Governance Inseparability in Franchising:
Evidences from Case-Studies in France and Brazil
Paulo F. Azevedo*
and
Professor, Dep. of Economics
FGV-EESP
pfa@fgvsp.br
Vivian L.S. Silva*
Prof., Dep. of Food Engineering
FZEA-USP
vivianlara@hotmail.com
Abstract
The literature of franchising largely relies on the analysis of the transaction between franchisor
and franchisees, sometimes also integrating company-owned outlets in the same investigation.
We submit that the appropriate design of franchise contracts depends not only on the features of
the transaction between franchisor and franchisees, but also on other transactions undertaken by
the franchisor, particularly in upstream contracts, a hypothesis known as ‘governance
inseparability’. Moreover, some institutional environment features that affect the choice of
governance mechanisms in the supply chain may indirectly influence the design of franchise
contracts. In order to explore this hypothesis, this paper presents a discrete structural analysis of
21 case-studies of food franchising in France and Brazil. The cases compare franchise chains in
each country that share similar business features – e.g. McDonalds’ operations in France and
Brazil – in an attempt to control variables related to the product and franchisors’ strategies. The
main findings are the following: a) firms choose a portfolio of governance mechanisms to govern
their set of transactions; b) upstream and downstream governance mechanisms are
complementary; and c) quality regulation and competition policy restrain upstream governance
mechanisms, having an indirect effect on the design of the franchise contracts.
1. Introduction
The literature of franchising largely relies on the analysis of the transaction between
franchisor and franchisees, sometimes also integrating company-owned outlets in the same
investigation. We submit that the appropriate design of franchise contracts depends not only
on the features of the transaction between franchisor and franchisees, but also on other
transactions undertaken by the franchisor, particularly in upstream contracts, an hypothesis
known as ‘governance inseparability’. Moreover, some institutional environment features that
affect the choice of governance mechanisms in the supply chain may indirectly influence the
design of franchise contracts. In order to explore this hypothesis, this paper presents a discrete
structural analysis of 21 case-studies of food franchising in France and Brazil. The cases
compare franchise chains in each country that share similar business features – e.g.
McDonalds’ operations in France and Brazil – in an attempt to control variables related to the
product and franchisors’ strategies.
The paper is structured as follows. Section 2 presents the main argument of governance
inseparability and its consequence to the franchising literature. The third section comprises
the results of the analysis of the 21 case-studies. First we explore the effect of the risk of
brand name loss on the choice of a portfolio of governance mechanisms. Then we describe the
existence of plural forms in the transaction between the franchisor and its outlets and how
they are complementary to upstream governance mechanisms. At last we look at the effect of
*
The authors contributed equally to the writing of the paper. Our sincere acknowledge to FAPESP and CAPES
for providing financial support as well to all the franchise chains for making the data available. The usual caveat
applies.
1
institutional variables on the choice of a portfolio of governance mechanisms. The last section
summarizes the main results and speculates about the consequences for future research.
2. Governance Inseparability and Plural Forms
There are several private arrangements to govern transaction hazards. The literature of
Transaction Costs Economics (TCE), since Williamson (1985), has had the merit of providing
a model that, given the characteristics of a particular transaction, predicts the adopted
governance structure. Moreover, transaction dimensions (asset specificity, frequency and
uncertainty) are to some extent observable, thereby allowing empirical tests of important TCE
propositions.
The argument initially presented by Williamson (1985) – and maintained in subsequent
works (Williamson, 1991; 1996) – matches transactions dimensions to the choice of a singular
governance structure (e.g. market, hybrid or hierarchy), which is arguably the most efficient
among the set of possible structures in mitigating transactions costs. However, there is
empirical evidence that existing governance arrangements influence the organizational choice
of newer transactions (Argyres and Liebeskind, 2002). Inasmuch as governance decisions of
each transaction seem to be related to each other, the choice of a particular governance
structure can not be analyzed isolatedly, a proposition known in the literature as governance
inseparability.
Williamson (1985) was already aware of the gains from taking into consideration the
whole set of transactions in the analysis of governance structures. In his words, TCE
“normally examines each trading nexus separately. Albeit useful for displaying core features
of each contract, interdependencies among a series of contracts may be missed or undervalued
as a consequence. Greater attention to the multilateral ramifications of contract is sometimes
needed” (Williamson, 1985: 393).
A more general argument recommends that the choice of a governance structure for a
given transaction should be inseparable from all other transactions the firm takes part in. The
main argument in the literature states that governance inseparability arises because the
existence of several contractual commitments with other parties restricts the decision rights
about governance choice (Argyres and Liebeskind, 1999). Those commitments constrain
future governance choices because a) they may impede switching to a superior form of
governance mechanism if the firm is already engaged in other governance structures in a
similar transaction to other parties; and b) they may obliterate governance differentiation
since the firm is constrained to use the existing type of governance mechanism in other
transactions. In a more recent paper Argyres and Liebeskind (2002) identified a case of
constraint on governance differentiation in the biotechnology industry.
Inasmuch as past choices restrain present options, both constraints on governance
switching and on governance differentiation make history relevant for the organizational
strategies. This case of path dependence differs from the one based on increasing returns
(Arthur, 1989), for which the timing alters the performance of a governance structure because
of gains from, for instance, learning and trust. Since past choices influence present and future
decisions, existing governance mechanisms should be taken into account when deciding how
to govern a newer transaction.
We submit that there is another reason for governance inseparability, which does not
need the reference to past decisions. The choice of governance structures for the various
transactions undertaken by a firm may be interdependent if there is some synergy between
complementary mechanisms of governance. This idea apparently contradicts the original
insight of Coase (1937), for whom different coordination mechanisms – in his initial
proposition, restricted to market and firm – were alternative ways to govern a given
transaction. Even though this insight is still one of the main foundations of TCE, governance
2
inseparability also revels that, besides being alternatives, governance structures may also be
complementary. For instance, franchising upstream contracts designed to reduce variability of
input quality may attenuate moral hazard effects in the transaction between franchisor and
franchisee.
The literature of franchising offers some cases where governance structures are
complementary and, as a consequence, the choice of governance mechanisms should be
inseparable. For example, Gallini and Lutz (1992) show that company-owned outlets signal
franchisor relevant characteristics, i.e., vertical integration is complementary to franchising
contracts. The literature of tapered vertical integration is also based on the notion of some
complementarities between hierarchy and other governance structures. For instance, Azevedo
(1996) submits that tapered vertical integration may be adopted to improve bargaining
position in a hybrid governance structure. Michael (2000) proposes a similar argument, in
which tapered integration permits the acquisition of information about the subsequent
production stage1, with consequences on bargaining.
What are the consequences of assuming governance inseparability in franchising? The
prolific franchising literature focuses on the transaction between franchisor and franchisees,
sometimes incorporating company-owned outlets in the analysis. Nevertheless if franchising
is subjected to governance inseparability, other governance mechanisms may have an effect
on either the design of a franchising contract or the decision to not franchise at all. As a
consequence, upstream governance structures employed by a franchisor – such as vertical
integration on the production of the inputs required by outlets – are missing variables in
several analyses about the determinants of franchising contracts. This may explain why
different franchise chains govern similar transactions with different governance structures
(different contract design or different proportion of company-owned outlets), provided that
they have distinct upstream governance arrangements.
3. Empirical Evidences from Governance Inseparability in French and Brazilian
Franchising
This section consists of a comparative analysis of a multi-case study of food franchise
chains in France and Brazil. As it is usual in multi-case studies (Yin, 1989), the data
collection was based on semi-structured interviews with chains managers. We compared 21
case studies (seven in France and 14 in Brazil) concerned with five food franchising sectors:
1) coffee shops, 2) fast food, 3) fine products, 4) grills and 5) sweets & chocolates 2. Cases
were selected based on brand name value, according to Aaker (1991) due to their stability and
relevance, evolution in franchising (in years) and dispersion. Couples of food franchise chains
were selected from the same sectors in each market, with an emphasis on the comparative
analysis of McDonald’s in both France and Brazil. Our focus on a comparative analysis
between France and Brazil is related to their historical and economic relevance in the
international franchising as well differences in their institutional environment, regarding for
1
Riordan (1990) emphasized this role of vertical integration, when he defined it as a change in the information
structure.
2
In the French market we investigated the French Grill Courtepaille, La Boucherie (both from grills segment),
Jeff de Bruges (chocolates) and Comtesse du Barry (specialized in foie gras, a classic product of French cuisine).
The group of cases also included operations in the French market of Segafredo Zanetti, an Italian group of coffee
shop, and Quick, a Belgian fast food franchise chain. In Brazil, we analyzed four originally Brazilian coffee
shops chains (Fran’s Café, Café Pelé, Café do Ponto (owned by SaraLee) and Casa do Pão de Queijo) besides the
also Brazilian Habib’s, China in Box, Vivenda do Camarão (fast foods), Bon Grillê (grills), Kopenhagen (fine
sweets & chocolates) and Amor aos Pedaços (sweets & chocolates). Our data set also included Brazilian
operations of the American The Nutty Bavarian (sweets & chocolates), Dunkin’Donuts (coffee & donuts) and
Arby’s (fast food). Finally we also compared the American McDonald’s (fast food) in both markets, France and
Brazil.
3
instance legal system, court decisions, quality regulation, competition policy, social norms
and consumption habits. Table 1 details the evolution of each chain, with information on
business and franchising experience, internationalization and number of franchised and
company-owned units.
‘Take in Table 1’
3.1. A Portfolio of Mechanisms to Mitigate the Risk of Brand Name Loss
Several franchise chains strategies – from the way they organize their transactions to
innovation efforts – are designed to deal with the trade-off between the costs of shirking and
the risk of brand name loss (under-provision of quality by franchisees3). The higher the value
of keeping quality standards, the more likely the efforts the franchise chains will direct to
overcome franchisees’ incentives to under-provide quality. Nothing new so far. However, this
proposition has strong implications on the organizational choice, in both downstream
(franchiser-franchisees) and upstream (supply chain) transactions. That is our major point.
The same variable (e.g. brand name value) determines the organizational choice of different
transactions, with different attributes. The organizational solution in upstream transactions has
an effect on the choice of franchise contracts, which is an evidence of governance
inseparability.
In almost all the 21 cases, when the value of maintaining product uniformity is higher,
the franchise chains tend to adopt organizational strategies that prevent free-riding behavior of
franchisees. The pay-off of keeping quality standards depends on both the brand name value
and the consumer’s sensitivity to variations in the attributes of products. In Barzel’s (1982)
seminal argument, brand name has a value because it transmits information about attributes of
products that saves consumers’ measurement costs. As a consequence, maintaining product
uniformity is worthy as it preserves the brand name capability to transmit information.
How sensitive consumers are to the variation in products attributes is also important. In
Barzel’s terms, if consumers are quite sensitive (have low measurement costs of product
attributes), the seller must incur higher measurement costs to prevent consumers from
collecting information themselves. As a consequence, chains will direct efforts to increase
quality control, for instance, reducing franchisees incentives to under-provide quality.
Among all the cases, Comtesse du Barry and Segafredo, in Europe, and Vivenda do
Camarão, and Kopenhagen, in Brazil, are examples of quite sensitive consumers. Due to
cultural reasons, French customers are capable of identifying the slightest variance in the foie
gras (Comtesse du Barry) and coffee (Segafredo), among other products. Brazilian consumers
of shrimps with creams at Vivenda do Camarão are also able to distinguish changes in the
skim milk suppliers and shrimp characteristics. Finally, Kopenhagen sells varieties of
chocolates as gifts for special occasions, comparable to jewels. Small variations of product
attributes also jeopardize its image as a sort of present, for Valentines Day or an engagement
proposal for instance. In all these cases franchisers vertically integrate the production of
inputs directly related to their brand names, such as foie gras, (Comtesse du Barry), coffee
beans (Segafredo in Europe), shrimps (Vivenda do Camarão) and chocolates (Kopenhagen).
Also the proportion of company-owned outlets is higher  as a consequence, incentives for
under-provision of quality are lower , and some innovative efforts are oriented to eliminate
franchisees’ tasks that affect the quality of products.
In general, there are three ways to avoid the costs related to the misuse of brand name
by franchisees: a) reducing the variability of the inputs supplied to chain outlets, by means of
governance structures such as hierarchy and hybrid modes in upstream transactions; b)
3
See for instance Bai & Tao (2000); Lafontaine & Raynaud (2002); Azevedo & Silva (2003); Bercovitz (2004);
Windsperger et al. (2004).
4
providing better incentives for outlet managers to meet quality standards, by means of
governance mechanisms in the transaction between franchisor and franchisees (e.g. higher
proportion of company-owned outlets or safeguards in the franchise contract); and c)
eliminating tasks performed by franchisees that affect attributes of products, which may be
achieved by means of innovation (e.g. ready to use products which do not require any hidden
action by franchisees) and organizational strategies (such as central kitchens and pre-cooked
meals, which may be interpreted as vertical integration of some tasks originally performed in
the outlets).
A comparative analysis of coffee shops in Brazil and France is illustrative. Although
Brazil is one of the main coffee producers, Brazilian consumers have not developed the
capability for distinguishing and appreciating different coffee flavors, different from French
consumers. After decades of pricing and trading regulation, Brazilian consumers have been
used to low quality coffee and acquired drinking habits that attenuate the effect of coffee
flavors. 4 After the deregulation in the early 1990’s, some companies tried to explore all sorts
of differentiation strategies, but those based on coffee flavors did not pay-off, and were
discontinued.
In order to analyze the effect of different consumer’s sensitiveness to product attributes,
we compared four Brazilian coffee shops (Café do Ponto (owned by SaraLee), Café Pelé,
Fran’s Café and Casa do Pão de Queijo) with Segafredo Zanetti operations in Brazil and
Europe. In all Brazilian chains of coffee shops, the franchisor has control on the supply of
roasted coffee by means of long term contracts (Café Pelé and Casa do Pão de Queijo),
exclusive dealing contract (Fran’s Café) and vertical integration (Café do Ponto).
Notwithstanding the control on roasting and grounding, all coffee chains use the spot market
to buy coffee beans with negligible control on their quality. Consistently with our proposition,
given the low sensitiveness of Brazilian consumers to coffee flavors, which depends primarily
on coffee beans, chains do not exert control on the coffee bean market.
The comparison with Segafredo Zanetti operations in Brazil and Europe is strikingly.
Segafredo Zanetti coffee shops have exclusivity on the distribution of the high-end coffee
blend (Nero) of the company, which also sells other blends to restaurants and hotels. In order
to strictly control the quality of coffee beans and roasting, Segafredo vertically integrates
coffee production on its own farm in Brazil and roasting on its plant in Bologna, Italy, which
supplies all coffee shops in Europe. Although Segafredo sells some blends in the Brazilian
market, the coffee beans that grow in Brazil are sent to European coffee shops, which is an
additional evidence that consumer sensitiveness is an important variable to understand
organizational strategies.
The cases clearly indicate that the higher the value of keeping quality standards, the
more likely the chances for franchise chain to adopt governance mechanism that provide more
control on all pertinent transactions. We also observed, that, for a given level of keeping
quality standards, the use of governance structures that provide more control on the supply
chain (upstream coordination) reduces the need of incentives and control on the transaction
between franchisor and outlet managers (franchisees or managers of company-owned outlets).
That is basically the idea of governance inseparability, which is investigated in the subsequent
sections.
3.2. Plural Forms in Franchise Contracts
Plural forms are an important subject in franchising literature. The co-existence of
franchised and company-owned outlets in the same chain is a well-known fact, deserving the
4
It is noteworthy that Brazilians tend to consume hotter and sweeter coffee, which reduces the capability to
distinguish different flavors. After 15 years of deregulation, the market for premium coffee has been slowly
increasing, together with the sensitiveness of consumers to slight changes in coffee beans attributes.
5
great attention it has received from researches. 5 Nevertheless, organizational forms in
franchising are more diverse than suggested by the literature. 6 Indeed, in addition to hierarchy
form (company-owned outlets) we have observed three different franchise contracts: 1)
conventional franchising; 2) partial franchising; and 3) management contract. In the
conventional franchising, the franchisor transfers to the franchisee the totality of initial
investments of franchised units. In addition, the franchisee pays the franchisor a lump-sum
franchise fee as well as a proportion of sales in royalties. In contrast, in the partial franchising,
the initial investments of franchised units are shared between the parties. The franchisor hands
on the expenses with the building (purchase/rent), retaining the residual rights over it,
whereas franchisees are responsible for investments in equipment, furniture and staff. In
addition to the regular taxes, the franchisee transfers to the franchisor an additional proportion
of sales as a rental fee. Finally, in the management contract the franchisor typically holds the
totality of initial investments of the unit, transferring only the management of the franchised
unit to the franchisee. In exchange, the franchisee pays the franchisor an administration fee as
well as royalties and rental fee, and not necessarily a franchise fee. In this format, the
franchisee resembles a manager of company-owned outlet with variable revenues according to
unit performance. Table 2 shows the main features and consequences of each governance
structure identified.
‘Take in Table 2’
An important difference among the various observed governance structures is their role
as a solution for capital restrictions ((Ozanne & Hunt, 1971); (Caves & Murphy, 1976);
(Mendelsohn, 1985); (Coughlan et al., 2001)). Whereas in the conventional contract the
franchisee is responsible for all investments, in the management contract he or she receives
similar high-power incentives without immobilizing his/her own capital. The very existence
of this type of franchising contract (management contract) is an evidence that raising capital is
not the unique reason to franchise, although it remains important to explain the adoption of
the conventional franchising.
An other important distinction is the role of each governance structure in providing
incentives against shirking and under-provision of quality. Inasmuch as franchisees retain part
of the residual claims over variations on unit sales, conventional, partial and management
contracts transfer to the franchisee higher incentives to work harder, contrarily to managers of
company-owned outlets. Nevertheless the three types of franchising differ in their incentive
intensity. Conventional franchising allocates a higher proportion of the residual claims to
franchisee, in the form of a return to his or her investments, which implies higher incentives
to not shirk.
On the other hand, franchise contract is more vulnerable to the moral hazard on quality
under-provision than company-owned outlets. These risks are comparatively higher under the
conventional franchising, unless, in addition to the payment scheme of this format, franchisee
incurs higher specific investments in the outlet (Azevedo & Silva, 2001). By guaranteeing to the
franchisor the control over the building location, the partial and management contracts
prevent former franchisees from using the same location in a similar activity, free-riding on
reputations towards consumers. In order to attenuate these risks, we observed that the
conventional franchising uses safeguards such as clauses of ex-post non-competition.
Despite such relation, it is noteworthy that in Brazil franchise chains do not fully
explore the diversity of franchise contracts, as observed in France/Europe. Whereas in Brazil
5
See Bradach and Eccles (1989), Dant et al. (1996), Bradach (1997), Bai and Tao (2000; 2000a), Azevedo and
Silva (2001), Lafontaine and Shaw (2001) and Pénard et al. (2002).
6
One exception is Bercovitz (2004) who also analyzes the choice of multi-unit franchising.
6
company-owned outlets are often combined with a unique franchise contract (in general the
conventional franchising), in France franchise chains employ a more complex portfolio of
governance structures in downstream transactions (Table 3). We submit that the difference
between the two countries is due to jurisdictional uncertainty. This result is better detailed in
section 3.4, which deals with the effect of the institutional environment on the choice of
governance.
‘Take in Table 3’
3.3. Governance Inseparability in Upstream and Downstream Transactions
As showed in the last section, franchise chains use plural organizational forms in the
transactions with their outlets. Not only do plural forms exist and are more diverse than the
well known dichotomy of company-owned and franchised outlets, but also the choice of a
governance structure for one transaction seems to be related to the choice for the others. Our
claim is that organizational choices are interdependent because governance structures are
complementary. In addition to governance inseparability of franchisor-franchisee transactions,
this section focuses on the role of upstream transactions, exploring the complementarities
between upstream and downstream governance structures.
Comtesse du Barry (foie gras) and Jeff de Bruges (chocolates) case studies are
illustrative. When compared with other chains, Comtesse du Barry and Jeff de Bruges have
the remarkable feature of supplying their units with ready-to-eat products7, i.e., they vertically
integrate processing activities that could otherwise be performed by either suppliers or the
outlet itself. By means of this organizational strategy, the company has better control on
quality standards in the outlet level, inasmuch as franchisees do not process or manipulate the
final product. The use of governance structures that provide more control on the supply chain
allows Comtesse du Barry and Jeff de Bruges to reduce the need for control on downstream
transactions. Indeed, Comtesse du Barry and Jeff de Bruges also employ licensing contracts
as an alternative mode of governance of outlets. The licencee, under an independent brand
name, has full autonomy regarding the entire business format itself. Among all other cases,
only Dunkin’Donuts employs a similar marketing channel strategy, combining licensing with
company-owned outlets and franchised units. However, their licensees must be located near
franchised or company-owned units, which are in charge of the supply of ready-to-eat
products to licensees. In such arrangement, Dunkin’Donuts also mitigates the risk of underprovision of quality.
The comparative analysis of Grill Courtepaille and La Boucherie (both of them
specialized in grills) provides another evidence of governance inseparability in upstream and
downstream governances. Although they operate in the same market and share similar
business features, Grill Courtepaille and La Boucherie have a quite different proportion of
company-owned outlets, respectively 79,2% versus 17,1% in 2004. The reason for this
remarkable difference in the level of control on the transactions with their outlets is the
governance structure used in the supply chain. Grill Courtepaille counts on a branch of Accor
Group (Accor Reste) for the selection of suppliers8, but it does not maintain the decision
rights over the choice of suppliers. Even in the case of inputs directly related to their brand
name (meat, bread, vegetables, cheese and wine), the franchisees have autonomy to deal
directly with local suppliers to explore regional specificities. On the other hand, one of the
main competitors of Grill Courtepaille, i.e., the also French La Boucherie, has vertically
integrated the supply of its restaurants, particularly regarding its key-products (meat, wine and
7
For those products directly related to their brand name: foie gras and chocolates.
Accor Group is the main shareholder of Grill Courtepaille. In fact, Grill Courtepaille restaurants tend to be
strategically situated physically closed with hotels from Accor Group. Some suppliers of Grill Courtepaille are
shared with Accor hotel chain.
8
7
other inputs related to La Boucherie business format, such as equipment, fittings and
marketing materials). Since 2000, Société CAVIAR (Centre d’Affinage des Viandes de
Restaurants) is responsible for: 1) selection, control and trading of product; 2) traceability,
hygiene and sanitary controls of raw-material; 3) cut meat, and 4) optimization of both
distribution and service practices of La Boucherie restaurants. The control on the supply chain
– greater in the La Boucherie case – explains why it does not exert the same level of control
on outlets as Grill Courterpaille does.
3.4. Institutional Environment and its Effects on Franchise Contracts: A Case of
Governance Inseparability
The comparative analysis of case studies of France and Brazil allows the investigation
of the institutional environment effect on franchising contracts. Particularly we looked at the
institutional variables that have a direct effect on some franchisors’ transactions and how they
indirectly influence the organizational choice in the other transactions undertaken by the
franchisor. In this section we detail the following arguments: a) jurisdictional uncertainty with
regard to the enforcement of franchising contracts; b) transaction costs in the capital market
and c) competition policy restrictions to vertical arrangements.
There is a reasonable consensus about the inefficiency of the Brazilian judiciary and the
consequences in economic arrangements9. This feature of the Brazilian institutional
environment has direct implications on the choice of governance structures, particularly on
the choice of the various franchising contracts (conventional, partial and management) and
company-owned outlets. The comparative analysis of plural forms, mentioned in section 3.2,
provides an example of this effect.
Brazilian jurisdictional uncertainty may be the reason why international franchise
chains do not adopt in Brazil the same organizational strategies they do in their original
countries. Differently from what is observed in other markets, Dunkin’Donuts, The Nuty
Bavarian and Arby’s do not explore the diversity of franchise contracts in Brazil, using only
the dual structure of conventional franchising and vertical integration. An exception is
McDonald’s, which retains control over building location, as it is usual in its operations all
over the world.
The McDonald’s position of maintaining its international strategy in Brazil generates
conflicts between the company and its Brazilian franchisees. The crisis began in 1996, when
the company started an accelerated growth strategy in the Brazilian market, which resulted in
a decline of unit sales. Since 1999, when Brazilian currency devaluated, the conflict has
worsened. The franchisees that had debts to the company indexed to dollar led the contract to
court, resulting in a series of onerous lawsuits in Brazil. By increasing the costs of franchising
in Brazil, the conflicts between McDonald’s and its franchisees are the main causes for
changing the company organizational strategy towards a higher level of vertical integration,
increasing the proportion of company-owned outlets (Figure 1).
‘‘Take in Figure 1’
In short, the jurisdictional uncertainty that affects the costs of franchising has induced a
higher level of vertical integration. It could be argued that this is not a case of governance
9
Pinheiro (2005), in an extensive survey, observed that Brazilian jurisdictional decisions are too lengthy,
unpredictable and biased towards the weaker part. Arida et al. (2005) argue that the inexistence of a long term
credit market in Brazil is caused by the poor guarantees the judicial system offers creditors. Zylbersztajn and
Nadali (2003) assert that the location decisions in the agribusiness sector are sensitive to the way the regional
courts judge contractual litigations between agricultural producers and food processors. Such inefficiencies are
the consequence of the delays and uncertainties regarding the court rulings.
8
inseparability, inasmuch as in each transaction higher cost of contracting increases the
likelihood of vertical integration. Nevertheless it is noteworthy that the use of franchising
contracts that provide more control to franchisors (partial franchising and management
contract) is widespread in France and not observed in Brazil. The higher proportion of
company-owned outlets in Brazil reduces the need for control on franchising contracts, which
is a possible explanation for the option of conventional franchising in Brazil.
The second argument is the transaction costs in the capital market. Brazil has one of the
highest interest rates in the world. 10 Macroeconomic foundations are certainly part of the
history that explains this anomaly in the Brazilian capital market, but there are institutional
variables that contribute to the high transaction costs in this market. Arida et al. (2005)
observed that long term credit market has not developed in Brazil because court rulings are
biased towards debtors. As a consequence, savings owners do not use long term contracts,
which are more likely to be in courts. In contrast, the French capital market is far more
accessible. This is another possible explanation of why France presents all types of
franchising contracts, contrarily to Brazil, in which the conventional franchising is the
absolutely dominant form. An imperfection in the transaction between franchisors and capital
lenders imposes capital restrictions that may be solved by the use of a franchising contract
(conventional) that attracts capital from franchisees. In France, the role of franchising as an
alternative to raise capital is attenuated because franchisors have better access to the capital
market. This is another evidence of governance inseparability in franchising11.
Finally, competition policy may constrain the choice of governance mechanisms in
upstream transactions, having an indirect effect on the design of the franchise contracts. For
instance, in France/Europe companies that have more than 30%12 of the market are not
allowed to impose vertical restraints to franchised outlets, such as exclusive suppliers or
vertical integration of input production. We expect that those restrictions have an effect on the
need for control on downstream transactions, in order to preserve the brand name value.
However the evidences of McDonald’s in France, a company subjected to that
competition policy restriction, suggest, at first sight, that the above proposition is actually
false. Inasmuch as McDonald’s can not control the variability of inputs, we expected that it
would use a higher proportion of company-owned outlets, which is a form to prevent
franchisees incentives to under-provide quality. Contrarily to our expectations, the proportion
of company-owned outlets that McDonald’s holds in France is historically quite lower than
the one observed in Brazil, even before court rulings raised the costs of franchising (Figure 1).
A more detailed look at the franchising contracts and quality regulation in France
provides a possible explanation for this result. The variability of input quality, particularly of
agricultural products, is quite lower in France than in Brazil due to a more effective French
quality regulation. The lower the variability of inputs, the less necessary to exert control on
the supply chain. In addition, as already mentioned, franchising contracts in France are more
diverse, including forms – such as partial franchising and management contract – that provide
better incentives for franchisees to keep up with quality standards. In short, in comparison
with Brazil, McDonald’s in France relies more intensely on franchising, by means of types of
contracts that provide more control to the franchisor.
10
In 2005 real interest rates were about 13% a year for fixed income securities.
The first two arguments explain basically the same empirical regularity: variety of franchising contracts in
France and predominance of conventional franchising in Brazil. As a consequence, we can not separate both
effects, but they are both plausible arguments based on the idea of governance inseparability.
12
European Competition Policy, according to the Regiment of Exemption 2790, of 1990, establishes that
retailing vertical arrangements, among then franchising contracts, are subject to the following clause: companies
with a market share that exceeds 30% are not allowed to require exclusive suppliers.
11
9
4. Concluding Remarks
There is not much dispute that firms choose a portfolio of governance mechanisms in
order to deal with the whole set of transactions they are engaged in. They even choose what is
firm and not firm. Less researched, however, are the consequences of not taking governance
inseparability into account when explaining firm boundaries and contracts that govern
particular transactions. The literature on governance inseparability proposes that former
transactions constraint the choice of present governance mechanisms (Argyres and
Liebeskind, 1999). In addition we submit that governance choice is interdependent because
different governance mechanisms employed by the same firm may be complementary.
Franchising is an interesting case where the appropriate design of a governance
structure of a particular transaction depends on the other governance arrangements. In a set of
21 case-studies we have gathered evidence that a) franchisors choose a portfolio of
governance mechanisms to govern this set of transactions; b) upstream and downstream
governance mechanisms are complementary, making the governance decision of each
transaction inseparable from the others; and c) quality regulation and competition policy
restrain upstream governance mechanisms, having an indirect effect on the design of the
franchise contracts. The latter finding is particularly relevant to the case of franchise chains
that explore foreign markets, being subjected to different institutional environments. If
competition policy, for instance, imposes some sort of restriction to vertical restraints, such as
an exclusive supplier to outlets, the franchisor will not be able to reduce quality variation of
inputs and, as a consequence, will face greater risk of loss of brand name value. Under the
pressure to mitigate hazards related to final product variability, the franchisor may be willing
to adopt franchising contracts that provide better incentives for franchisees to provide
specified quality standards.
If this proposition is correct, existing governance mechanisms should be taken into
account in any analysis of the determinants of governance choice. Inasmuch as franchising
literature largely relies on the transaction of the franchisor and his/her outlets (franchised or
company-owned), with no reference to upstream governance mechanisms, we submit that
those studies may have omitted variables. However how the absence of those variables affects
current results of the literature is not clear. Actually the huge empirical support of the TCE
basic argument (Klein, 2004) suggests that omitting existing governance mechanisms does
not have a strong effect on the prediction power of the theory.
For future research we suggest gathering information on the whole set of franchisors’
transactions, to empirically test the effect of upstream governance on downstream franchising
contracts. It is also recommended to embrace the task of a cross-country analysis in order to
capture the effects of institutional environment variability.
5. References
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12
6. Appendix
Table 1. Summary of Franchised Chains’ Evolution**
company
segment
level of
upstream
coordination
Jeff de Bruges
France
World
sweets &
chocolates
XXXXX
fine
products
grills
C. Barry
France
World
La Boucherie
France
World
G. Courtepaille
France
grills
proportion of company-owned outlet (number of company-owned outlets; and franchised units)
years of
foundation
year of
franchising
beginning
1997
1998
1999
2000
2001
2002
2003
2004
1986
NO
NO
NO
NO
NO
NO
24.7%
22.9%
NO
20.9% (43; 162)
19.1% (43; 225)
XXXXX
1908
NO
1975
NO
NO
NO
NO
NO
NO
15.1%
-
NO
32.3% (21; 44)
30.55% (22; 50)
XXX
1974
NO
1987
NO
NO
NO
NO
52.3%
NO
NO
25.0%
NO
NO
17.1% (6 ; 29)
15.0% (6 ; 34)
1961
2000
91.8%
91.9%
90.5%
85.9%
NO
NO
79.2% (126; 33)
1971
1980
NO
1978
1991
NO
NO
NO
NO
NO
NO
1964
1992
1965
1997
88%
end of
Brazilian
operations
NO
NO
NO
NO
NO
1946 (58)
1983 (21)
1955
1991
NO
NO
NO
NO
NO
1.0%
1.5%
NO
NO
1955
1972
1979
1955
1979
1987
20.0%
13.0%***
40.0%***
20.0%
13.0%***
40.0%***
20.0%
13.0%***
40.0%***
20.0%
13.0%***
40.0%***
20.0%
13.0%
40.0%
20.0%
NO
68.0%
XX
NO
Quick
Belgium
France
World
fast food
XXX
fast food
XXX
NO
Arby’s
U.S.
Brazil
Dunkin’Donuts
U.S.
Brazil
sweets &
chocolates
XXX
McDonald’s
World***
France
Brazil
fast food
XXX
**
100%
NO
26.9%
-
NO
34.6% (108; 204)
28.6% (114; 285)
20.0%
16.23% (168; 867)%
73.0% (401; 148)
Based on primary data; GVconsult (2004); ABF (Franchising Brazilian Association); and FFF (Franchising French Federation). NO: data not obtained. *** McDonald’s estimate.
13
Table 1. Summary of Franchised Chains’ Evolution** (Part 2)
segment
level of
upstream
coordination
sweets &
chocolates
XXX
grills
XXX
fast food
XXX
fast food
XXX
fine sweets &
chocolates
XXXXX
fast food
XXX
sweets &
chocolates
XXX
coffee shops
XXX
coffee shops
X
Café do Ponto
Brazil
Café Pelé
Brazil
coffee shops
C.P. Queijo
company
A. Pedaços
Brazil
Bon Grillê
Brazil
China in Box
Brazil
Habib’s
Brazil
Kopenhagen
Brazil
V. Camarão
Brazil
N. Bavarian
U.S.
Brazil
years of
foundation
franchising
beginning
(years of
experience)
1982
proportion of company-owned outlet (number of company-owned outlets; and franchised units)
1997
1998
1999
2000
2001
2002
2003
2004
1989
NO
9.8%
11.1%
15.0%
12.2%
NO
NO
11.9% (5; 37)
1994
1996
NO
66.0%
63.0%
57.0%
51.0%
NO
NO
74.5% (38; 13)
1992
1994
NO
8.6%
3.0%
9.7%
10.9%
NO
NO
9.2% (11; 108)
1988
1991
NO
43.0%
NO
NO
-
NO
24.0%
31.1% (81; 179)
1928
1992
NO
NO
NO
NO
30.0%
NO
NO
29.3% (47; 113)
1984
1990
NO
89.0%
86.0%
68.0%
50.0%
NO
NO
70.5% (31; 13)
1989
1989
1997
NO
NO
NO
NO
43.0%
NO
NO
NO
24.7% (18; 55)
1986
NO
NO
NO
NO
NO
NO
NO
0.29%
NO
NO
6.9% (2; 27)
0.4% (2; 470)
1972 (32)
1992
NO
13.8%
NO
NO
NO
NO
NO
1.0% (1; 100)
X
1976 (28)
1992
NO
8.9%
NO
NO
NO
NO
NO
1.7% (1; 56)
coffee shops
X
1992 (12)
1994
NO
0.0%
NO
NO
NO
NO
NO
1.7% (2; 115)
coffee shops
XX
1967 (37)
1987
NO
NO
NO
NO
NO
NO
NO
0.0% (0; 406)
S. Zanetti
Italy
France
Europe/World
Fran’s Café
Brazil
Brazil
**
70’
Based on primary data; GVconsult (2004); ABF (Franchising Brazilian Association); and FFF (Franchising French Federation). NO: data not obtained.
14
Table 2. Features of the Governance Mechanisms Identified in French and Brazilian Franchising
characteristics
governance
mechanism
investment
franchisee:
conventional 100% initial
investments
payments
outlet
residual
risk
scheme
control
claim
sharing
franchise fee
plus
franchisee franchisee
royalties
franchisee
and
partial
franchisor
share initial
consequences
higher risk
higher gains in capital and human
to
resources raising; and in the reduction of
franchisee
moral hazard prob. in shirking
franchisee some risk
idem plus
rent fee
franchisor
investments
(lower than transferred
in conv.
to
contract)
franchisor
higher franchisee motivation in work as
franchisor
(franchisee
idem plus
management
contract
administration
franchisor:
fee
100% initial
resembles
the manager
of
companyowned
investments
hard as desired by franchisor, reducing
transfer to risk shared monitoring costs comparing to hierarchy
franchisee
between
form
(lower than franchisor
partial
and
contract)
franchisee
outlet)
hierarchy
(company-
-
franchisor
-
owned outlet)
15
higher risk
comparative gains in the control of
to
franchised brand name
franchisor
(reducing moral hazards on quality)
Table 3. Governance Mechanism Employed According to the Chain Market ***
governance mechanism
company
conventional
partial
management
hierarchy
(companyowned outlet)
grills
•
NE
NE
•
sweets &
chocolates
•
NE
NE
•
•
NE
•
•
•
NE
NE
•
•
NE
•
•
•
NE
NE
•
•
NE
•
•
•
NE
NE
•
NE
•
•
•
•
NE
NE
•
NE
•
•
•
NE
•
NE
•
NE
•
•
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
NE
•
•
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
•
NE
NE
•
segment
Grill Courtepaille
in all markets
Jeff de Bruges
in all markets
Comtesse du Barry
target markets
other markets
fine products
target markets
other markets
grills
target markets
other markets
coffee shop
La Boucherie
Segafredo Zanetti
Quick
target markets
other markets
McDonald’s
global standard
Brazil
Arby’s
global standard
Brazil
fast food
China in Box
Brazil
Vivenda do Camarão
Brazil
Habib’s
Brazil
Bon Grillê
Brazil
grills
Dunkin’Donuts
global standard
Brazil
Amor aos Pedaços
Brazil
sweets &
chocolates
The Nutty Bavarian
Brazil
Kopenhagen
Brazil
fine sweets &
chocolates
Fran’s Café
Brazil
Café do Ponto
Brazil
Café Pelé
coffee shop
Brazil
Casa do Pão de Queijo
Brazil
***
NE: governance mechanism not employed by the chain.
16
% company-owned
Mix contratual
(% lojas outlet
próprias)
80
Brazil
Brasil *
70
60
50
40
30
Mundo**
World **
20
10
França**
France
**
0
1998
1999
2000
2001
2002
2003
Figure 1. Evolution of the proportion of company-owned outlets
employed by McDonald’s in Brazil, France and in the World
*Forecast of stability for the next years = about 70%. ** McDonald’s estimate.
Based on primary data in addition to COOREA (2003) and GAZETA MERCANTIL (2003).
17