Introduction

This chapter covers a lot of ground, focusing as it does on the relationships among franchising, vertical integration, and various types of vertical restraints in both theory and practice. We begin with a description of the extent of company ownership in franchised chains. The vast majority of franchised firms operate at least some of their units themselves while franchising the rest. Thus, they choose some degree of vertical integration and then use contractual devices to organize the other units in the chain. There is considerable variation across franchised chains in the extent of company ownership, which in itself is worth exploring. In fact, why firms choose different proportions of company-owned units is a question that has received significant attention in the empirical literature on franchising.

Next, we describe a set of vertical restraints, many of which appear in franchise contracts. We show how, in combination or individually, these vertical restraints in theory allow franchisors to achieve the same results as vertical integration would permit. In particular, we examine the use of simple lump-sum fees, sales royalties, output royalties, input purchase requirements, resale price controls, and output quotas. We introduce these here, and then return to many of them in later chapters as we explore the sources of conflict between franchisors and franchisees. Finally, in the last section of this chapter, we review agency-theoretic arguments that have been used to explain variation in royalty rates across franchised chains.