Spatial Competition and Interdependence in Strategic Decisions: Empirical Evidence from Franchising

This article investigates spatial competition and spatial interdependence in two key strategic variables in franchising: the proportion of franchised outlets (PFO; i.e., franchise proportion) and the royalty rate. Employing a simultaneous equations model and data from 353 U.S. franchise chains in 43 sectors in 2005, we find robust evidence for significant spatial competition and stable interdependence in these two strategic variables. Specifically, we find spatial competition in each strategic variable, and spatial interdependence between the two strategic variables. Each strategic variable and its spatial lag are strategic complements in spatial competition due to the market share effect, while the two strategic variables are strategic substitutes in spatial interdependence due to the market power effect, and the former effect is stronger than the latter effect. Besides, we also find that franchisors are strongly inclined to a combination of a low royalty rate and a high franchise proportion, which evolves and stabilizes in the long-run equilibrium. These findings provide a consistent framework with which to explain many stylized facts in franchising, such as the time-invariance of a uniform royalty rate, the stability of a mixed organizational structure, and the coexistence of head-on competition and diversification of chains of different sizes.