Pizza Hut, Inc. Managing a Franchise System Distribution Channel Strategy L. P. Bucklin Spring 2000

Key Learning Areas in PH How should PH respond to the franchisees? What is the effect of PH coercive tactics? How should change be engineered by PH? How can PH increase its control? Should PH seek to buy out franchisees? Why did the PH channel delay so long in responding to the Domino threat?

Key Take Home Issues I The Business Format franchise contract provides –a tight frame for system operation –a basis for administration and control Economic conditions continuously challenge this frame –conditions affect parties differently –conflict is a typical consequence

Key Take Home Issues II The ability to manage conflict in a BF system is a major key to success Key elements to franchise system success –Recognition of limits of economic power –An understanding of the differential impact of change and response upon system members –A communication system permitting dialogue –A system of equitable and fair dealing to build trust

Antecedents to Conflict Diminished competitive strength of the franchise strategic plan Lack of management commitment to individual franchisee welfare PH policies not within its contractual authority Need to enact major change swiftly PH sought to use coercive power to change the system

Effect of Coercive Tactics The effect of coercive tactics depends upon –the underlying strength of each party's position –their impact upon the other party's well being –the extent that they lie within the expected and legitimate limitations of the franchise contract Usage of coercive tactics results in latent hostilities that inhibit trust and commitment Failed use of coercion reduces future power

Coping with Conflict Unless economic power is very high, using coercive tactics typically fails –Induces organization on part of partners –Induces partners to seek alternatives –Reduces level of cooperation Employ positive incentives where possible Fully understand economic bases for conflict and seek to minimize

Control of the PH Channel The channel controlled by committees of franchisees and company executives Committee system leverages franchisee, large-member power Committee seeks middle ground, consensus, avoid major change because of diversity Decisive and rapid action difficult to take; allow competitors room to gain position

Evolution of Governance Mode Early presence of powerful franchisees Initial management evolved from a franchisee perspective Limited competitive pressure during early years enabled system to operate loosely without significant penalty Attempts by Pepsi-Co to graft rapid change create conflict and further indecisiveness

Reasons for the Costly Delay Failure to perceive threat of home delivery –Home delivery did not have an immediate impact on core business –Domino growth rate capability underestimated –Difficulty in finding an effective response Domino threat affected franchisees differently Contractual constraints hampered ability of PH to act to respond to unforeseen events

Pizza Hut’s Ability to Govern Within context of the existing channel, PH had a limited capability to make radical change –Operationally, constrained by the committee system –Strategically, constrained by contract clauses which specified the franchiser ability to act No mechanism in place to respond to challenges outside of the contract Limited response potential from committee

Improved Symmetric Governance Techniques Joint annual strategic planning –annual identification of strategic threats –annual agreed upon objectives Put shared risk and reward systems in place to facilitate response –limit royalties until franchisee achieves minimum payback on new investments –potential for gross margin sharing Continuous updating of contracts to facilitate response to environmental change

Impact of PH’s CSC System High costs for CSC and dedicated delivery units –raised franchisee break-even –increased operator risk –raised complex operational problems –increased need for fresh capital CSC system inappropriate for many sites –requires high demand levels –dense population areas

The PH Response Arbitrary exercise of coercive power could seriously damage system Forcing franchisees to develop CSC will lead to losses for many PH must motivate franchisees to build defenses quickly Franchisee resistance may have saved PH from making a bad economic decision

Implications: Why a Mixed Ownership System? Franchise operators may function more effectively in smaller markets –Franchisees work harder than managers –Watch pennies more effectively –Develop important local roots Integration more effective in bigger markets –Large stores provide wages to attract managers –Greater control needed to respond to competition