Reasons why entrepreneurs franchise their business is widely addressed in franchising literature. Typically, academia discusses 3 main theories as to why entrepreneurs choose to franchise their business: Resource-Scarcity Theory (using franchisee resources), Risk-Sharing Theory (sharing risks with franchisee), and Agency Theory (reducing management costs & conflicts).
It is likely that one or more of the theories expressed below resonates with your current expansion dilemma. And, also it’s likely that franchising could provide you with a proven route to rapid growth.
Resource Scarcity Theory
A business turns to franchising in order to access to scarce resources, particularly capital and managerial resources, and in order to rapidly expand to gain market share.
Rapid expansion through franchising may be essential in order to build the economies of scale in purchasing and advertising to compete effectively against more established businesses.
A business turns to franchising when the desire to achieve economies of scale pressures them to expand at a rate beyond what is possible only using internally generated resources.
As “co-entrepreneurs”, franchisees have already chosen a low-risk path by embracing franchising over independent business ownership given franchising has been shown to have a significantly lower failure rates than independent businesses. In exchange for this low-risk route to business ownership, franchisees may be willing to accept higher-risk locations with less profit potential.
The agency theory relationship is considered a hybrid system in which the franchisor tries to maximize the value of the chain while reducing the supervision costs to a minimum.
(Supervisory costs include: management capability, knowledge of the local market, distances between the desired location and the central office; and, local demographic density and proximity between the current locations and planned locations.)
The franchisor decides between owned or franchised units based on the supervision cost.
Franchisors can eliminate or reduce many supervision costs because the franchisee is necessarily stimulated to obtain the best possible results for recouping the initial investments and generate a high profit margin, which also benefits the franchisor’s results.
Also, franchising largely alleviates the franchisors’ need for costly observation of employed managers to efficiently “manage” a locations profitability on continual basis.