hazards to entrepreneurial cooperation need to be thoroughly understood, since they diminish the strategic leverage by which these organizational arrangements can overcome impediments to exploiting market opportunities. Specifically, it has been examined why and how franchisors can discover and exploit opportunities for cultivating and sustaining both integrity trust and competence trust to ensure franchisee compliance which is a critical driver of cooperative relations associated with successful franchises. Importantly, this is shown how trust is comprised of the distinct dimensions of both integrity and competence that differentially impact on conflict and compliance.

This essay suggests that without mutual trust, much franchisor time will be directed into managing dissatisfied franchisees, and in reconciling dysfunctional conflict that can distract from building the strategic side of the business. When conflict is dysfunctional, it is unlikely the franchisees will commit fully and cooperatively to the spirit and intentions of the franchise contract, squandering valuable social capital for both franchisor and franchisees. In short, the ability to overcome opportunism, reflected in discouraging non-compliance, is a major challenge for successful entrepreneurs within franchise systems. The essay revealed that franchisee’s trust in the integrity of the franchisor is significantly damaged by relational conflict, and this form of trust is a necessary prerequisite for franchisee compliance with organizational norms. Conversely, franchisee’s trust in the competence of the franchisor is not significantly influenced by relational conflict, and this form of trust has a less substantial influence on compliance. Overall, it has been suggested that franchisors, which are generally eager to improve conformity with operational guidelines, would greatly benefit from a richer understanding of the role that multiple forms of trust play as preconditions to franchisee compliance, and should endeavor to develop relational forms of governance in order to augment contractual norms and encourage reciprocal behaviors.

It has also been evaluated how industry structure, ownership, and the nature of partner contributions to joint ventures influence the gains in wealth. Our results for joint ventures point to the fact that there are significant gains from two firms acting in a relationship-based activity. These gains are bigger than for asset sales, but not as big as when firms join through a merger. Given significant returns to both parties, joint ventures provide affirmative and encouraging returns to firms to help justify their investments, and are a valuable component of the market for corporate control. The managerial implications of my study are that firms in high-tech industries are most likely to benefit from development of joint ventures within the same industry. Moreover, these high-tech companies should think more than once regarding the decision of forming a joint venture with a partner from a totally different national culture. The disadvantages and costs of cultural issues and differences may overshadow the benefits.

To sum up this essay tries to highlight the major and minor differences between joint-venture and franchising. This essay also establishes the notion that nowadays more and more firms are indulging in franchising and joint ventures. Though there are advantages and disadvantages to both forms of business there is still a need for proper investigation and research before a firm makes the choice, a proper SWOT analysis is also required. In the end of essay one thing on the note is that the choice should be made according to the long-term objectives of the firm, nature of the business and financial status of the firm.