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

Term Paper, 2004

26 Pages, Grade: 1,0 (A)



1 Introduction

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

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

4 Case study – Benetton

5 Analysis and evaluation

6 Conclusion

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

8 References and Bibliography

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)

Another problem besides the lack of all information is uncertainty in the environment and future which makes it impossible to write complete contracts. (Jensen and Meckling 1976) In addition the agent has to act often in complex situations and as a result it is impossible to view if it goes equal with the goal congruence. The agent could make decisions that influence not just his welfare, but also the principals. Likewise it is important to consider the different possibilities of the risk behaviours between the principle and the agent. Different preferences to deal with expected risk situations could lead to different scenarios. (Lafontaine 1992, p.266) Agents are assumed to be risk avers, i.e. they prefer a low but secure income. Principals are assumed to be risk neutral, i.e. for an employer the value of a secure profit is equal to the value of the expected returns. (Williamson, Masten 1999, p.216) However, the two most significant problems in regarding the asymmetry of information are adverse selection and moral hazard.

2.2.1 Adverse selection

Adverse selection considers the case that the agent’s level of performance can not be directly observed. Therefore, the principal needs a control mechanism to monitor the agent. For example, an employee has to sign-in in a time-check-system of the company when he is going to work and has to sign-out when he is leaving the company. This time-check-system supports the agent in order to obtain ‘signals’ relating to the agent. Furthermore, to distinguish high performance agent from low performance agent could occur through other ‘signals’, in the form of accounting system, cost accounting, certificates, diploma, and evidences, etc. (Douma and Schreuder 2002, p.126)

2.2.2 Moral hazard

The second problem as mentioned above is moral hazard, which can be subdivided in three areas, i.e. hidden action, hidden information, and moral hazard within teams. (Douma and Schreuder 2002, p.120) That means that the agent could change his behaviour after (ex-post) the contractual agreement.

2.2.3 Moral hazard with hidden action

An agent who agrees to a contract and signs the contract commits to perform appropriately. The problem is that the principal has no knowledge as to why the result is how it is and maybe what factors have influenced this result. The result could be due to unpredictable circumstances in the environment or because of the laziness of the agent. For example, a shareholder as a principal has not really the possibility to observe the agent. If the annual statement of account is poor, it is difficult for the principal to find out why this occurred. On the one hand the result could be bad because of the poor work of the manager. On the other hand it could be due to other negative factors, e.g. downwards trend in the industrial sector. Hidden actions could be reduced through ‘screening’. The principal tries to find appropriate methods in order to reduce the information asymmetry. For example, assessment centre, product tests, etc. (Douma and Schreuder 2002, p.127)

To what extent the agent acts to the best interest of the principal, depends on the directly related income and the expected utility. (Lafontaine 1992) As a solution for this issue the principal agent theory provides an incentive and penalty framework that takes into account the principal’s and agent’s objectives. The agent’s reward structure can be designed in different ways. For example it can be a wage contract, i.e. the agent obtains a fixed salary, regardless of the payoff, rent contract, i.e. the agent obtains the payoff minus the rent, or quasi rent contract (takes into account the difference between the first and second-best opportunity). (Garg and Rasheed 2002) and (Douma and Schreuder 2002, p.127)

In the case that one party depends more on the business relationship than the other, for example a special investment is due, could lead to hold up problems. The principal tries to protect himself through refunds, e.g. initial payment, equity participation, abatement guarantee. The refunds provide a good punishment method to reduce the opportunistic behaviour of the agent. Another possibility to avoid opportunistic behaviour is the creation of a long-lasting business relationship, e.g. long-term contracts, share of revenues (e.g. franchising, joint ventures). (Lafontaine 1992)

2.2.4 Moral hazard with hidden information

This is the case when the environment has influence before (ex-ante) the agent makes the decision, if he will work well. The principal can observe the decision of the agent, but is not able to take into account the uncertainties in the environment. Because of that, the agent could misinterpret the environmental framework and thus legitimate his behaviour. (Besanko, Dranove and Shanley 1996)

2.2.5 Moral hazard in teams

For example, in a law firm, each team member could be a principal, because he gives instruction to the team in order to obtain satisfying results from the team production. At the same time each team member is an agent and committed to work in the best interest of the team. It is impossible that everyone can control everyone at any give time and because the profit will be divided by all of them, all could have an incentive to live off the cost of the other team members. (Douma and Schreuder 2002, p.120)

In conclusion this means that because of the permanent asymmetry of information between principal and agent there is no optimum solution. If this were the case, than would it be clear for the principal, which mistakes the agent has made, and which are caused by uncertainties in the environment. As a result, the principal could influence the agent so that they work side by side and if not, he would sanction him. This means there is a need for a pareto-optimum agency contract, which would take into account the minimisation welfare loss against the first-best solution in which information would be costless and for everybody available. (Jensen and Meckling 1976) and (Douma and Schreuder 2002, p.120)

2.3 Agency theory and franchising

The principal agent theory considers contracts where the principal delegates decisions to an agent. This can be transferred to franchising arrangements, because these arrangements involves information asymmetries and target conflicts. The agent has the possibility of ‘free riding’. Free riding is a situation where a franchisee does not behave to the agreed rules in the contract. Furthermore, through self-interest the franchisee damages the image of the franchise system of the principal. The franchisee does not have drawbacks because of this behaviour. For example, the franchisee could obtain through the production of poor quality, a cost advantage. The franchisor would obtain a damaged image. (Douma and Schreuder 2002, p.173) However, an aim of the principal agent theory is to design franchise contracts that attempt to avoid such opportunistic behaviour through information, incentives, and control mechanisms. (Brousseau and Glachant 2002)

A point of criticism is the more unrealistic assumption of strong opportunistic behaviour (self-interest, e.g. through disregard of withholding, deception, etc.). It considers not, how the organisational structure influences the behaviour. (Shane 1996) However, this could be explained through the transactions cost analysis in 2.3.

2.4 Transaction costs theory

Under the assumption of bounded rationality, opportunistic behaviour and a particular situation of the transaction it will be attempt to find efficient coordination structures. The transaction cost analysis approach founded by Coase (1937, p.386) and further developed by Williamson concentrates on how organisations behave within the environment and why organisations exist. (Williamson and Masten 1999, p.182, p.151) Transaction cost analysis considers the efficiency of exchange when resources are allocated within the organisation or through the market. That means transaction costs take into account internal transactions and market transactions. (Williamson and Masten 1999, p.33) Transaction costs are those that occur because of the organisation and administration of the division of labour. Transaction cost includes real, monetary costs as well as opportunity costs. Transactions can occur before (ex-ante) and after (ex-post) the conclusion of a contract. E.g. initiation costs, agreement cost, administration costs, control and adaptation cost.

2.4.1 Dimensions of transactions

According to Williamson transaction costs can be divided into the following three criterions: uncertainty/complexity, asset specificity, and frequency. (Williamson and Masten 1999) Uncertainty/complexity

Uncertainty in a complex environment of markets makes it impossible to always obtain the appropriate information in regard to the belonging transaction. Furthermore uncertainty relates to the unpredictable future. Williamson argues that the choice of the operating structure and thus the costs of governance depend on the uncertainties and complexities within the surroundings. As a consequence, he suggests that vertical integration could be a powerful tool that organisations can use to reduce ambiguity. (Williamson and Masten 1999, p. 25), (Lipczynski and Wilson 2001, p.272) and (Barney 1996, p.344) Asset specificit

Physical assets and human assets are viewed as organisation-specific assets. Asset specificity affects transactions between parties. Asset specificity can be low for both parties, it can be for one party low and for the other party high or finally it can be for both high. The degree of asset specificity could be taken to measure if an organisation would reduce transaction costs whether if it integrates vertical or if it exchanges on the market. However, if an orgnaisation might integrate vertically it could control the transactions. (Williamson and Masten 1999, p. 283)

The degree on specificity is the quasi-rent. This is the difference between the actual investment and the second best usage possibility. The higher the quasi-rent the higher the asset specificity. If the specificity is high, this results in a high degree of dependence between the contract partners. This again reinforces opportunistic behaviour. An extreme case would be a bilateral monopoly; however, high asset specificity leads to high transaction cost. (Douma and Schreuder 2002, p.120)


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Franchising a good strategy for a company operating throughout Europe - Case study Benetton -
University of Abertay Dundee
1,0 (A)
Catalog Number
ISBN (eBook)
File size
593 KB
Franchising, Europe, Case, Benetton
Quote paper
Christine Klock (Author), 2004, Franchising a good strategy for a company operating throughout Europe - Case study Benetton -, Munich, GRIN Verlag,


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