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To Franchise or Not to Franchise?

3/17/2008 --

Performance differences between corporate-owned and franchised hotels are slim to none, according to new research.

ANN ARBOR, Mich.—For a company pondering the question, "To franchise or not to franchise?" new research from Michigan's Ross School of Business suggests that performance differences between corporate-owned and franchised outlets, when chosen right, could be slim to none.

Ross Professor of Business Economics and Public Policy Francine Lafontaine and colleagues Renáta Kosová of Cornell University and Rozenn Perrigot of University of Rennes 1 studied the effect of vertical integration on the performance of individual hotels. They found that a company's decision whether to franchise or own a particular hotel has little effect on yield (average price) or performance.

Lafontaine and her team studied an unnamed multi-chain hotel company that has both franchised and corporate-owned hotels under each of its several brands, running the gamut from budget to luxury. They collected data to determine whether organizational form for each hotel has an effect on any of three outcomes: monthly revenues per available room (i.e., what the industry calls "RevPar"), price or yield (average room rate per month), and monthly occupancy rate. Across all three variables, Lafontaine and her colleagues found that franchising per se does not have a statistically significant effect.

"We conclude that the firm chooses which outlets to franchise and which to own in a way that yields no differences in pricing or performance, in the end, between the two sets of hotels," the authors state. "This result is important as it suggests that when firms can choose, they indeed adjust organizational form in such a way that there are no real differences in outcomes."

"This does not mean that franchising and company operations do not have different incentive effects, because they do," says Lafontaine, "but simply that firms are smart about how or where they choose to rely on these differences."

In the past, empirical evidence had suggested there were persistent performance differences between corporate-owned and franchised businesses. However, the authors note that much of that evidence comes from studying firms that have been forced into a particular organizational structure by legislative intervention. For their research, Lafontaine and her colleagues instead studied a situation in which the decision-maker (here the hotel company) was not forced by legislation into its particular structure.

The authors also ruled out that their findings might be driven by other potential influences on the hotels' performance such as the presence of air conditioning, swimming pools, or restaurants, as well as proximity to an airport or train station.

"We view the results as suggesting that multi-unit firms can choose organizational form in a way that is responsive to the differences in market conditions across outlets, such that when all is said and done, organizational form itself has no direct effect on outlet-level performance or pricing," says Lafontaine.

Lafontaine and her team recognize that while their findings are conclusive, the evidence is limited to data from a single company. Future research might strive to include data from multiple firms and different industries.

Written by Leah Sipher-Mann

For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847, bernied@umich.edu