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Labor-Intensive Industries

Franchising is a very useful method of business in labor-intensive industries and is less valuable in capital-intensive ones. For instance, a large number of maid services (with their low equipment-to-staff ratios) are franchised, but very few health clubs (with their high equipment-to-staff ratios) are franchised. As you have probably noticed, people often shirk, failing to work as hard or as diligently as they can. Machines, on the other hand, do not shirk. Shirking is often combated by giving people incentives to perform, such as compensating them from the profits of their effort. Perform, and they earn a lot; shirk, and they do not. Of course, giving people incentives to perform is what franchising does. It makes the operator of an outlet a residual claimant on the profits of the outlet rather than a wage employee. So franchising motivates the operators of outlets not to shirk. Because people shirk but machines do not, the incentives provided by franchising are more important in labor-intensive industries than in capital-intensive ones. Therefore, the franchising mode of doing business is most appropriate in labor-intensive industries.

Moreover, franchising gives outlet operators an incentive to monitor costs more closely than hired managers. Because franchisees keep the profits from their operations after all costs are subtracted from revenues, they have a very strong incentive to keep costs down. This means that franchisees often watch their employees more carefully than managers do. They also tend to hire family members at less than market wages, as a way to cut costs. The more labor intensive the industry is, the greater is the effect of efforts to hire inexpensive labor or monitor costs as a way to improve the profitability of a business. This is one reason why we tend to see franchising in labor-intensive industries such as household maintenance and cleaning, but not in capital-intensive ones such as construction.

Stop! Don't Do It!

  1. Don't fight the odds; franchising works best in industries in which knowledge is standardized, codified, and easy to learn.

  2. Don't own outlets in industries in which brand names are a key competitive advantage; you will benefit from franchising in these industries.

  3. Don't franchise in a capital-intensive industry; you will achieve few benefits from it.

  4. Don't ignore the value of franchising as a way to keep costs down.

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