Brighter prospects? Assessing the franchise advantage using census data

• Date: 01 April 2019
• Author: Marek Zapletal,Xu Zhang,Francine Lafontaine
• Published date: 01 April 2019
• DOI: http://doi.org/10.1111/jems.12289

Received: 13 February 2017

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Revised: 20 August 2018

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Accepted: 20 August 2018

DOI: 10.1111/jems.12289

ORIGINAL ARTICLE

Brighter prospects? Assessing the franchise advantage

using census data

Francine Lafontaine

1,2

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Marek Zapletal

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Xu Zhang

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1

Ross School of Business, University of

Michigan, Ann Arbor, Michigan, USA

2

Centre for Economic Policy Research,

London, UK

3

The Brattle Group, Boston,

Massachusetts

4

London Business School, London, UK

Correspondence

Francine Lafontaine, Ross School of

Business, University of Michigan, Ann

Arbor, MI 48109.

Email: laf@umich.edu

Abstract

This paper uses Census microdata to examine how starting a business as a

franchise rather than an independent business affects its survival and growth

prospects. We assess factors that influence the decision to become a franchisee

and use various empirical approaches to correct for selection bias in our

performance analyses. We find that franchised businesses on average exhibit

higher survival rates than independent businesses; but importantly, the

difference is small compared with claims in the trade press. The effect is also

short lived: conditional on surviving a year or two, we no longer find survival

(or growth) differences. We then explore two potential sources for this small

survival advantage, namely franchisors’screening process and the benefits

arising from the brand and business know‐how provided by franchisors. We

find evidence that both of the sources contribute to the franchising advantage.

KEYWORDS

Business growth, business survival, entrepreneurship, franchising, independent business,

know‐how, retail, screening, services, Survey of Business Owners (SBO)

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INTRODUCTION

Franchising is an important form of business organization in many retail and service industries, which themselves

constitute a large and growing segment of the US economy. According to the US Census Bureau, there were

453,326 establishments of franchised chains in 2007, contributing $154 billion in payroll for their 7.9 million

employees.

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Given its importance in the US economy, it is perhaps surprising that research on franchising

decisions, and its effect on business performance, remains scarce. The goal of this paper is to investigate

specifically whether franchised businesses’survival and growth prospects compare favorably with those of

independent businesses.

Whether franchised businesses are more likely to be successful, that is, whether they are more likely to survive longer,

has been of much interest to industry participants and scholars. One regularly finds claims in the trade press suggesting that

starting a franchise is a much safer way of going into business. The empirical evidence on this topic, however, has been

mixed.

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Bates (1995a) and (1995b), for example, documented that in the late 1980s, the failure rate of franchised businesses

was somewhat greater than that of the independent businesses, and much greater than that suggested by industry insiders

and the trade press.

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In summarizing the literature on this topic, Blair and Lafontaine (2005) state:

[…] substantial business risks exist for individuals who choose to invest in a franchise. In fact, franchising is

no safer on average than independent business ownership, and in some cases is actually riskier. […] Of course,

business failure is a fact of life. Our point is that this is just as true for franchisors and franchisees as it is for

other players in the economy. We see this as no cause for alarm, but as a fact that should be more widely

J Econ Manage Strat. 2019;28:175–197. wileyonlinelibrary.com/journal/jems © 2018 Wiley Periodicals, Inc.

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known and recognized in the franchise community. Ultimately, a false sense of security can only lead to

hardship and disappointment.

In theory, it is indeed unclear whether franchised or independent businesses should have a survival advantage. On

the one hand, starting a business as a franchise should be less risky than launching an independent business because

franchisees benefit from their franchisor’s brand name awareness and know‐how and may realize cost savings from

more efficient supply chains and bulk purchasing. That franchised establishments have become a ubiquitous part of

modern life today suggests that franchising is often an efficient mode of business entry and operation. Independent

business owners, however, do not have to pay franchise fees or ongoing royalties on revenues, and they retain complete

autonomy, allowing them to adapt as needed to their local market and changing market conditions. These differences

allow for the possibility of superior performance by nonfranchised businesses. The coexistence of both types of

businesses in the marketplace suggests that neither form of business ownership clearly dominates the other.

In this paper, we use Census data to assess whether the survival and growth prospects of franchised businesses are

more promising than those of independent businesses. Of course, this analysis requires caution because the franchising

decision is not random, and the factors that affect the franchising decision may also affect survival directly. Thus, one

must control for “selection into franchising”when examining whether franchising has a direct effect on survival (see,

e.g., Kosová, Lafontaine, and Perrigot (2013) on this issue). Williams (1999), Kaufmann (1999), and Mazzeo (2004), for

example, show that characteristics of the business owners, such as education, age, and managerial experience, increase

the likelihood of entering into a franchise relationship relative to independent business startup. Our findings on the

factors that affect the probability of starting a franchise relative to an independent business are in line with theirs.

We also contribute to the broad literature on the extent of, and determinants of, the survival and growth prospects of

business startups.

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Factors that have been identified in this literature can be grouped into three broad categories:

characteristics of business owners,including race and gender, and measuresof their human capital, such as educationand

prior business experience (Bates, 1990; Boden & Nucci, 2000; Cooper, Gimeno‐Gascon, & Woo, 1994; Cressy, 1996; Evans

& Leighton, 1989; Fairlie & Robb, 2008; Kalleberg & Leicht, 1991; Kalnins & Mayer, 2004; Lafontaine and Shaw, 2016;

Lazear, 2004; Millán, Congregado, & Román, 2010; Pfeiffer & Reize, 2000); the amount of capital and the sources of

financing that a business owner is able to access to start their business (e.g., Bates, 1990, Carpenter & Petersen, 2002,

Cooper et al., 1994,Cressy, 1996, Fan et al., 2017, Holtz‐Eakin, Joulfaian, & Rosen, 1994, Hurst& Lusardi, 2004, Kamshad,

1994, Kerr, Kerr, & Nanda, 2015, Schäfer & Talavera, 2007); and finally, the macroeconomic conditions faced by the

business. The latter includes factors affecting the industry within which the new business operates, the local business

environment, and the regional or national level of economic activity (e.g., Agarwal & Audretsch, 2001; Audretsch

& Mahmood, 1995;Audretsch, Houweling, & Thurik, 2000; Boden & Nucci, 2000; Fritsch, Brixy, & Falck,2006; Haapanen

& Tervo, 2009; Pfeiffer & Reize, 2000; Tveterås & Eide, 2000; Wagner, 1994). A number of these factors, however, arise

from decisions made by business owners. Examples include the form of financing, the timing of entry, the location and

choice of business activities, and the skills that the entrepreneur chooses to acquire (see, e.g., Cressy 1996, Kalnins &

Lafontaine, 2013, Lazear, 2004, Pfeiffer & Reize, 2000).The issue of selection mentioned above applies here as well and is

addressed in someof this literature. For our purposes, however, the main point is to recognize that these factorsneed to be

controlled for in the analyses of the effect of the franchising decision on both business survival and growth.

Our data are from the US Census Bureau’s Survey of Business Owners (SBO) and Longitudinal Business Database

(LBD). The SBO provides information on selected characteristics of businesses and business owners. The LBD includes

information on all businesses, including the timing of entry and their yearly employment. We rely on the LBD to

determine survival status for the first few years in business and measure business growth over this period. The industries

covered in this study are the retail trade sector (North American Industry Classification System [NAICS] 44‐45), the

accommodation and food services sector (NAICS 72), and other services sector (NAICS 81).

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These sectors together

accounted for more than 77% of franchised businesses according to the 2007 Census (Kosová & Lafontaine, 2012).

We find that in simple mean comparisons, the 1‐year survival rate of new single‐establishment franchised businesses

is about 6 percentage points higher than that of independent businesses. For the 2‐year survival rate, this difference is

7 percentage points. These are much smaller differences than those mentioned in much of the trade press.

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This is

partly because the average survival rates of both kinds of businesses are higher than one might expect based on the

trade press—at around 90% for 1 year and 80% for 2 years—leaving little room for a higher survival rate for franchises.

Controlling for factors that may lead an individual to pursue a franchise rather than open an independent business

reduces the difference in survival rate slightly, to about 5 percentage points for the 1‐year survival rate, and 6 percentage

points for the 2‐year survival rate. We use Rosenbaum sensitivity tests as well as an instrumental variable (IV) and a

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