Royalty Structures and Franchisee’s Investment Incentive
Pp. 198-216 (19)
DongJoon Lee, YongHoon Choi and SangHeon Han
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
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.
Faculty of Commerce, Nagoya University of Commerce and Business, 4-4 Sagamine Komenoki-cho Nisshin-shi, Aichi 470-0193, Japan.