Analysis On Performance Barriers And Self-enforcement Of Franchising Under The Incomplete Contracting Theory

Franchising is a widely used business model in the world, its development speed and scale are obvious. Domestic China also recognized the advantages and importance of franchising, and is also active in the development of franchising, but the understanding of this business model is not enough depth and thorough. There are many theoretical research on franchising in domestic China, this paper is in the perspective of incomplete contract to study on franchising, studying its contractual nature and its contractual incompleteness. This paper uses foreign and domestic analysis results to study franchising contracts, studying its incompleteness, a variety of performance barriers result from the incompleteness, and the self-performance incentives in franchising contracts.The first part of this paper describes the franchise model’s generation, and this business model’s rapid development in the United States and Europe. Then China’s domestic development of franchising is analyzed, domestic franchising starts late, but its development is very rapid, however, there are various problems in it, such as inadequate legal environment which cannot keep up with the pace of domestic franchising’s development, the development of franchising is not standard and so on. So, study on Franchising is meaningful. Then comes the relational literature overview and the description of the structure of the paper.The second part introduces some key definitions of franchising at first, defines the contractual relationship of franchisor and franchisee, sums up the contractual nature of franchising from the various definitions of franchising. Franchising is an organization between markets and enterprises, the relationship of franchisor and the franchisee is based on franchising contracts with the nature of long-term contract. According to the Williamson’s division of contracts, this type of trading relationship fits for the relational contracts. This paper investigates franchising contracts’ incompleteness. The reasons result in franchising contracts’incompleteness are the bounded rationality, asymmetric information and transaction costs.The third part analyzes several kinds of performance barriers. The incompleteness of franchising contracts will cause performance barriers, information asymmetry will cause the principal-agent problem, namely moral hazard and adverse selection problems, here analyzed franchisor moral hazard problem and the franchisee moral hazard problem. Adverse selection problem may result in the entire franchising market’s "bad money drives out good money" effect, thus resulting in a decline in the quality of the market. The franchisor and the franchisee respectively put intangible assets and various facilities required into franchising, and these assets have specificity, they will cause a "lock-in" effect, which may have a "hold-up" behavior. Meanwhile other performance barriers will exist in franchising contracts, such as the cost of standardizing contract terms, and the difficulties of courts’enforcement.The fourth part analyzed the role of reputation mechanism and benefit-sharing contracts for self-performance incentives. Although there are a variety of performing barriers, franchising has incentives for self-enforcement itself. Reputation mechanism is a mechanism in which the franchisor and the franchisee use their reputation capital as the range of self-enforcing contracts, once one party defaults, its reputation capital will be damaged, and this will lead to the great increase of transaction costs with its potential trading partner. Benefit sharing contracts can lead franchising contracts into self-enforcement, a certain percentage of franchising revenues are paid to the franchisor as franchise fee.The fifth part of this paper uses KFC as a case to analyze its franchising. Firstly, this part introduces KFC’s development in the world as well as in China, and uses its franchising in China as an example, introduces the "do not start from scratch" franchising mode, the conditions of selecting its franchisees, the limitations of the franchising area, the franchising fee, as well as the training situation of franchisee. And this part pointed out that "do not start from scratch" franchising mode may cause potential performance barrier. Then comes the analysis of reputation mechanism, benefit-sharing contracts in KFC’s provisions to incite the self-performance.Franchising, the business model on a global scale to develop rapidly, is widely used, which indicates that this business model has the advantages of its own. It’s impossible to give up franchising because of its performance barriers, and there are mechanisms to incite the self-enforcement in franchising, namely reputation mechanism and benefit-sharing, they guide franchising into self-enforcement, and ensure the successful performance of the contracts. This paper analyzes franchising contracts and attempted to make some efforts for Chinese franchising, so that the franchisees can understand the potential risks of this business model, and learn the success experience from KFC’s franchising, thus using the incentive mechanisms in franchising its own to promote the self-enforcement of two parties of contracts.