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An Incomplete Contracting Model of Governance Structure Variety in Franchising

For the purpose of explaining governance structure variety in franchising, we explore the impact of governance structure on the incentives to invest in specific assets for the franchisor as well as the distributors. Wholly-owned, wholly-franchised, and mixed (dual distribution) franchise systems are considered. Circumstances are identified when a dual distribution governance structure uniquely allocates efficient ownership over assets. Whether dual distribution benefits are realized in a franchise or a cooperative franchise depends on whether most value is added upstream or downstream. A disadvantage of a dual distribution system is the deterioration of the investment incentives of the party having no authority, i.e. either the company-owned outlet manager in a traditional franchise or the franchisor in a cooperative franchise. A wholly-franchised system may therefore be efficient even when unique dual distribution benefits are present. A necessary condition for the efficiency of a dual distribution governance structure is a positive systemic effect, not the value of the brand name or location (or other) differences between outlets.