Firms` Strategic Decisions: Theoretical and Empirical Findings

Volume: 2

Royalty Structures and Franchisee’s Investment Incentive

Author(s): DongJoon Lee, YongHoon Choi and SangHeon Han

Pp: 198-216 (19)

DOI: 10.2174/9781681082530116020010

* (Excluding Mailing and Handling)


We analyze two royalty structures in a two-tier industry in which a franchisee makes a demand increasing investment. Suppose the franchisor can propose either a margin-based royalty (MBR) or a sales-based royalty (SBR). We show that the SBR has the advantage of providing a greater incentive for the franchisee to invest, but has the disadvantage of inducing a greater double-margin distortion. On the other hand, the MBR has the advantage of influencing a smaller double-margin distortion, but has the disadvantage of weakening the incentive for the franchisee to invest. Our main claims are two: the first is that if the market is non-elastic, the franchisor enjoys a higher pay-off from SBR than from MBR. The other is that the investment level under SBR is always larger than that under MBR, regardless of market elasticity.

Keywords: Double marginalization, downstream firm, franchisee’s investment, franchisor, margin-based royalty, market elasticity, royalty structures, sales-based royalty, successive monopoly, take-it-or-leave-it contract, upstream firm.

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