Information Structure and Contractual Choice in Franchising

We develop a formal model to explain the existence of dual distribution in franchising by assuming variations in location profitability. We posit that location quality dictates the choice between franchising and company ownership. We analyze the contract choice problem when location quality is (1) private information for the franchisor; (2) private information for the franchisee, and (3) common knowledge. We show that (1) can result in the coexistence of company-owned and franchised stores. Under (2) all stores will be franchised. (3) can lead to only company-owned stores or only franchised outlets, depending on monitoring costs.