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Local Production in Limited Geographic Markets

Franchising makes more sense in industries in which providing customers with a product or service requires small-scale production and distribution in a wide variety of different geographic locations. This is why franchising does not occur in most manufacturing industries. Most manufactured products can be created in large volume in a central location and shipped around the world from that location. In most manufacturing industries, the right incentives and controls needed to deliver a large volume of a standardized product to customers can be put in place without franchising.

However, in other industries, such as fast food, the product and services provided to customers cannot all be delivered from a centralized spot; they must be provided from a variety of different locations. Providing the right incentives and controls to deliver a large volume of a standardized product to customers in these industries can be enhanced by franchising. Therefore, franchising is much more likely to occur in retail and service businesses than in manufacturing businesses.

Moreover, within the set of all retail and service businesses, franchising tends to work best where some aspect of the operation, such as building the brand name or sourcing supply, is subject to economies of scale, but production and distribution need to take place on a small scale in a variety of different locations. As a result, some aspects of the operation benefit from centralization, while local outlets provide a way to deliver the product or service to end customers. The restaurant industry provides a good example. The brand names that attract customers are subject to significant economies of scale. However, the production and distribution of meals takes place on a small scale in a variety of locations because people won't travel very far for a restaurant meal.

One of the effects of being in an industry in which production and distribution occur on a small scale in a variety of locations is that businesses face severe limits on the growth of sales at individual locations. You might be able to grow your semiconductor plant dramatically and ship your products around the world, but you are not going to be able to grow sales at your restaurant very much without adding another location. Your product cannot be shipped to another location, and people will travel only so far to get your product, limiting the number of customers in your geographic market.

To grow sales in industries in which the potential for sales growth at existing locations is quite limited, entrepreneurs and managers need to increase the number of locations that their businesses operate. Franchising is a very effective strategy in businesses where sales growth tends not to come from expansion of sales at existing units, but from unit growth. For reasons that will be discussed in greater detail in the next chapter, franchising makes it possible to add outlets with less management supervision than is the case without franchising.

Stop! Don't Do It!

  1. Don't franchise unless your industry requires some activities subject to scale economies and others that require local activities in a limited geographic area.

  2. Don't franchise in an industry in which sales growth comes easily from expansion of operations at existing locations.

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