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How Franchisors Can Use Contract Ambiguity to Their Advantage

How Franchisors Can Use Contract Ambiguity to Their Advantage

Xu (Vivian) Zheng, David A. Griffith, Ling Ge and Uri Benoliel

Being sued damages the brand. There was no positive development for 7-Eleven in February 2020 when Mitoshi Matsumoto, who owned a 7-Eleven outlet in Higashiosaka, Japan, received international press coverage by filing suit against the chain. Nor was there any joy at Domino’s Pizza Australia in January 2020 when Australian fast-food veteran Frederick Aloysius Mario White filed suit against the chain. Franchisors want to minimize litigation in business relationships. A new study in the Journal of Marketing explores which steps can be taken to do that.

While best practice suggests business contracts should be written to be clear so that there are no misunderstandings (which could lead to contract disputes and litigation), we find that franchise contracts often contain ambiguous terms. For example, contracts frequently use terms such as “good faith effort” and “reasonable costs.” The fact that a term such as “good faith effort” is open to multiple interpretations might be cause for concern. However, we find that contract terms that are ambiguous in relation to the franchisor’s obligations enhance collaboration, minimize franchisee-initiated litigation, and enhance franchisor financial performance.

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Specifically, we find that in a franchise setting, where the franchise agreement is written by the franchisor, contract ambiguity of franchisor obligations is used as a strategic tool to enhance joint problem solving and collaboration with franchisees as well as to deter franchisee-initiated litigation. The ultimate outcome for the franchisor is enhanced financial performance of the franchise system. For instance, our findings indicate that a one unit decrease in franchisee-initiated litigation leads to a 7% (i.e., $45,285.38) increase in franchisor net income. We also note that these findings extend beyond franchise systems because contracts predominate in interorganizational governance, often with similar power differences, where one party is the contract drafter and the other is the contract taker, such as a powerful manufacturer writing contracts offered to less powerful suppliers.

We also note that the written contract is only one aspect of interorganizational governance and point out two other significant aspects that managers should consider. First, we find that franchisor training programs, when combined with contract ambiguity of franchisor obligations, serve as a buffer against franchisee-initiated litigation. Our results highlight the importance of franchisors not only viewing training programs as vehicles for increased franchisee efficiency, but also viewing investments in these efforts as important mechanisms that can aid in socializing franchisees, thereby facilitating the management of the franchise system. We strongly recommend franchisors invest in building strong and expansive training programs that develop shared values with franchisees in order to enhance cohesion. Extending this to the broader interorganizational governance context, we highlight the simultaneous practice of socialization efforts with employment of contract ambiguity. For example, a powerful retailer should use supplier training programs to build esprit de corps and as a context for the clarification of misunderstandings that may arise from the contract, thus facilitating joint problem solving and collaboration.

Second, we caution franchisors about the potential negative consequences related to franchisee associations and the importance of carefully managing relations with an association. Consider the case of Denny’s. In 1988 Denny’s formed the Denny’s Franchisee Council as a way for franchisees to communicate with the corporate office. However, in 1997 the Denny’s Franchisee Council became independent from corporate sponsorship and reformed as the Denny’s Franchisee Association. This may be an example wherein the franchisor-sponsored association stimulated bonding between franchisees (instead of bonding with the franchisor), thus creating a countervailing power to the detriment of the franchisor. Similar suggestions may extend to other network governance situations, cautioning that the increased connectivity and bonding among multiple business partners could work counter to a firm’s governance efforts.

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From: Xu (Vivian) Zheng, David Griffith, Ling Ge, and Uri Benoliel, “Effects of Contract Ambiguity in Interorganizational Governance,” Journal of Marketing.

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Xu (Vivian) Zheng is Assistant Professor of Marketing, College of Business, City University of Hong Kong, Hong Kong.

David A. Griffith is Professor of Marketing, Department Head of the Department of Marketing, Hallie Vanderhider Chair in Business, Mays Business School, Texas A&M University.

Ling Ge is Assistant Professor, Department of Information Technology & Decision Science, G. Brint Ryan College of Business, University of North Texas.

Uri Benoliel is Senior Lecturer, Commercial Law Department, College of Law and Business, Ramat Gan, Israel.