Toward a theory of social venture franchising.

This article examines the relevance of the two main theories used to understand business format franchising--resource scarcity theory and agency theory--for social venture franchising through an in-depth case study of one of the United Kingdom's first and most high-profile social franchises. We posit that both theories can be reframed to take account of the distinctive characteristics of social franchise systems. In developing our arguments, we present four findings that, taken together, move us closer toward a theory of social venture franchising.

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There are currently strong economic and political forces encouraging nonprofits to move away from philanthropy and government subsidy as sources of revenue, and instead to generate their income through trading as social enterprises (Emerson, 1999; Gronbjerg, 1998). As this commercial logic has become more deeply embedded, the issue of growth has become a key priority (Dees, Anderson, & Wei-skillern, 2004), and social enterprises have increasingly turned to franchising as a strategy for achieving economies of scale. Although there is now a substantive body of literature on business format franchising, little is known about the distinctive nature of social venture franchising. This is the issue that we address in this article.

Specifically, we examine the relevance of the two main theories used to understand business format franchising--resource scarcity theory and agency theory--for social venture franchising through a case study of one of the United Kingdom's first and most high-profile social venture franchises. This enterprise has attracted widespread support among politicians, policy makers, and social investors, but proved unsustainable as a franchise model. We posit that both theories can be reframed to take account of the distinctive characteristics of social franchise systems, and present four findings that move us closer toward a theory of social venture franchising.

Our first finding is that, as with business format franchising, access to resources including capital, managerial expertise, and local knowledge constitutes a key motivation for social venture franchising. Second, consistent with the strategic behavior of business format franchisors, social venture franchisors are not liable to reduce their proportion of franchised outlets over time. Third, the costs of selection are higher in social venture franchising than in business format franchising because (1) franchisees are organizations rather than individuals, and (2) franchisees are assessed on their ability to achieve social as well as commercial objectives. Finally, we argue that the dual goals inherent in social venture franchising make goal alignment more complex and resource intensive than in business format franchising, leading to higher agency costs.

The article is structured as follows. In the next section, we define business format franchising and describe the two main theories that have been used to conceptualize it. In the third section, we outline our conception of social entrepreneurship and social venture franchising. This leads into our research question, and a description of the data collection and analysis procedures. Following an account of the case study, we then consider the applicability of resource scarcity and agency theories to social venture franchising. Finally, we suggest directions for future research and consider the implications of our study for social entrepreneurs.

Business Format Franchising

Business format franchising consists of a contractual relationship between two independent firms in which a parent company (the franchisor), having developed a product or service, agrees to allow another firm (the franchisee) to sell that product or service in a specific way, in a particular location, and during a given period in return for a one-off initial fee and an annual sales-based payment (Curran & Stanworth, 1983). Franchising differs from other interorganizational forms in two key respects (Combs, Michael, & Castrogiovanni, 2004b). In the first instance, it is usually confined to products and services that require proximity to customers, and therefore involves a chain of geographically dispersed organizations. Second, there tends to be a rigid and clearly defined division of labor between the franchisor and the franchisee. Franchisees are responsible for managing outlets in ways consistent with the business model developed by the franchisor, while for its part, the franchisor usually makes a commitment to provide training and managerial support, invest in and develop the shared brand, and monitor the performance of other franchisees (see also Caves & Murphy, 1976; Rubin, 1978).

Theoretically, the study of business format franchising has been dominated by resource scarcity and agency theories. In the following two subsections, we outline the key assumptions that underpin each perspective.

Resource Scarcity Theory

First proposed by Oxenfeld and Kelly (1969), resource scarcity theory suggests that firms' motivation to franchise stems from a shortage of the resources required for expansion. Because new firms tend to be established below minimum efficient scale (Azoulay & Shane, 2001), there is a negative correlation between growth and exit rates for young firms (Audretsch, 1995). This suggests that new ventures need to grow quickly if they are to compete successfully against established competitors. Oxenfeld and Kelly (1969) argue that franchising allows rapid market penetration in the early stages of firms' growth trajectories by improving access to key resources.

Most importantly, resource scarcity theory suggests that franchising helps to overcome the financial constraints frequently encountered by new ventures, which are often excluded from mainstream financial markets and may be less able to commit retained earnings to fund expansion (Combs & Ketchen, 1999). Moreover, new ventures often lack the capacity to nurture managerial talent, and may possess insufficient local knowledge about the markets in which they seek to expand (Shane, 1996a). Franchising offers a potential solution to both of these contingencies by broadening the scope of available talent beyond the boundaries of the firm, and shifting to the franchisee much of the risk inherent in the introduction of new products to new markets (Kaufmann & Dant, 1998). In other words, limited availability of managerial expertise may be a key factor behind a firm's decision to franchise, particularly when expanding into unfamiliar locations (Combs, Ketchen, & Hoover, 2004a).

When franchisors grow beyond a certain size, however, their capital constraints are likely to be substantially smaller than in new ventures. Established franchisors are also likely to possess the requisite knowledge to train outlet managers, and to control their performance (Stanworth & Curran, 1999). Thus, as firms mature, the pressure on key resources lessens, and franchisors turn their attention to maximizing returns from each outlet. Because franchised outlets are generally less profitable than firm-owned outlets (Brown, 1998), resource scarcity theory predicts that franchisors will seek to reintegrate the most profitable units into their ownership structure. Indeed, the theory suggests that effective franchise systems eventually take the form of wholly owned chains.

Resource scarcity theory is arguably the first attempt to explain why franchisors opt to franchise differing proportions of outlets (Castrogiovanni, Combs, & Justis, 2006), and has been subject to relatively extensive empirical examination. Several studies have shown that resource constraints appear to be an important factor behind firms' decision to franchise (e.g., Lafontaine & Kaufmann, 1994). However, it is also clear that franchisors do not seek to acquire all of their franchised outlets as predicted by resource scarcity; this would be too costly, and in any case, there is little incentive for franchisors to buy back poorly performing outlets (Castrogiovanni et al., 2006). Indeed, there is strong evidence to suggest that franchisors tend to opt for a stable level of franchised outlets over time, although the proportion of franchised outlets varies significantly between franchises depending on, e.g., brand name value (Lafontaine & Shaw, 2005) (see also Combs & Ketchen, 2003; Lafontaine & Kaufmann, 1994).

Agency Theory

Agency theory is concerned with exchanges in which one party (the principal) delegates responsibility for a specific set of actions to another party (the agent) (Jensen & Smith, 1985). A core assumption of agency theory is that agents and principals (both of whom are self-interested) are likely to have different interests and attitudes toward risk, leading to divergent decision-making preferences (Eisenhardt, 1989a). Information asymmetries between the principal and the agent (usually favoring the agent) mean that it is difficult for the principal to monitor the actions of the agent. This is compounded by the fact that the principal cannot create a contract that specifies how the agent should behave under all circumstances, making it impossible to ensure that the agent makes decisions in the principal's best interests (Alchian & Woodward, 1988).