Decision Sciences Journal
Volume 30, Number 2
Spring 1999
Variable Royalty Rates for Improving Franchise Channel Coordination
Surinder Tikoo
Department of Business Administration, State University of New
York at New Paltz, New Paltz, NY 12561, tikoos@npvm.newpaltz.edu
Suresh K. Nair
Department of Operations and Information Management, School of
Business Administration, University of Connecticut, Storrs, CT
06269, suresh@sba.uconn.edu
ABSTRACT
A business format franchisor obtains a major part of its revenues
from franchise royalties, which are typically a fixed percentage
of franchisee gross sales. When a fixed royalty rate is used
and the marginal costs of operating the franchise are increasing,
the franchisee does not have an incentive to increase sales beyond
a certain “optimal” volume. We present a model that
recommends the use of a variable franchise royalty rate for extending
this optimal sales volume. For a general convex cost function,
we show that a new lower rate can be applied to incremental sales
beyond the original optimal level. We show that this new rate
should be less than half of the original rate when a quadratic
cost function is applicable. Adopting a variable royalty rate
increases franchisor royalty revenues and franchisee profits.
Subject Areas: Conflict, Distribution Channels, Franchise
Royalties, Franchising, Marketing, Optimization, and Variable
Rates. |