Franchise ownership redirection: real options perspective

Abstract

Background: For over 40 years, the franchise ownership redirection hypothesis has attracted the attention of many scholars. This study, differing from previous ones, proposes an alternative approach for this hypothesis using a real options framework with the extension of agency theory. Method: The real options model is built using the least square Monte Carlo method, where the franchisor’s decision to franchise is perceived as a deferred investment while maintaining the right of future acquisition. Result: Tested using monte carlo simulation based hypothetical case, the model shows a different result from classical real options call model. This is mainly due to franchise contractual arrangement, where royalty fee lower the threshold of acquisition cost in converting the franchise outlet to company owned. Conclusion: The aim of this study is to create an analytical framework that helps a franchisor decide whether or not toacquire and convert a franchise unit to a company-owned unit at a certain point in time, analyzing the choice as a deferment of investment. The franchisors that faces the opportunity to optimize profit by converting the franchise unit to a company-owned unit should acknowledge it as real options thus negotiate the terms with their franchisees.