Mitigating Underinvestment Through an IT-Enabled Organization Form

Information technology (IT) enables a new refinement of the horizontal network organization. We show that IT can be applied to a hybrid form of market and hierarchy, franchis­ing, and demonstrate how the resulting horizontal network organization can be an improved organization form. Specifi­cally, we use IT-enabled "ownership of customers" to refine the horizontal network organization and show how that re­finement can alleviate the problem of franchise underinvest­ment in traditional franchising. In traditional franchising each franchise underinvests relative to investments in an integrated firm because the benefits that accrue to other franchises from its investment (horizontal externalities) are not accounted for in its investment decision. Ownership of customers is a combination of identifying individual cus­tomers with individual franchises, monitoring customer trans­ actions across franchises, and transferring benefits between franchises based on those transactions. Because ownership of customers rewards franchises for the beneficial horizontal externalities generated by their investments, the levels of investment that are chosen by franchises may be increased, although not to the levels that would occur in an integrated firm. As long as IT costs are covered, the franchisor is always more profitable and, if necessary, the franchisor and fran­chisees can be jointly more profitable. Consequently, if prof­ its can be redistributed in lump-sum form, then the fran­chisor and franchisees can be individually more profitable. The analysis applies to all horizontal organizations where ownership of customers is feasible and where there are sufficient transactions between units for ownership of cus­tomers to be worthwhile