The Benefits of Franchising and Vertical Disintergration in Monopolistic Competition for Locationally Differentiated Products
28 Pages Posted: 3 Nov 2008
Date Written: March 1993
A model of franchising competition in locationally differentiated products is constructed. A franchisor (upstream firm) collects a marginal transfer fee per unit of output sold by a franchisee (downstream firm). For example, the marginal transfer fee can be realized as a markup on variable inputs supplied by the franchisor. A franchisor also collects a lump-sum rent(commonly called "franchising fee") from each franchisee. Acting in the first stage, a franchisor can manipulate the degree of competition in the downstream market through his choice of the marginal fee while keeping the franchisee s profits at zero through the lump sum rent. Franchisees choose prices for the final goods in the second stage. It is shown that, at the unique subgame-perfect equilibrium, the marginal fee is above marginal cost. Compared to a regime ofvertically integrated firms, prices are higher, there are more numerous outlets when contractual costs are small, and social surplus is lower in the franchising regime.
Keywords: Franchising, Locational Differentiation, Vertical Disintegration
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