University of Abertay Dundee
Mini Project on Europe

Franchising a good strategy for a company
 operating throughout Europe?
– Case study Benetton –

von

 Christine Klock

3rd year, 2004

Contents

1 Introduction  1

2 Agency theory and transaction costs theory  2
2.1 Agency theory  2
2.2 Information asymmetry  2
2.2.1 Adverse selection  3
2.2.2 Moral hazard  3
2.2.3 Moral hazard with hidden action  3
2.2.4 Moral hazard with hidden information  4
2.2.5 Moral hazard in teams  4
2.3 Agency theory and franchising  4
2.4 Transaction costs theory  5
2.4.1 Dimensions of transactions  5
2.4.3.1 Uncertainty/complexity  5
2.4.3.2 Asset specificity  5
2.4.3.3 Frequency  6
2.4.2 Hierarchy, market and hybrid forms  6
2.4.3 Transaction costs and franchising  6

3 International franchising  8
3.1 Cooperative international strategy through the basis of contracts  8
3.2 Advantages of international franchising  9
3.3 Disadvantages and problems of international franchising  10
3.4 Master franchising  10
3.5 Franchising in Europe  10

4 Case study – Benetton  12

5 Analysis and evaluation  13

6 Conclusion  15

7 Appendix  17
7.1 Appendix 1: Utility curve for the cost of symmetric information  17
7.2 Appendix 2: Asset specificity and uncertainty/complexity determine governance structure  18
7.3 Appendix 3: European Franchising Statistic 1994 and 1997  19

8 References and Bibliography  21

1 Introduction

The purpose of this dissertation is to focus on franchising and to examine, if franchising is a good strategy for a company operating throughout Europe. In order to find an answer to this question further sub-tasks have to be researched. It will identify the characteristics of the franchise system and its advantages and disadvantages. Furthermore, why franchising is a useful hybrid organisational form for organisations to entry, be in business and to expand without enormous financial resources. Moreover, criteria in terms of transaction costs and resource scarcity will be explained.

Once a company decides to go abroad and to target a certain European country, it has to develop and determine a strategy to enter the new market. There are several methods a company can use, for example indirect, exporting, direct exporting, licensing, franchising, joint ventures, direct investment and informal networks. Considering as a case study the corporate strategy of the Italian company Benetton, it will be analysed, if franchising is a successful mode to be used in business and to expand throughout Europe. Here is to be added that the analysis of the franchise system of Benetton will occur exclusively through the selection of the most important characteristics of a franchising strategy highlighted in chapter three. An extension of this selection would go beyond the scope of this project.

The dissertation consists of (including this introduction chapter one) six chapters. Chapter two encompasses the theoretical framework. Here, agency theory and transaction costs analysis will be explained. The agency theory will be used to explain the business relationship between franchisor and franchisee. Coase developed in 1937 the transaction costs analysis which was further developed by Williamson (Williamson and Masten 1999, p.181), however, this approach could explain the importance for organisations to find the suitable coordination structures, whether be it vertical integration, non-vertical integration, or a hybrid form that includes elements of both. Furthermore, the agency theory and the transaction costs analysis will be applied to franchising. Accordingly, franchising as a hybrid organisational form will be explained in detail.

In chapter three the trend of franchising in Europe will be analysed and the international franchise concept with its advantages and disadvantages will be explained. This involves the master franchising.

In the following chapter four the case study will be introduced. The company profile of Benetton will be presented in the context of the clothing retail industry. Here, it has to be said; although the ‘Benetton Group SpA’ operates in diverse industry sectors it will be concentrate only on the clothing retail industry. An extension of the different operating fields of Benetton would go beyond the scope of this project.

Furthermore, chapter five will be an analysis of the company profile of Benetton linked in the context of the theoretical background. It will be evaluated if franchising, as a strategic tool to operate in different European countries is successful. Finally, the dissertation will close with a conclusion in chapter six.

2 Agency theory and transaction costs theory

2.1 Agency theory

Agency theory describes the relationship of at least two parties who agree to work together. One party called the principal (e.g. manager) who delegates work to another party naming agent (e.g. subordinate). The relationship of the principal and agent can be both explained in mathematical models or it can be descriptive. (Jensen and Meckling 1976) This dissertation will focus on a descriptive explanation. It should be taken into account that because of the numerous agency relations within an organisation, it depends on who is principal and who is an agent (e.g. between shareholder and manager, voters and politicians, shareholder and management, and patients and physicians, etc.). (Douma, S., Schreuder, H. 2002, p.109) Because of the divergent preferences and objectives it is attempted to form contracts to stimulate the parties to yield commonly results. However, there is still a definition problem due to the law of incomplete contracts. (Jensen and Meckling 1976), (Sashi, Karuppur, 2001, p.509) and (Brousseau, Glachant, 2002, p.251)

2.2 Information asymmetry

Williamson (Williamson and Masten 1999, p.24) refers to Simon who argued that human beings have bounded rationality. Bounded rationality considers the limited capacity of human beings to find solution for complex problems that could take place when a transaction occurs. However, asymmetry in information means that it is impossible for both parties to observe all the relevant information they need for the decision-making process. The agent could have hidden information and as a result he could behave opportunistic. This may has negative effects on organisation’s results. (Anthony and Govindarajan 1995, p.569) Lafontaine 1992, p.266) argued in order to avoid this dilemma the principal could monitor or provide incentives for the agent so that the agent is not any more interested in opportunistic behaviour. Accordingly this would increase the transaction costs, which will be discussed in section 2.2. (See Appendix 1)

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