aHF5429 .235 .U6D36 1993

tates entof re

economic Research Servie«

Agriculture and Rural Economy Division

Franchising and Rural Economic Development

Perspectives on Possible Effects

Thomas C. Dandridge Cecilia M. Falbe E. Melanie Dupuis

Franchising and Rural Economic Development: Perspectives on Possible Effects. By Thomas C. Dandridge, Cecilia M. Falbe, and E. Melanie Dupuis. Agriculture and Rural Economy Division, Economic Research Service, U.S. Department of Agriculture, Staff Report No. 9301.

Abstract

Studies of organizational type in rural entrepreneurship have concentrated on independent vs. branch establishments. Franchising is a third organizational alternative that is growing dramatically in the retail and service sectors. Franchising entails an agreement by the owner (franchisor) to grant to a franchisee the right to use a name and business format in return for an initial fee and sales royalties. Theories of business organization indicate that franchising may reduce the risk of firms planning to locate outlets in rural areas. As a consequence, franchises may become more popular in the rural consumer and producer service sectors. The actual effect of franchising on rural service enterprises is not clear. Franchises may simply replace many local businesses, or they may offer new services not previously available. Most government and private business databases do not distinguish franchises as a separate organizational category.

Keywords: Franchising, rural development, economic development, business organization, management support

The limited distribution of this paper facilitates its review and critique by the authors' research colleagues. The paper does not reflect an official position of the U.S. Department of Agriculture and it has not been subjected to the internal review process received by official Department publications.

Use of company names does not constitute endorsement by the U.S. Department of Agriculture.

Washington, DC 20005-4788 February 1993

iii

Contents

Page

Introduction 1

Definition and Types of Franchises 1

Theories of Franchising 2

Characteristics of Successful Franchises 4 Recognized Image 4 Advertising 5 Location Strategy 6 Selection and Aggregation of Franchisees 6

Franchise Outlet Growth and Rural Economic Development 8 Characteristics of the Rural Retail Sector 8 Franchising and Rural Risk 10 Effects on the Rural Retail and Producer Service Sectors 11 Effect of Franchising on Rural Customers 12 Effect of Franchising on Rural Entrepreneurship 13 Franchising and the Future in Rural Areas 14

Conclusions 16

References 18

Appendix Table 1—Firms with a Rural Location Strategy 24

Appendix—Databases on Franchises 26

IV

Franchising and Rural Economic Development

Perspectives on Possible Effects

Thomas C. Dandridge Cecilia M. Falbe

E. Melanie Dupuis

Introduction

A franchise is a hybrid form of business that incorporates aspects both of branch store chain outlets and of local independent outlets (Rubin, 1978). Recently, national and regional multi-outlet chain stores have moved increasingly into rural markets (Borich, Steward, and Hatle, 1985; Fitchen, 1991, p. 61; Rora and Flora, 1988; Stone and McConnon, 1982). Some of these chain outlets are company-owned branch stores. Other chains have franchised outlets. In both rural development assessments and the popular press, the increased presence of chain stores in rural areas has caused concern over the possible loss of local independent enterprises in the rural retail and service sectors. However, the franchise aspect of some chains has received little attention. This report looks at the nature of franchising and assesses whether the effects of franchise outlets in rural areas differ significantly from those of company-owned outlets.

Defínition and Types of Franchises

A franchise is a granting of rights from one individual or organization, public or private, that owns these rights to another individual or organization, either through purchase, rental, or some other form of exchange. The owner of the rights (the franchisor) sells it to others (the franchisees), usually for the local distribution of a product or service, usually receiving an initial payment and ongoing royalties in return.

Franchising shares some characteristics with both independent and company-owned outlets (Mathewson and Winter, 1985). A franchise is like an independent firm in that local managers are also owners of the establishment. The franchisee owner-manager has a greater say in the operation of the outlet than does the manager of a company-owned store. Also, as an owner, a franchisee's income is dependent on the profits or losses of the operation, and not

The authors are affihated with the School of Business, University at Albany, State University of New York. The authors acknowledge the contribution of Marc Cassidy to this project.

on a fixed wage (Norton, 1988b; Rubin, 1978). However, franchise outlets are integrated with the larger company in that the owner is contractually obligated to distribute a particular product or to provide a service in a particular way.

Franchise systems are organized in different ways, generally falling into three major types. Product and trade-name franchising grants a dealer the right to sell a particular product line. Most automobile dealers and franchised gasoline station owners fall into this category. Because of the high product price or volume of these outlets, this type of franchising accounted for 71 percent of franchise sales dollars in 1987 (Kostecka, 1989). A newer form, business format franchising, may also involve the right to distribute a certain product; however, it also involves selling the right to use a particular format, or sales approach, in the merchandising of a service or product. The franchisee must use the image and business format of the franchisor and must change these at the franchisor's discretion. For example, McDonald's franchisees buy not only the right to sell McDonald's products but the building design, logos, food names, cooking techniques and other aspects of the business that "make" a McDonald's outlet. This is the fastest growing form of franchising today (Kostecka, 1989). A third form, voluntary association franchising, is sometimes referred to as a franchise and sometimes as a cooperative. These systems develop when a number of independent firms come together to achieve greater business efficiencies, such as buying power, economies of scale in distribution, technological links with suppliers, and brand-name recognition and advertising, not as readily available to an individual firm. Most nationally recognized hardware stores, such as Ace or True Value Hardware, as well as some pharmacy chains, fall under this category.

The franchise system is a form of business organization that has a great deal of potential for flexibility, local initiative, and adaptiveness. However, the amount of entrepreneurial freedom given the franchisee varies from one franchise system to the next. Some franchisors depend on their franchisees to adapt the management of the outlet to local conditions and markets. For example. Subway, a submarine sandwich franchisor, requires the use of a specific bread and six different fillings. However, franchisees are free to experiment with other fillings that may be popular with their customers. The profits and risks of ownership provide the franchisee with a strong incentive to be sensitive to the needs of local markets. Other franchises control their franchisees in much the same way that companies run branch outlets. In these cases, the franchisee has little freedom to make changes that would respond to local market needs.

Theories of Franchising

Why do companies franchise outlets rather than owning them outright? Three major theories seek to explain franchisor motivation: life-cycle, risk-sharing, and market power theories.

Life-cycle theories hold that franchising is a shortrun move by companies seeking to expand quickly to exploit economies of scale necessary to promote brand names (Caves and Murphy, 1976; Mathewson and Winter, 1985). Franchising also secures easy credit for quick

expansion from franchisees, to the extent that they are self-financing^ (Caves and Murphy, 1976; McGuire, 1971; Oxenfeldt and Thompson, 1968-69; Ozanne and Hunt, 1971). In the long run, life-cycle theorists argue that franchisors will eventually convert these outlets to company-owned stores.

The life-cycle theory of franchising has been largely disproved. Empirical data show the persistence of franchised outlets in multi-outlet companies (Anderson, 1984). Martin (1988) measured the proportion of company-owned outlets over time in a number of sectors, using logic life-cycle functions. These measures showed that while there is a tendency to increase the proportion of company-owned outlets, there is no indication that companies are moving toward entirely company-owned systems. He concluded that franchising "is not a temporary phase on the path to complete ownership integration. It represents a long-run market solution to monitoring and risk-diversification problems" (Martin, 1988, p. 965).

Risk-sharing theories argue that the franchise form of organization distributes risk differently than either branch plant or independent firm organization (Martin, 1988). In franchise organizations, franchisor and franchisee share both risks and profits. Companies are willing to share profits through a franchise in order to lessen risk. Economists define risk as "imperfect information." A firm expanding into new regions is increasing its risks unless it has perfect information about both the markets in the region and the managers in its outlets. By sharing profits with an owner-manager who has incentives to acquire that information for his or her outlets, the franchisor increases the system's access to information as well as decreases the investment the company makes in each oudet.

Some explanations of franchising focus more broadly on transaction costs, which are not only money costs, but also the time, effort, and risk in running a business. According to this explanation, franchisors save the transaction costs that arise from monitoring store managers in company-owned oudets (Alchian and Demsetz, 1972; Jensen and Meckling, 1976; Mathewson and Winter, 1985). As firm size grows, this "entrepreneurial capacity problem" increases (Alchian and Demsetz, 1972; Coase, 1988 [1937]; Williamson, 1975).^ In traditional branch-outlet firms, "hired supervisors are not perfect substitutes for the owner-supervisor, the entrepreneur, because no hired factor can have the same incentive as an owner. In the theory of the firm, ownership and efficient monitoring are inextricably linked" (Norton, 1988b, p. 107). Franchising, Norton argues, allows a firm to grow, particularly firms that must grow by becoming more geographically dispersed, while overcoming the problem of entrepreneurial capacity.

It is possible to see franchising as a partnership or form of "collective action" (Astley, 1984; Astley and Van de Ven, 1983; Hawley, 1950), in which both franchisor and franchisee benefit (Magrath, 1989). According to economic sociologists, social relations are more important "in bringing order to economic life than is supposed in the markets and hierarchies line of

^"Morc than half of new franchisees now use the equity in their homes as collateral on loans to buy franchises" (Stem and Abelson, 1991. p. 153).

^While classical economics treats fimis as homogeneous entities, the "theory of the fimi" as first presented by Coase (1937) and further developed by Williamson (1975). introduced to economics the idea that firms can have different fonms of organization based on different choices available to firm managers. Transaction-cost theory describes the firm as having a choice between producing and selling its good (to "transact") through the market or integrating production and distribution within the firm through internal, hierarchical relationships.

thought" (Granovetter, 1985, p. 501). Rather, business relations are often based on trust, commitment, informal networks, and social relationships (which often include power relationships, discussed below) (Astley, 1984; Granovetter, 1985). However, no one has addressed directly how franchise organization fits into a context of social networks and partnership, except in terms of social control or power (Perrow, 1986). Other work by Falbe and Dandridge is in process, which studies the "advisory council" of many franchisors, established as a formal network to increase franchisee input and power.

According to "market power" theories, franchising monopolizes access to a good, or makes proprietary a good that is otherwise easily copied. The franchisor achieves market power in a vertical chain through monopolization of its brand name and access to inputs and the consequent limited ability of franchisees to substitute for franchisor mputs (Blair and Kaserman, 1982; Inaba, 1980; Lee, 1984; Sklar, 1977). A number of market-power theorists criticize risk-sharing views for ignoring the role of unequal power relationships in the determination of organizational structure (Granovetter, 1985). "Most franchises, as in the fast-food industry, are devices to spread risks and buffer the headquarters from uncertainties. Given the limited entrepreneurship opportunities that our economy offers for people who lack wealth or unique skills, there are always many who are willing to work very hard for low and risky returns" (Perrow, 1986, p. 253).

There are evident relationships between these explanations for franchising. For example, risk and credit can be seen as forms of transaction costs and the main transaction cost mentioned in franchise theories, monitoring, can also be seen as a risk-reduction strategy related to information access. Basically, all of these theories explain franchising as a way for companies to make their outlets more profitable through partnership with an owner-manager, the franchisee.

Characteristics of Successful Franchises

Franchising is, therefore, distinct from other forms of business organization. The independent firm has total equity control. The branch outlet manager has no equity; all ownership rights belong to headquarters. The franchisee has local equity and shares local profit, while equity of the principal company and format control rest elsewhere.

In the growing service economy, franchise businesses have evolved a number of competitive strategies. While not intrinsic to the legal definition of franchising, and not universal to all franchises, successful systems have developed particular competitive strategies. Most franchisors promote publicly recognized brand names for the product or service provided with national and regional media advertising. Other franchisors solicit "master" franchisees, encouraging multi-unit aggregate ownership. Some franchisors also attempt to control environmental factors by locating in the new rural service centers, such as mall and commercial strip developments.

Recognized Image

To economists, nationally or regionally recognized brand names associated with a product or service have a value, referred to as brand-name capital. Marketing experts have noted that

brand-name recognition is particularly important in transient markets, that is, markets where the potential customers do not know the community well or have not established long-term relationships with product and service providers. The fast-food franchise chains that locate along highways are the ultimate transient-market service providers. Many customers seeking services along highways have never before stopped in those areas. Economists characterize these customers as seeking to reduce risks in their food consumption choices. Their risks are due to the limited knowledge they have of food services available in an area. By choosing to eat at the familiar brand-name fast-food outlet, they reduce the uncertainty of the product they buy (Klein and Saft, 1985, p. 349).

Franchises and chain outlets prevail in other markets with transient characteristics. For example, areas of newer development are often populated with residents who have not established long-term relationships with service and product providers. In addition, national economic conditions have led to regional differences in economic growth, with some regions booming while others are busting. This situation has caused certain portions of the work force to relocate frequently, following boom economies around the country. Therefore, even more settled communities now have a more transient segment that relies on brand-name recognition in many of their purchases.

Finally, marketing studies indicate that brand-name preference is not simply a factor of transience. Even older and more settled communities may turn to franchisors if they perceive brand-name products and services to be of higher quality. The willingness of video shoppers to pass over the limited selections of mom-and-pop video stores for the new, large franchised outlets shows how nontransient markets may abandon established service relationships if they believe that franchise outlets are superior.

Advertising

For the most part, the development of brand-name recognition and choice has depended on the use of national and regional media advertising. Therefore, franchisors often heavily advertise their brand-name products. Many retail and service franchise systems, such as H&R Block, depend primarily on television advertising for development of name recognition. However, a number of firms, such as Radio Shack, depend on direct mail, newspaper supplements, and other forms of advertising.

Both television and newspaper advertising involve disseminating information to a regionally bounded market. Advertising and regional location are thus mutually dependent. Television stations, generally located in regional market centers, reach an audience within a limited reception area. Therefore, both franchise and company outlet chains tend to buy their television advertising by region.^ However, use of expensive television advertising is not efficient without a widespread network of outlets within the station's reception area. Therefore, franchisors highly dependent on television to promote brand-name recognition often conceive their outlet location strategies in terms of "areas of dominant influence" (ADI's).

'Many cable television networks, however, are national, so advertisers must use different advertising strategies.

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Some franchisors measure their success not by the number of outlets or their national representation but by the number of ADFs in which they are dominant. For example, Sonic Drive-ins, a franchisor of drive-in fast-food restaurants, has a location strategy directed at market dominance in as many ADFs as possible. According to Stephen Lynn, the president of Sonic, his strategy is different from Burger King's, which has locations in 206 ADFs and is dominant in only 5 percent of them; Sonic has locations in only 85 ADFs, yet is dominant in 31 percent of them. According to Lynn, this saturation of a smaller number of television markets enables the company to promote its outíets efficiently (personal interview, June 5, 1991). (See app. table 1 for a listing of the personal interviews.)

Location Strategy

While each franchisor has a particular location strategy, the patterns of outlet diffusion fall into two major types: (1) the hierarchical pattern, in which franchises locate stores first in high-traffic areas in the largest cities in a region, then spread out to towns of increasingly smaller population; and (2) the neighborhood wave pattern, in which a firm saturates a region with stores (Craig, Ghosh, and McLafferty, 1984). Franchise firms with an emphasis on ADI dominance are more likely to pursue a neighborhood wave pattern of diffusion. Newer franchisors have also noted that hierarchical location puts outlets directly into competition with other established firms, whereas neighborhood wave and ADI dominance strategies enable a franchise system to more easily gain local reputation and brand-name recognition in a crowded market (Garrett, 1989; Lynn, personal interview, June 5, 1991).

Franchises have several strategies for finding optimal locations within a region. One strategy is to use scientific location techniques, often a formula that takes into account local demographic patterns, amount and speed of traffic in particular sites, and relationship to other outlets. Another strategy is to locate in "created" optimal locations, such as regional malls. For example, A&W, a drive-in restaurant chain with many rural locations, locates new roadside outlets primarily in shopping malls (Köhler, personal interview, July 23, 1991). Mall stores enable a franchisee to have more reliable access to a particular type and amount of customer traffic. Malls are usually a combination of company-branch outlets and franchised outlets, with some independent outlets. Large company-branch department stores are usually the anchor stores that attract customer traffic to the mall. However, franchises often pay high rents to locate in malls with large anchor stores.

Recently, franchise outlets have begun to locate in central urban business districts. Franchises have traditionally avoided central business districts, possibly because they tend to serve less transient markets and compete more directly with independent businesses. This new locational move of franchises may reflect a change in the nature of service markets in central business districts, or it may simply be an attempt to compete in a new service environment.

Selection and Aggregation of Franchisees

Franchises sometimes rely on knowledgeable franchisees to find optimal store locations. Hardee's, a restaurant chain, is a good example of this strategy. Many of its franchisees are multiple-outlet owners, some with several hundred outlets. Hardee's forms agreements with these franchisees because of their familiarity with the areas in which the company wants to locate stores. For example, one of Hardee's largest franchisees is Carlton Knoll, who was at

one time a tobacco buyer. His business required that he visit many small towns in his area. He bought roadside lots from farmers in the busier towns and located Hardee's outlets there. This turned out to be a very successful strategy, both for Hardee's and for Mr. Knoll. Acconiing to Hardee's management, many of their franchisees are people with this kind of familiarity with local areas (Atañas, personal interview, July 22, 1991).

Franchisors sometime create these local expertise links through "master franchising," selling the rights to locate multiple outlets in a region. For example. Southland, the corporation that franchises 7-Eleven convenience stores, often links up with people familiar with a region as a location strategy in rural areas. In Southland's case, the company sells a domestic license territory to a particular franchisee. One franchisee owns the right to locate 7-Eleven stores in South Dakota. Studies of multiple-outlet location strategies have noted that the saturation of markets with outlets may pit one outlet against another. A regionally based master franchisor is more likely than a mom-and-pop franchisor to resist such a strategy (Craig, Ghosh, and McLafferty, 1984, p. 24).

Southland also sells individual mom-and-pop franchises, usually looking for a local person to run the operation. However, unlike domestic-license franchisees, the franchisee under this agreement owns the inventory only. The company owns the land, building, and the equipment in the store (Beeder, personal interview, July 25, 1991).

Some master franchisors are part of major multinational corporations. Citibank, for example, owns a number of Pizza Hut outlets. Other master franchisors are major corporations in themselves.

Some companies, like Sonic Industries, prefer one "mom-and-pop" owner for each outlet. In accordance with the transaction-cost theory of franchising, the company believes that owner-managers are more motivated and that multiple-outlet franchisees have the same problem as branch outlets, in motivating managers (Lynn, personal interview, June 5, 1991). Often franchisors who work with mom-and-pop owners have a greater say in the location of the oudet. Sometimes, as in the case of Southland's mom-and-pop 7-Eleven stores, the company provides not only the site but the building itself (Beeder, personal interview, July 25, 1991).

Franchising can optimize the advantages of integrated and independent businesses. However, the ideals of organizational theory do not always work out in real life. For example, a recent Forbes article on the difficulties of franchising points out: "Ideally, the interests of franchisor and franchisee are one and the same: The better the franchisees do, the more revenue the parent organization makes. But business life rarely follows the ideal; the franchise business is rife with potential and real conflicts of interest." The article cites both an American Bar Association estimate that only a third of all franchises are more than marginally profitable, and an American Arbitration Association report that disputes between franchisees and franchisors have risen six-fold since 1980 (Stem and Abelson, 1991, p. 152). Therefore, the potential of this form of organization can be undercut by poor franchisor-franchisee relations. Company-oriented franchisors will downplay partnership with the franchisee, and emphasize strategies that increase the control of centralized management until franchisees are little more than managers with extra incentives. Organizational sociologists have based their "market power" view of franchising on this type of franchisor activity.

Franchise Outlet Growth and Rural Economic Development

The retail and local service sectors comprise a major part of rural economies. In addition, the small business sector, in both urban and rural areas, consists mostly of retail and local service firms. A survey of small businesses in rural Georgia found that 84 percent of them were retail or service firms (University of Georgia, 1992). A study of rural New York State counties found that the service sector accounted for over 60 percent of employment (Büttel, Lancelle, and Lee, 1988, p. 211). Therefore, while the location of a large manufacturing firm may have a greater effect on job opportunities in rural towns, the retail and local service sectors generate much of the business activity in these areas.

The growth of franchise businesses is one of the most significant recent changes in the rural service sector. Unfortunately, an assessment of the role of franchises in the rural service sector involves some speculation, because there is little hard evidence enabling researchers to make generalizations about either franchising or the rural service sector.

Characteristics of the Rural Retail Sector

Most evidence concerning the rural retail and local service sectors is limited to studies of single communities. There have been no nationwide studies looking specifically at the rural retail and local service sectors. There are also no national studies measuring changes in the nature of rural retail and local service business.

As a result, evidence is often contradictory and based on anecdote or on newspaper accounts. On the one hand, many studies note the decline of retail business and other local services in many of the smallest rural towns (Anding and others, 1990; Beale, 1978, p. 44; Fitchen, 1991, p. 62). Other studies point to the chain-store invasion of rural areas and its effect on local businesses (Borich, Steward, and Hatle, 1985; Flora and Flora, 1990 and 1988; Leistritz, Murdock, and Leholm, 1982; Stone and McConnon, 1982).

On the other hand, the business literature talks increasingly about the undiscovered profitable locations available in small towns. Many of these articles describe small towns as the "last frontier" for locating outlets (American Demographics, 1985; Garrett, 1989; Heenan, 1989; Johnson, 1982; Mueller, 1988; Miller, 1986). One trade magazine. Chain Store Age Executive, describes this new strategy and quotes a Sears official, G. Joseph Reddington: "The reason for the new focus is that most metropolitan areas have little growth or potential for regional malls. Retailers are looking for other opportunities and are looking toward success stories like Wal-Mart's" (Miller, 1986, p. 19). In effect, these firms are poised at what geographers call the population threshold, in that they have covered all profitable large city locations and are now looking at smaller towns. Firms are estimating the minimum population threshold that will support an outlet and devising strategies to break that threshold.

These differences between the rural economy and business literature discussions of the rural retail and producer service sectors reflect contradictory ideas about what is going on in these sectors today. The retail decline literature paints a picture of rural towns left without services. The business literature paints a picture of rural towns as potential profit sectors waiting to be discovered. The chain-store invasion literature shows rural areas as being profitable markets, yet when nonlocal businesses enter these markets, local independent

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businesses often go into decline (Marsh, 1991). On the other hand, many accounts note that rural shoppers have welcomed chain outlets, driving long distances to these stores to get a greater selection at a lower price (Johnson, 1984; Marsh, 1991).

While contradictory on the surface, each of these discussions of the rural retail and producer service sectors contains some truth. According to one midwestem study of rural retail business, the smallest towns were losing retail services. However, larger towns were gaining services (Anding and others, 1990). These findings reflect the growth of a new rural phenomenon: the rural service center. Towns that have become rural service centers are often profitable places for the location of chain stores, both company-owned and franchised. Therefore, the smalltown niche that business magazines point to exists as much as the empty storefronts that the rural economy studies describe. While the business literature is not specific on the subject, it appears that rural retail centers are more likely to locate in larger small towns, often county seats, new rural commuter towns just outside of suburban areas, or towns located at the intersection of two major highways (Lessinger, 1987). Regional malls often locate at these highway intersections. Towns that are losing retail and local services are "smaller" small towns, often located on county roads far from major highways, and with service sectors that cater primarily to local farmers or other primary sector workers (Anding and others, 1990; Johansen and Fuguitt, 1984).

Smaller towns have few services and these services tend to be general businesses or services that need to be close to customers. People travel to larger towns for more specialized services. For multi-outlet businesses such as chain stores, central place theory suggests that smaller towns tend to be less profitable and more risky locations. This is consistent with the emphasis the theory places on a hierarchical pattern of store location (Brown, Brown, and Craig, 1981; Craig, Ghosh, and McLafferty, 1984, p. 11).

Economists studying rural entrepreneurship and new venture startups—of both service and manufacturing firms—also characterize rural businesses as risky; chain stores regard smaller towns as less profitable. Their reasons fall into two categories: (1) environmental, and (2) organizational. Environmental factors include customer base, but also lack of local business resources such as training and credit (Aldrich, 1979; Allen and Hayward, 1990; Falbe and Dandridge, 1991). Another environmental factor is the lack of economic diversification in rural areas. According to Martin, urban areas have the advantage of "high population densities and diversified local economies." Greater variability in sales due to a rural region's dependence on one or a few industries means that a rural firm "requires more management inputs and this implies rising monitoring costs" (Martin, 1988, p. 956).

Economists also argue that, for multi-ouüet firms, rural outlets exacerbate the entrepreneurial capacity problem in that remote and dispersed rural locations are more difficult to monitor. Rural outlets are, therefore, riskier in terms of internal management control of product and service quality as well as efficiency (Brickley and Dark, 1987; Martin, 1988; Norton, 1988b; Rubin, 1978, p. 229).

Despite these problems, studies of new ventures in rural areas suggest a more positive outcome. Buss and Lin (1990) show that rural businesses have survival rates as high as those of urban businesses. Other assessments of rural business opportunities note the advantages of lower operating costs and superior lifestyles that result in higher productivity (Heenan, 1989).

One study looked in particular at organizational factors and found that independent firms were more likely to survive in rural areas than in urban areas (Miller, 1990). These contradictions indicate, at the least, that an assessment of the risk and opportunities of rural environments is more complex than originally thought.

Franchising and Rural Risk

While economists and others consider rural environments as risky places to start new businesses, they consider franchising a form of organization designed to reduce risk. This overlap has prompted a number of economists to examine the propensity of multi-outlet firms to franchise in rural areas. For example, Martin predicts that oudets in dispersed rural areas will be franchised and outlets in urban areas will be company-owned. The chain firm, Martin explains, franchises rural outlets because its management is "risk averse" and, therefore, chooses to share risk in rural areas with a franchisee (1988).

Numerous studies indicate that multi-outlet chains are more likely to franchise outlets in rural areas than in urban areas (Brickley and Dark, 1987; Martin, 1988; Norton, 1988b; Rubin, 1978, p. 229). Table 1 illustrates the propensity to franchise in one sector, the Census of Business classification "Refreshment Places," in urban and rural States. This Census of Business classification represents eating places that do not provide waitress service. The classification is, therefore, a good representation of fast-food establishments. While State-level evidence is less than ideal, the table does show a greater propensity for chains to franchise in rural regions.

Another dimension of risk is the relative survival rate of businesses. We can generally assume a branch store survives only as long as the parent company receives what it perceives to be an acceptable return on investment. The parent company may, therefore, close a store that may actually be profitable but not meeting company performance goals. The independent store may fail to survive for a variety of reasons related to the owner, but generally closes

Table 1—Refreshment places franchised and their percentage of total sales, by type of State, 1987

Franchise sales Type of State Establishments as a share of

franchised^ total sales

Percent

Rural States^ 38 55 Urban States' 25 40 Other States* 34 46

U.S. total 32 44

»SIC 5812 (part). ^Forty-one percent or less of the Slate's population (1980) residing in urban places. ^Seventy percent or more of the State's population (1980) residing in ufban places. *More than 41 percent, and less than 70 percent, of the State's population (1980) residing in urban places.

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when the owner perceives that financial or personal costs are overwhelming the benefits of ownership. A franchise, once established, may have the greatest stability. The franchisor has a vested interest in an image of stability and growth. The franchisor may buy the franchise back, or sell it to another entrepreneur, rather than let the location close. Thus, an established franchise may be less likely to close than either a branch or an independent outlet.

These organizational strategies are interesting when looked at in the light of central-place theory. Central-place theory does not take organizational consideration into account. Under its assumptions, location decisionmakers, when faced with the riskiness of rural locations, will simply not locate an outlet in those areas. On the other hand, organizational theorists, while assuming that rural locations are riskier, argue that a firm can make strategic organizational changes that adapt to riskier environments.

Evidence indicates that franchisors often take this organizational point of view. As mentioned earlier. Southland usually sells a license to franchise rural States to a master franchisor. Hardee's also tends to give regional entrepreneurs the responsibility to franchise particular rural regions. This strategy minimizes risk by tapping into the franchisee's knowledge of local markets. Rural outlets, under this scenario, are more likely to be franchised and urban outlets company-owned.

Some chains, both company-owned and franchised, have not worked on the assumption that rural locations are riskier. In fact, some multi-outlet chains have location strategies that emphasize rural areas over urban areas. Wal-Mart, a large discount-store chain with company-owned outlets, pioneered this location strategy. Hardee's, a franchisor firm with a similar "rural first" strategy, refers to it as "capturing the fringe" (Atañas, personal interview, July 22, 1991). This strategy is exactly the opposite of the hierarchical pattern of store location. Instead of starting with locations in larger towns and spreading to surrounding smaller towns, Hardee's locates outlets in rural areas first, then later moves into the higher population centers. This may be described as a variation of the neighborhood wave strategy. Other franchisors, such as Uniforce Temporary Services and Sonic Drive-ins, also practice this location strategy (appendix table 1).

Once again, there are connections between the particular location strategy of a franchisor firm and its organizational strategy. Firms that emphasize "capturing the fringe" often set up partnerships with regional entrepreneurs whose knowledge of the local area is important to franchisor firms.

Effects on the Rural Retail and Producer Service Sectors

The effect of franchise chain outlets on rural business environments is controversial and not adequately studied. People often refer to local independent businesses in rural business districts as Main Street businesses. Many studies have noted the difficulties independent rural businesses face when put in competition with chain-store outlets, both company-owned and franchised. However, interviews with rural business people do not reveal absolute opposition to chain ouüets in their towns. In fact, many local business people seem to welcome and even seek out chain firms to locate in their towns. As a number of rural business people told us in interviews, in effect, "A town is validated by a McDonald's."

11

This statement may reflect the phenomenon of the rural service center: the entry of chain businesses into a town may increase traffic to the town and, therefore, actually increase business for local independents. However, the development of certain towns into rural service centers means that local people increasingly drive past their local retail service businesses to patronize businesses in the new service centers. Therefore, to truly measure the effect of rural chains, it may be necessary to look at the regional rather than the local effects on Main Street businesses.

While the effect of an individual franchise chain on rural retail businesses may not be clear, franchise locational strategies may have a cumulative effect If franchises choose to locate primarily in regional malls or new commercial strips away from central business districts, this may divert shoppers from the older commercial areas (Borich, Steward, and Hatle, 1985; Stone and McConnon, 1982). However, if franchises locate on Main Street in rural towns, they may compete more directly with independent businesses, but they will not be pulling traffic away from the area. Therefore, an assessment of chain-outlet effects on rural retail sectors is more complex than their simple effects on individual firms.

The effect on producer services is different. As many rural research reports indicate, producer services are desperately needed in rural places. Rural towns lack accounting, employment, consulting, and sometimes even attorney services. If franchising could bring these services to underserved areas, that would be a great benefit to local business. In addition, producer service franchises, because of their links with national and multinational firms, would be likely to offer greater resources and access to larger networks than independent firms would. The rural producer service sector, however, has not received much attention and there are no figures on the prevalence of franchised producer services in rural areas. H&R Block has a presence in rural areas. In addition, one personnel firm, Uniforce Temporary Services, has pursued a rural "capture the fringe" location strategy (Garrett, 1989).

Effect of Franchising on Rural Customers

According to central-place theory, people living in rural places necessarily have fewer local services tíian urban people have. At some population threshold, the number of possible services increases. On the other hand, organizational variation and management strategies may allow firms to change the minimum population threshold and thereby profitably enter rural and smalltown markets.

The organizational perspective on locational strategy has direct implications for rural customers. Many rural people welcome both company and franchise chains to their areas, as they often perceive these firms to offer a greater choice of goods at a better value. In some cases, these chains offer a service not previously available. For example, Casey's General Store, a franchised convenience store company, locates primarily in smaller rural towns. Casey's stores are somewhat larger than most convenience stores, carrying a larger array of items, plus gasoline. Casey's management believes this larger inventory keeps people from driving to a larger town to pick up general goods (and, while there, convenience goods as well). Casey's management claims they have been extremely successful with this strategy (Shaner, 1990).

12

Casey's "go where they ain't" strategy, as well as the focus on general goods, is described in the business literature as one way to locate profitable rural outlets. If this is in fact the case, from the perspective of rural communities, such a strategy may mean greater local access to goods and services.

Fitchen has remarked on the importance of franchise convenience stores in rural areas. In many of these towns, "local people have quickly adapted the minimarket form to fit their functional need for a community meeting place. News and gossip, warmth and a welcome are the social commodities available here. Even under a fake mansard roof mass produced in plastic in the late twentieth century, convenience stores serve a modem day equivalent of the old village general store" (1991, p. 260). Fitchen has also noted that the one village grocery or convenience store also provides important services for rural poor people, such as a telephone and groceries within walking distance of village houses that are increasingly broken up into small apartments and rented to poorer people (1991, p. 122). While franchise outlets are controversial for some (rural customers), Fitchen notes that it is usually newcomers who "made their money elsewhere" who resist these outlets, usually for aesthetic reasons (1991, p. 260). Therefore, as with the previous discussion concerning the effects of franchising on the rural retail sector, the effects of franchise outlets on rural customers are complex and can not be generalized about

EfTect of Franchising on Rural Entrepreneurship

When starting a new venture, a prospective entrepreneur needs to answer three main questions: (1) How am I going to learn how to organize my business? (2) Who can help me start this business successfully? and (3) What resources am I going to need to organize a successful business startup (Gartner, 1985). Few studies have examined why entrepreneurs choose to franchise rather than start an independent business. Falbe and Dandridge have examined franchising from a rural startup perspective (1991). They argue that entrepreneurs choose franchise business because franchisor firms offer organizational knowledge, business networks, and resources including training, credit, and producer services necessary for a successful startup. Many researchers have noted that these factors are commonly less available in rural areas. Therefore, the advantages of franchising may be particularly evident to a rural entrepreneur.

Aldrich (1990) noted that prospective entrepreneurs may hesitate to found an organization if they are uncertain of how to construct it Potential entrepreneurs, he argues, learn how to construct businesses from observing their environments and by imitating what others are doing. Obviously, the small number of establishments in an average rural town would give less opportunity for observation and imitation, thereby reducing an entrepreneur's chances to gain organizational knowledge. Studies have shown that many rural entrepreneurs have no previous business experience. Lack of experience leads to early mistakes in marketing and pricing that are very difficult to correct (Heenan, 1989).

Franchising provides potential entrepreneurs, as franchisees, with organizational knowledge, including a business system. Franchisors commonly offer training (LaVan, Coye, and Latona, 1988), marketing, operations, and other functional knowledge that may act as an alternative to the entrepreneurial team that is associated with the success of new independent ventures

13

(Timmons, 1979). This support gives franchisees collective experience on which they can build.

Even with organized business knowledge and a supportive network, a business will have difficulty succeeding without access to resources. These include credit and finance assistance, a skilled labor force, professional and technical support services, professional training, appropriate infrastructure and the government capacity to provide it, and an adequate economic base in the community (Aldrich, 1979; Allen and Hay ward, 1990; Falbe and Dandridge, 1991). Many of these resources are not available in rural areas. One study found that rural areas lack basic business services, such as advertising, accounting, and legal counsel. Furthermore, rural venture capital, both formal and informal, is rare and conventional bank financing difficult to obtain (Mueller, 1988). On the other hand, banks often perceive a businessperson associated with a franchise as a low-risk borrower (Kotow, 1988). Franchising, therefore, may be helpful in extending business opportunities in rural areas through increased assistance with obtaining credit.

Another important resource in business startups and survival is access to technology, particularly organizational and information technology. One of the major reasons for the spread of the firanchised hotel-motel business is that the franchisor offers access to a nationwide computerized reservation system (Gatty, 1988). These nationwide systems are technological networks that no single hotel-motel owner could reproduce. An isolated, independent rural business without access to these technologies may face higher costs or provide poorer service.

Recently, rural new venture researchers have given attention to the "entry strategy" aspect of new business ventures. Wortman (1990a), for example, has suggested a more thorough examination of entry strategies that are successful for the neophyte rural entrepreneur. Choosing to enter the market as a franchisee is both an entry strategy and a general organizational strategy. Vesper (1990) has argued that franchising provides a competitive entry wedge. This may be particularly true if the franchisor has a "take no prisoners" approach to local competition. For example, Uniforce offers financing to its franchisees to buy out their local competition (Garrett, 1988).

The lack of access to resources, networks, and organizational knowledge is one reason many people argue that rural environments are more "risky" for new business startups and survival. Franchise organizations not only involve sharing of risks but may reduce risks by giving entrepreneurs the organizational knowledge necessary for starting a business, a support network composed of both the franchisor and other franchisees, and greater access to resources like training, credit, and information. On the other hand, choosing a franchisor firm is in itself a risky business, since irresponsible franchisors may not live up to promises of company business support. Distinguishing between supportive and less responsible franchisors also requires access to information about these firms. Such information must legally be provided to potential franchisees, and any private or public encouragement of potential rural franchisees should include an emphasis on the importance of this information.

Franchising and the Future in Rural Areas

Any consideration of the rural economic environment must also consider current changes in that environment, and in the economy in general. While much of the literature on

14

organization and location assumes an immutable set of economic rules, the more recent literature argues that the rules have changed. Bell, referring to what he calls the new economic "Information Age," argues that information has become the most important resource to exploit (1976). Some new economy analysts, such as Piore and Sabel (1984), and Storper and Christopherson (1987), call it the age of "flexible specialization," a new phenomenon in which companies pursue new strategies of growth, including the external sourcing of production, and, therefore, of labor markets. Other observers (Gershuny and Miles, 1983) emphasize the decline in manufacturing and the rise of the service sector as the major source of job growth.

In addition, massive technological and organizational change is occurring in retailing. For example, "point-of-sale" (POS) systems, which track sales through a cashier's scanning of bar codes, are often linked with ongoing market research when that same cashier asks the purchaser for his or her zip code. This POS system, which also allows for better control of inventory, is often linked to an "electronic data interchange" (EDI) system that links retailers with suppliers in a "just-in-time" ordering system that eliminates the need for maintaining an expensive instore inventory. These systems enable retail firms to be more sensitive to consumer demands and, therefore, better able to identify and exploit different market niches. This change in ordering systems has had an enormous effect on distribution and manufacturing systems, which have responded with their own increasingly flexible information-centered production as well as organizational "dis-integration" through subcontracting.

These new technologies may have a major effect on retail organization. Franchising is a form of organization that helps to solve problems of monitoring for the franchisor. New information technologies also lower risk by increasing the capacity to monitor, which gives the chain store greater access to information. If technology helps to lower risk for the chain firm, franchise partnerships may not be necessary. On the other hand, if risk keeps these firms out of rural areas, lowering this risk may make it profitable to locate oudets there. While it is not yet possible to judge the effect of these new technologies on retail organization, the independent, isolated firm is clearly at a disadvantage.

Once again, the lack of data hampers even speculative thinking on this subject. It is unclear how the future development of this new service economy or the development of new retail technologies will affect the rural service sector. However, noting the changes that have already occurred in the rural service sector. Flora and Rora recommend that local entrepreneurs and chambers of commerce "fill empty storefronts not with new businesses selling goods, but with businesses dispensing services. And those services must be closely linked to the local population and their needs, particularly the unique needs of the elderiy population" (1990, p. 201). Franchised outlets may be one way to bring these services to local rural communities.

We should also note that franchising itself is evolving. Many of the newest franchise innovations are designed to make outlets profitable in markets not currently served. For example, a new form, the satellite franchise, brings the goods or services of an established outlet to other more isolated locations for brief periods. A mobile unit or temporary storefront can extend the goods or services of another permanent location. This new form of franchising may be particularly important to rural areas.

15

Conclusions

The literature on franchising contains little empirical data on the role of this organizational form in rural areas. Therefore, any conclusions we draw must be speculative. However, it seems likely that franchised consumer and producer service outlets are moving into rural areas and that they will continue to do so. Franchises may outcompete both independent and company-owned businesses for two major reasons: (1) its hybrid nature enables franchising to benefit from both centralized control and independent management initiative and innovation; and (2) the sharing of risk between franchisor and franchisee makes possible the survival of outlets in more risky locations, such as rural areas.

However, the effect of this new wave of franchising on rural areas is not clear. The literature on organization and location would suggest two possibilities. Those enthusiastic about franchising might argue that outlets tied to franchise systems can be specially adapted to risky retail environments, such as rural markets. As a result, these systems may be able to provide rural areas with more local services. These outlets may outcompete independents because franchisees have access .to outside resources, such as training and technology, through the franchisor. Yet, because owners are often local entrepreneurs, these outlets can operate with a greater community commitment and stability. In any case, supporters of franchising would note, franchise outiets often locate in areas where local independents have already failed.

The opposing viewpoint would see franchises as lowering the quality of life in rural areas. Opponents point to the fact that franchises tend to locate in regional shopping centers, which generally pull shoppers away from small business districts. These franchises also compete with, and replace, local independents.

Opponents may also argue that the advantages of ties beyond the local area do not make up for the loss of what independent firms provide to the community, such as aesthetic values that fit into local architecture, a long-term commitment to the economic health of the community, involvement in local business and social networks, and the provision of service adapted to specific local needs.

It is impossible to determine which of these scenarios is in fact the case without empirical data on franchising in rural areas. However, recent research does show that the dichotomy between independent small businesses and dependent company affiliates is oversimplified. As rural development analysts have shown, the independent small business is often a subcontractor with a single client (Young and Francis, 1989). Other small businesses have dealership contracts, franchise agreements, or are involved in voluntary associations. Branch plants can also exhibit varying degrees of independence, depending on the organization of the parent company (Hall, 1991). Even within the franchise sector, the independence of entrepreneurship in local outiets varies. It is, therefore, necessary to go beyond basic definitions of independent and branch outlets before deciding the effect of a certain type of outlet on the decisionmaking control in a community.

Systematic study of franchises in rural areas faces a serious problem: there are no business data that distinguish franchises as a separate form of organization. Most business data identify franchises as either independent or as "company-affiliated" firms. Without such data, it is impossible to carry out an empirical assessment of franchising's role in the economy,

16

rural, urban, or otherwise. More specifically, until franchises are distinguished from other fcyms of organization in the business data, policymakers will be unable to empirically assess their current role in economic development or monitor the success of new franchising initiatives. Were new data available, it would be fruitful for future research to address the following issues:

1. To what extent are rural services franchised? How does this compare with urban services? Has the percentage of franchised businesses in rural areas risen?

2. Do franchises replace existing firms—branch outlets or independents—or do they fill voids left by these firms or provide services not previously available?

3. Rural counties are highly diverse in their economies. Do franchises play different roles in different rural counties? Are franchises concentrating in "boom" counties and ex-urban development areas?

4. Are there incentives that could motivate franchisors to increase their rural locations, or to modify their locational strategies so as to benefit rural communities more fully, for example, to move into central business districts rather than mall shopping centers?

5. What are the effects of franchise ownership and franchise strategy on rural entrepreneurs? Does the training they receive as a franchisee enable them to successfully start other businesses?

The major policy question concerning rural franchises is whether these businesses benefit local communities and what types of communities they are most likely to benefit. Leaders of local development may consider trying to attract franchise outlets to their communities, as a way of gaining jobs and sorely needed consumer and producer services. These people may also hope to bring business development training to local entrepreneurs in rural areas. On the other hand, they may worry that franchises will contribute to the continuing loss of local decisionmaking and distinctiveness in a rural community.

Local leaders involved in economic development and business zoning permits often attempt to influence the "mix" of businesses in their community. This review attempts to give these leaders as much information as is available concerning the benefits and drawbacks of franchise outlets. As mentioned above, limited data make it difficult to make strong recommendations. However, based on this literature review, we believe that the answers to these questions will depend on specific community and franchise contexts. For example, a community that bases a large amount of its income on tourists attracted by its unique image may not want to target a fast-food franchise to locate in its quaint downtown. However, that same community may welcome a national hotel/motel franchise chain that would build compatible room capacity to bring in more visitors to local attractions. That same town may welcome a producer service outlet—accounting/tax preparation or a printing/copy business—that would help local businesses fill these service needs more efficiently and cheaply. Conversely, a downtown with many empty storefronts might welcome a franchised restaurant which, along with serving travelers, could become the local gathering place. Many franchise restaurant outlets now serve this function in rural areas, and many people in these areas consider them a local asset.

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Appendix Table 1—Firms with a Rural Location Strategy

Name Business Rural strategy Source of information

A&W

Ames

Fast food

Discount store

Carmike Cinemas Cinemas

Casey's General Convenience si Stores*

Dollar General Discount store

Family Dollar Discount store

Giant Tiger* Discount store

Hardee's* Fast food

Careful location choice; currently, food courts in regional malls

Direct mail advertising targeted at particular zip codes; emphasis on "nonyuppie" customers

Looks for communities with less than one screen per 10,000 persons and with rundown current facilities

Low startup and operating costs; carry a wider variety of goods than urban convenience stores

Small stores with few items and low prices

Small stores with few items and low prices

Full-line stores in rural areas, niche market stores in cities

Saturate region with outlets; community involvement; location-savvy franchisees

Kwik Trip Convenience store Emphasis on self-service, diversity of services including a deli

Jacks Discount store "depth and breadth" cater to all types of customers

Long's Drugs Discount drug store New strategy: down-size its conventional city store

Lowe's Home building products

Smaller stores with greater per square foot sales and low margins to discourage competition

Pay Less Ehug Discount drug store New strategy: down-size its conventional city store for rural markets

Picadilly Cafeterias Restaurant Oriented to midsized towns, with a nonurban image

Personal interview, Larry Köhler, Director of Franchise Sales, July 23, 1991

American Demographics^ 1985

Barrett, 1988

National Petroleum News, 1988; Shaner, 1990

Fisher, 1989

Fisher, 1989

Schwartz, 1990

Personal interview, Roger Atañas, Director of Franchise Development, July 22, 1991; Russell, 1990

Dwyer, 1990

Johnson, 1990

MiUer, 1986

Fisher, 1989

MiUer, 1986

Fisher, 1989

Continued—

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Appendix Table 1—Firms with a Rural Location Strategy—Continued

Name Business Rural strategy Source of information

Radio Shack*

Sears

Sonic Industries*

Southland

Uniforce Temporary Services*

Uni-Marts*

Wal-Mart

Wawa Convenience Stores

Electronics store

Department store

Drive-in fast food

7-Eleven convenience store

Temporary help

Convenience store

Discount store

Company stores in cities; in small towns, links up with existing retailers

Down-size store

Low startup and operating costs; regional market dominance

Often sells "domestic hcenses" to master franchisee in rural States

Avoids location with larger temp firms, helps franchisees buy out competition

Lower operating costs and less competition

Forerunner of rural strategists; large stores with wide variety of items

Convenience stores New strategy

Personal interview. Bob Owens, Vice President of Franchising, July 19, 1991

MiUer, 1986

Personal interview, Stephen Lynn, President, June 5, 1991; Lubove, 1990

Personal interview, Wayne Beeder, Manager of Franchise Systems, July 25, 1991

Garrett, 1989

Shaner, 1989

MiUer, 1986

MiUer, 1986

^"Indicates a franchising firm.

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Appendix—Databases on Franchises

International Franchise Association

The International Franchise Association publishes a list of franchisors. Each listing describes the business, the number of franchised and company-owned outlets, the cash investment needed to start an operation, franchisee quahfications, and a company contact person. The list is published to assist potential franchisees find franchise businesses. It gives little information concerning existing franchise establishments. It is also not a complete list of franchisors.

USEEM

This Small Business Administration database of new business startups distinguishes between incorporated and independent firms. Unfortunately, this does not enable one to identify franchises, because some outlets are owned by parent companies, by master franchisors, and by other forms of multi-outlet corporations. Therefore, incorporated multi-outlet franchises fall under the "corporate affiliate" identification, while "mom-and-pop" type franchises are independents. Therefore, not only are franchise organizations obscured under another category in this database, they fall under more than one category. Therefore, this database, while containing franchise organizations, is not satisfactory for the study of franchising.

Census of Retailing

This database distinguishes franchise firms in one SIC industry code (5812): "Eating Places." In this industry, firm surveys ask whether the outlet uses the trade name of a franchisor and then whether the outlet is owned by the franchisor. This database therefore distinguishes between company-owned and franchisee-owned outlets. Data are tabulated by State and are published as Census of Retailing, Miscellaneous Subject Table #13. A special tabulation by county would be available for a fee. Norton (1988a and b) used this data in his study of franchising, as well as SIC number 7011, "Motels and Tourist Courts" in the U.S. Census of Service Industries, which he states contains similar data.

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