Franchising as power-biased organizational change
Brian Callaci, University of Massachusetts–Amherst
Economic theories of franchising tend to emphasize the efficiency-enhancing aspects of franchise contracts. By replacing salaried store managers with independent “franchisees” who are near-residual claimants on store output, franchising aligns the incentives of retail managers with brand owners. But efficiency explanations of franchising have failed to fully address the special nature of franchisee agents: franchisees are not production workers directly producing output incentivized by residual claimancy to eschew shirking. Rather franchisees are themselves managers of production workers. Incorporating this second level into the model and analyzing data from 530 franchise contracts, this paper shows that franchising is an example of power-biased organizational change. Through residual claimancy and contract terms that disempower both franchisees and workers, franchising motivates franchisees to exert high levels of effort at the task of monitoring and extracting labor effort from wage workers. In this second level principal-agent problem, franchisor power over franchisees and workers can increase profits without raising efficiency: rather than achieve more output per unit input, franchisors squeeze extra labor effort from the labor input. Franchise contracts represent a labor market strategy, despite franchisors not formally employing production workers.