November 8, 2012
**See Mr, Law for clarification on this**
Economics of Franchise Contracts
- more general than franchise and franchisee
Klein's point is the legal definitions of Franchise aren't really important
Klein's central point: General malincentive problem, (incentives aren't aligned) - how do contracts terms solve this problem? Combination of written contract terms who's goal is to allow the market mechanism to work.
(Market mechanism is the threat of exit)
If you cheat, you may win in the short run, but in the long run you will lose the premium stream into the future. That is why market mechanism is implemented. (threat of exit gives them each incentives)
a) Franchiser's share a common brand name.
(problem that arrives with this is a freerider problem)
- A Franchisee can take advantage of the fact if you pollute the reputation you can save your costs without it reflecting the negative costs of loss of reputation. Shirk quality of food, not clean the bathrooms, etc.) Free riding on reputation. Brand name is a public good among Franchisees. (problem arises when a common brand name is being shared)
b) Double Marginalization Problem
(successive monopoly problem)
Problem is because there is a markup upon a markup.
- Manufacturer sells to the distributor who marks up the price. Because there are two markups, industry profits are not maximized. (This is an incentive problem, but impiracly this is not easily observed, not the most important according to Klein) Because there are two profits, industry profits are not maximized.
c) Free-riding on special services
- Audio equipment example
Supplying the service of letting people try out stereo equipment, then there is a guy who is in the basement selling stereos at a cheaper cost. - Essentially the bargain basement retailers are the ones that survive, which is bad for the...