law.biu.ac.il€¦ · Web viewhave long been debated in franchise law, with some states adopting...
Transcript of law.biu.ac.il€¦ · Web viewhave long been debated in franchise law, with some states adopting...
REVITALIZING THE CASE FOR GOOD CAUSE STATUTES:
THE ROLE OF REVIEW SITES
Adi Ayal* and Uri Benoliel****
ABSTRACT
Good cause statutes (GCSs) require franchisors to show “good cause” (i.e. a material breach of the franchise contract) before terminating contractual relations with a franchisee. These have long been debated in franchise law, with some states adopting them, others rejecting them, and proponents of both sides arguing about accompanying federal regulation.
Proponents of GCSs argue that they protect small and local franchisees from opportunistic termination by large and national chains, invoking ‘big business vs. local entrepreneur’ rhetoric and stressing the asymmetric information and inherent unequal bargaining power plaguing most such relations. The classic law and economics approach, however, opposes the adoption of GCSs. This approach relies on a central argument: GCSs disrupt an indispensable control mechanism against franchisee free riding, namely the ability of the franchisor to terminate any franchise contract at will.
This article calls for a rethinking of the classic economic analysis of GCSs, in light of the revolution that review sites – namely websites which allow customers to post reviews about franchisees – have brought to the marketplace. After reviewing the classic analysis and the case for ‘at will’ termination, we show that online review sites create a novel and effective control mechanism against franchisee free-riding. Using hotel franchises as a case-study, we show that even in an industry where most customers are non-repeat travelers, unlikely to return to the same site often enough to constrain free-riding, online reviews serve as a substitute for at-will termination. More specifically, we argue that there are four interrelated conditions necessary for review sites to serve as effective control mechanisms, and all are met in this case. First, that customers are sufficiently motivated to write reviews (despite not being financially remunerated for doing so). Second, that review sites facilitate analysis of information by including active measures to reduce information overload. Third, that review sites are sufficiently trustworthy. Fourth, that review sites influence consumer purchasing decisions. With ‘at will’ termination supplanted by online review sites, the case for GCSs as franchisee-protection from franchisor opportunism is thus revitalized.
ARTICLE CONTENTS
* Faculty of Law, Bar-Ilan Univeristy. Phd Economics (UC Berkeley); Phd Law (BIU). ** ** Faculty of Law, College of Law & Business. J.S.D. (UC Berkeley); LL.M (Columbia University).
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I. INTRODUCTION............................................................................................................................3
II. THE LEGAL FRAMEWORK.........................................................................................................5
III. THE CLASSIC ECONOMIC ANALYSIS.......................................................................................8
A. The Free-Riding Problem............................................................................................................8
B. Constraining Free-Riding by Threat of Termination....................................................................12
IV. THE MISSING CONTROL MECHANISM: REVIEW SITES.......................................................15
A. Review Sites: A General Description.................................................................................................15
B. Customers’ Motivation to Write Reviews..................................................................................17
C. Review Sites as Cognitive Facilitators................................................................................................21
D. Trustworthiness of Online Review Sites.............................................................................................25
E. Review Sites Impact Customer Purchasing Decision Making............................................................27
V. CONCLUSION............................................................................................................................30
I. INTRODUCTION
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Good cause statutes (GCSs), which require franchisors to show “good cause” before terminating
contractual relations with a franchisee, have long been debated in franchise law, with some states
adopting them, others rejecting them, and proponents of both sides arguing for (and against)
accompanying federal regulation.
Proponents of GCSs argue that they protect small and local franchises from opportunistic
termination by large and national chains, invoking the inherent unequal access the parties have to
relevant information and the asymmetric bargaining power plaguing most such contracts.1 The
classic law and economics approach, however, opposes the adoption of GCSs.2 The conventional
economic argument is that free-riding is rampant in franchise networks, due to the incentive each
individual franchisee has to enjoy the chain’s reputation while skimping on the investment
necessary to promote the national brand and ensure quality at the local venue.3 An ‘at will’
contract is argued by legal economists to be an indispensable control mechanism for managing
chains and preventing free riding. It allows franchisors to swiftly terminate the contract without
having to prove in court that the franchisees neglected their duties, thus keeping the latter under
constant threat of losing their business if quality is neglected.4 According to this view, since
franchisee investment in quality is multi-faceted and relies mostly on effort and care, providing
1 Articles expressing varying degrees of support for GCSs include Peter C. Lagarias & Robert S. Boutler,
Reality of the Controlling Franchisor: The Case for More, Not Less, Franchisee Protections, 29 FRANCHISE
L.J. 139 (2010); Boyd Allan Byers, Making a Case for Federal Regulation of Franchise Terminations – A
Return of Equity Approach, 19 J. CORP. L. 607 (1994); David Hess, The Iowa Franchise Act: Towards
Protecting Reasonable Expectations of Franchisees and Franchisors, 80 IOWA L. REV. 333 (1995); Donald P.
Horwitz & Walter M. Volpi, Regulating the Franchise Relationship, 54 ST. JOHN’S L. REV. 217 (1980); Tracey
A. Nicastro, How The Cookie Crumbles: The Good Cause Requirement For Terminating A Franchise
Agreement, 28 VAL. U. L. REV. 785 (1994); Paul Steinberg & Gerald Lescatre, Beguiling Heresy: Regulating
the Franchise Relationship, 109 PENN. ST. L. REV. 105 (2004).2 For a detailed analysis see infra Part III. 3 See infra Part III.A. 4 See infra Part III.B.
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verifiable proof of free riding at a level sufficient to show “good cause” in court is often very
costly, if not outright impossible.
This article calls for a rethinking of the classic economic analysis of GSCs in light of the
revolution that review sites – namely websites that allow customers to post reviews about
franchisees – have brought to the marketplace. We argue that review sites may serve as an
effective control mechanism against franchisee free-riding, thereby serving as a substitute for ‘at
will’ termination. Review sites, such as Expedia.com, Booking.com, Hotels.com, and
Priceline.com, have become increasingly popular over the past decade.5 On these sites, millions
of customers write reviews on individual franchisees and rate them on multiple dimensions of
quality.6. The Internet revolution has thus created a method by which customers punish free-
riding directly, by communicating their dismay to other potential customers and negatively
affecting the franchisee’s revenues.7 Online review sites thus provide a direct disincentive to free
riding that would reduce customer experience, effectively enlisting reviewers in disciplining
wayward franchisees, and making ‘at will’ contracting unnecessary. Insofar as the review
mechanism supplants the contractual one, traditional arguments against GCSs lose much of their
weight, while the arguments for such laws retain their power. The prevalence of online reviews
thus requires a re-assessment of the pros and cons of GCSs, and should help to convince
previous detractors that perhaps the time is ripe for change.
This paper will proceed as follows: Part II will review the statutory framework underlying GCSs,
and present their underlying purposes. Part III will provide theoretical context by delving into the
classic law and economic analysis of GCSs.Part IV will detail the novel mechanism, overlooked
so far in the debate over the desirability of GCSs: online review sites. Part V concludes.
5 Other review sites in the hotels and motels industries include, for example, TripAdvisor, Orbitz, IgoUgo,
HolidayCheck, Virtual Tourist, Cheaptickets, Travelocity, Yahoo! Travel, Zoover, Agoda, and TravBudy.6 See infra Part IV.B. 7 See infra Part IV.E.
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II. THE LEGAL FRAMEWORK
To date, only seventeen of the fifty states have adopted statutes requiring “good cause” as a
condition for the termination of a franchise contract by a franchisor.8 Under these statutes, good
cause is commonly defined as a franchisee’s failure to adequately comply with the requirements
of the franchise agreement.9 Where a GCS applies, a franchisor terminating the contract without
good cause must pay damages to the franchisee.10 Such damages typically include loss of
tangible assets used in the franchise (especially where these are adapted to specifications set by
the franchise), but also loss of goodwill and forgone profits.11 Such terms are usually mandatory,
8 The seventeen “good cause” states are Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana,
Iowa, Michigan, Minnesota, Nebraska, New Jersey, Rhode Island, Tennessee, Virginia, Washington,
Wisconsin. ARK. CODE ANN. § 4-72-204(a)(1) (2010); CAL. BUS. & PROF. CODE § 20020 (Deering 2010);
CONN. GEN. STAT. ANN. § 42-133f(a) (2010); DEL. CODE ANN. tit. 6, § 2552(a) (2010); HAW. REV. STAT. ANN.
§ 482E-6 (LexisNexis 2010); 815 ILL. COMP. STAT. ANN. 705/19 (LexisNexis 2010); IND. CODE ANN. § 23-2-
2.7-1(7) (LexisNexis 2010); IOWA CODE ANN. §537A.10(7); MICH. COMP. LAWS. ANN. § 445.1527(27)(c)
(West 2010); MINN. STAT. ANN. § 80C.14(3)(b) (West 2010); NEB. REV. STAT. ANN. § 87-404 (Lexis-Nexis
2010); N.J. STAT. ANN. § 56:10-5 (West 2010); R.I. GEN. LAWS § 6-50-1 et seq. (2010); TENN. CODE ANN. 47-
25-1503; VA. CODE ANN. § 13.1-564 (West 2010); WASH. REV. CODE ANN. § 19.100.180(2)(j) (West 2010);
WIS. STAT. ANN. § 135.03 (West 2010). 9 See ARK. CODE ANN. § 4-72-202(7)(a) (LexisNexis 2007); CAL. BUS. & PROF. CODE § 20020 (Deering 2007);
CONN. GEN. STAT. ANN. § 42-133f(a) (LexisNexis 2007); HAW. REV. STAT. ANN. § 482E-6(2)(H) (LexisNexis
2007); 815 ILL. COMP. STAT. ANN. 705/19(b) (LexisNexis 2007); IND. CODE ANN. § 23-2-2.7-1(7) (LexisNexis
2007); IOWA CODE ANN. § 537A.10(7); MICH. COMP. LAWS. ANN. § 445.1527(27)(c) (LexisNexis 2007);
MINN. STAT. ANN. § 80C.14(3)(b) (LexisNexis 2007); NEB. REV. STAT. ANN. § 87-402(8) (LexisNexis 2007);
N.J. STAT. ANN. § 56:10-5 (West 2007); TENN. CODE ANN. 47-25-1502(4); WASH. REV. CODE ANN. §
19.100.180(2)(j) (West 2007); WIS. STAT. ANN. § 135.02 (West 2010). 10 ARK. CODE ANN. § 4-72-208(b) (2007); CONN. GEN. STAT. ANN. § 42-133g(a) (2007); DEL. CODE ANN. tit. 6,
§ 2553(c) (2007); HAW. REV. STAT. ANN. § 482E-9(b) (LexisNexis 2007); 815 ILL. COMP. STAT. ANN. §
705/26 (2007); IND. CODE ANN. § 23-2-2.7-4 (LexisNexis 2007); IOWA CODE ANN. §537A.10(13); MINN.
STAT. ANN. § 80C.17(1) & (3) (2007); NEB. REV. STAT. ANN. § 87-409 (LexisNexis 2007); N.J. STAT. ANN. §
56:10-10 (West 2007); TENN. CODE ANN. 47-25-1509; VA. CODE ANN. § 13.1-571(a) (2007); WIS. STAT. ANN.
§ 135.06 (West 2010). 5
voiding contractual clauses where franchisees waive their rights, as otherwise franchisors will
find it easy to restore ‘at will’ termination by specifying as much in the franchise agreement.12
Two main purposes have been proposed for GCSs: correction of the perceived inequality in
bargaining power between franchisors and franchisees;13 and protection of franchisees from
perceived franchisor opportunism.14 While the imbalance in bargaining power is an overarching
characteristic of most franchise agreements, franchisor opportunism is more direct. Franchisors
might threaten to terminate the franchise relationship in order to force franchisees to “agree” to
modifications of the original contract.15 Such modifications might include raising the royalty
11 See, e.g., Roger D. Blair, Measuring Damages for Lost Profits in Franchise Termination Cases, 8 FRANCHISE
L.J. 3 (1988-1999); ROGER D. BLAIR & FRANCINE LAFONTAINE, THE ECONOMICS OF FRANCHISING 280 (2005);
Joseph Schumacher & Kimberly Toomey, Recovering Lost Future Royalties in a Franchise Termination Case,
20 FRANCHISE L.J. 116 (2000-2001). 12 See, e.g., CAL. BUS. & PROF. CODE § 20010 (Deering 2010); CONN. GEN. STAT. ANN. § 42-133f(f) (2010);
DEL. CODE ANN. tit. 6, § 2552(e) (2010); HAW. REV. STAT. ANN. § 482E-6 (LexisNexis 2010); IOWA CODE §
537A.10(4) (2012); 815 ILL. COMP. STAT. ANN. 705/41 (LexisNexis 2010); MINN. STAT. ANN. § 80C.21 (West
2010); WASH. REV. CODE ANN. § 19.100.220(2) (West 2010); WIS. STAT. ANN. § 135.03(3) (West 2010). 13 See, e.g., WIS. STAT. § 135.025(2)(b) (2011); see also Christopher J. Curran, Claims Against a Franchisor
upon an Unreasonable Withholding of Consent to Franchise Transfer, 23 J. CORP. L. 135, 152 (1997); Lagarias
& Boulter, supra note 1, at 141; Dennis D. Palmer, Franchises: Statutory and Common Law Causes of Action in
Missouri Revisited, 62 UMKC L. REV. 471, 491 (1994); Thomas M. Pitegoff, Franchise Relationship Laws: A
Minefield for Franchisors, 45 BUS. LAW. 289, 289 (1989).14 See, e.g., WIS. STAT. § 135.025(2)(b) (2011); see also Geib v. Amoco Oil Co., 29 F.3d 1050, 1056 (6th Cir.
1994); Bitronics Sales Co. v. Microsemiconductor Corp., 610 F. Supp. 550, 556 (D. Minn. 1985); Hartford
Elec. Supply Co. v. Allen-Bradley Co., No. CV 96562061S, 1997 WL 297256, at *3 (Conn. Super. Ct. May 28,
1997), aff’d, 736 A.2d 824 (Conn. 1999); Holiday Inns Franchising, Inc. v. Branstad, 537 N.W.2d 724, 728–29
(Iowa 1995); McDonald’s Corp. v. Markim, Inc., 306 N.W.2d 158, 162 (Neb. 1981); Kubis & Perszyk Assocs.
v. Sun Microsystems, Inc., 680 A.2d 618, 626 (N.J. 1996); David L. Cahn & Jeffrey S. Fabian, Mobility, the
Home, and the Scope and Application of State Franchise Relationship and Termination Laws, 30 FRANCHISE
L.J. 107, 107 (2010); Curran, supra note 13, at 152; Palmer, supra note 13, at 491; Pitegoff, supra note 13, at
289.15 Michael J. Lockerby, Franchise Termination Restrictions: A Guide for Practitioners and Policy Makers , 30
ANTITRUST BULL. 791, 833 (1986); Munno v. Amoco Oil Co., 488 F. Supp. 1114, 1118 (D. Conn. 1980); 6
rates directly, or achieving a similar result by forcing the franchisee to purchase additional items
from the franchisor (rather than obtaining them from other sources) at higher prices or better
terms (for the franchisor). In other cases, franchisors might use their at-will termination power to
encroach upon the franchisee’s previously-agreed exclusive territory, raise participation rates in
national advertising and marketing campaigns, and more.
Franchisor opportunism might also include more final measures, such as actually terminating the
contract in order to transfer the franchise to another franchisee paying higher fees or to their own
network of franchisor-owned locations.16 Such opportunistic termination is more likely when the
franchisee in question was actually successful in running the business and building a substantial
customer base, as these are seen as transferable assets and the resultant profit looms larger than
the previously agreed upon fees and royalty rates.
The vast majority of good cause statutes were adopted in the 1970s, concurrently with a wave of
public outcry against large businesses exploiting the small and the need for the latter’s legal
protection.17 Still, to this day most states have no GCSs on the books. Since 1992, 30 states have
considered enacting franchisee protection laws, including GCSs.18 In each case, the proposed
laws did not pass.19 At the federal level, several GCSs have also been rejected.20 For example, in
Byers, supra note 1, at 621.16 BLAIR & LAFONTAINE, supra note 11, at 271; Nicastro, supra note 1, at 801; Mark Pruitt, Disclosure and Good
Cause Legislation: ‘‘Where’s the Beef’’ in Franchise Regulation?, 90 COM. L.J. 563, 565 (1985); Lockerby,
supra note 15, at 834; Byers, supra note 1, at 621; Hess, supra note 1, at 334. See, e.g., Neptune T.V. & App. v.
Litton Microwave, Etc., 190 NJ. Super. 153, 163-64,462 A.2d 595, 601 (NJ. Super. A.D. 1983).17 Thomas M. Pitegoff & W. Michael Garner, Franchise Relationship Laws, in FUNDAMENTALS OF FRANCHISING
183, 185 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008)18 James A. Brickley, Royalty Rates and Upfront Fees in Share Contracts: Evidence from Franchising, 18 J.L.
ECON. & ORG. 511, 519 (2002).19 Id.20 See, e.g., Ernest A. Braun, Policy Issues of Franchising, 14 SW. U. L. REV. 155, 203–04 (1984); Robert W.
Emerson, Franchise Terminations: Legal Rights and Practical Effects When Franchisees Claim the Franchisor
Discriminates, 35 AM. BUS. L.J. 559, 562–63 (1998); Horwitz & Volpi, supra note 1, at 218.7
1998 and 1999, the federal government declined to enact several bills that would have made it
unlawful for a franchisor to terminate a franchise agreement prior to its expiration without good
cause.21 To date, no general federal law on franchise termination has been enacted.
III. THE CLASSIC ECONOMIC ANALYSIS
Given the centrality of law and economics in legal scholarship, it is not surprising that legal
economists play a dominant role in the debate about the desirability of GCSs. The classic law
and economics analysis of GCSs views them as impediments to contractual termination, where
such termination is an indispensable mechanism for controlling free-riding franchisees.22 In the
following sub-sections we detail the reasons franchisees might find it in their interest to shirk
their duties and free-ride on the reputation of the chain to which they belong, and why ‘at will’
contracting is considered as an essential control mechanism against free-riding. In section IV we
then show how online review sites provide an alternative mechanism, supplanting ‘at will’
contracting and providing new support for GCSs.
A. The Free-Riding Problem
For every individual franchisee, her investment in quality benefits the franchise chain as a whole.
Expenses necessary to attain customer satisfaction are thus fully borne by the individual
franchisee, while the benefits of repeat purchase and brand recognition are dispersed among all
franchises on the network. This leads to an obvious incentive to free-ride on other franchisees’
efforts, and skimp on local investment in quality.23 As a result, the level of quality produced by
21 Small Business Franchise Act of 1999, H.R. 3308, 106th Cong. (1999); Small Business Franchise Act of 1998,
H.R. 4841, 105th Cong. (1998). 22 For a detailed analysis see infra Part III.B. 23 For the literature on franchisee free-riding, see, e.g., Benjamin Klein, The Economics of Franchise Contracts, 2
J. CORP. FIN. 9, 12 (“Each franchisee can reduce its costs by reducing the quality of the product it supplies”);
Roland E. Kidwell et al., Antecedents and Effects of Free Riding in the Franchisor-Franchisee Relationship, J. 8
each individual franchisee is expected to be lower than that they would all agree to, if a binding
commitment could be enforced.24 Common claims are that franchisees conserve funds by
neglecting the appearance of their employees, skimping on workplace cleanliness, and
overcharging customers.25 Simply put, the individual franchisee incentive is to
"cheat" customers by providing them with low-quality products or services, at the same price
charged by other franchisees in the chain, who maintain a higher level of quality.26 Free riding is
thus expected wherever mechanisms to control it are missing, or too weak to counter the
monetary incentive created by the accompanying reduction of costs.
BUS. VENTURING 522, 525 (2007) (”A franchisee engaged in a contractual relationship with a franchisor might
seek to lower his or her own costs by failing to participate in activities that would be collectively profitable for
the overall franchise network”); Janet E. L. Bercovitz, The Organizational Choice Decision in Business Format
Franchising: An Empirical Test, in ECONOMICS AND MANAGEMENT OF FRANCHISING NETWORKS 38, 44 (J.
Windsperger and G. Hendrikse eds., 2004) (“the outlet manager may free-ride on the system's brand name and
substitute cheaper, lower quality inputs in order to lower their store's operating costs”); Note, A Clarification
and Reformulation of Prevailing Approaches to Product Separability in Franchise Tie-In Sales, 67 MINN. L.
REV. 1165, 1174 (1983) (“Individual franchisees, on the other hand, have an incentive to lower quality, which
decreases the franchisee's costs”); James A. Brickley et al., An Agency Perspective on Franchising, 20 FIN.
MGMT. 27, 29 (1991) (“The cost savings from providing a lower quality product go directly to the given [free-
riding] franchisee”).24 Victor P. Goldberg, The Free Rider Problem, Imperfect Pricing, and the Economics of Retailing Services , 79
NW. U. L. REV. 736, 746 (1984) (“All of the franchisees have a short-run incentive to produce a below-average
product”); James A. Brickley et al., The Economic Effects of Franchise Termination Law, 34 J.L. & ECON. 101,
104 (1991) (“Individual franchisees have an incentive to…produce a below-standard-quality product”);
Benjamin Klein, Transaction Cost Determinants of “Unfair” Contractual Arrangements, 70 AM. ECON. REV.
356, 358 (1980) (“there is an incentive for an individual opportunistic franchisee to cheat the franchisor by
supplying a lower quality of product than contracted for”); Byers, supra note 1, at 620-621 (“Free riding occurs
when the franchisee reduces its costs by offering products and services below franchise quality standards”).25 Kidwell, supra note 23, at 525 (“Examples [of franchisee free riding] include failure to follow company
procedures in terms of quality or service, overcharging customers, or lack of effort regarding appearance of
employees or the workplace”).26 Alan J. Meese, Franchise Tying Contracts, 95 MICH. L. REV. 111, 118 (1996) (“This free riding will consist of
attempts to “cheat” customers, by providing them with products inferior to those ordinarily associated with the
trademark, presumably at the same price charged by those fellow franchisees who maintain a higher level of
quality”).9
A classic truism oft-repeated in the law and economics literature, is that firms provide
differential levels of service to different customers, based on their probability of repeat
purchase.27 Where facing repeat players, sellers maximize long-term returns, investing in current
quality and customer satisfaction in order to attract future business.28 Where one-shot customers
are prevalent, sellers maximize current returns by skimping on quality or service, with common
examples being “tourist traps” and the like.29 In the case of franchise chains, the relationship is
similar. Where franchises serve mostly local repeat customers the risk of franchisee free-riding is
relatively low, since one expects reputation to travel by word-of-mouth and most customers to be
repeat, rather than one-shot players.30 In contrast, where non-repeat customers, such as hotel
27 See generally, JEAN TIROLE, THE THEORY OF INDUSTRIAL ORGANIZATION (1988), chapter 3; For specific
applications, see generally, William J. Baumöl & Daniel G. Swanson, The New Economy and Ubiquitous
Competitive Price Discrimination: Identifying Defensible Criteria of Market Power , 70 ANTITRUST L.J. 661
(2003); Jacques Crémer, On the Economics of Repeat Buying, RAND J. ECON. 396 (1984).28 See generally, Pinelopi Koujianou Goldberg, Dealer Price Discrimination in New Car Purchases: Evidence
from the Consumer Expenditure Survey, 104 J. POLIT. ECON. 622 (1996).29 See generally, JONATHAN D. CULLER, FRAMING THE SIGN (1988); DENNIS W. CARLTON & JEFFREY M.
PERLOFF, THE ECONOMICS OF INFORMATION (1989), chapter 3.30 Benjamin Klein & Lester F. Saft, The Law and Economics of Franchise Tying Contracts, 28 J.L. & ECON. 345,
348 (1985) (“the creation of “neighborhood stores” increased the repeat purchase probability and hence reduced
the incentive of individual franchisees to free ride on the group”); Kidwell et al., supra note 23, at 531(“repeated
business established a relationship between customer and operator that potentially lowers the likelihood of free
riding; it would be rational to decrease free riding on a brand name when there is a greater chance that
customers would offer repeat business”); Lorelle Frazer & Donald J. Stokes, Franchising Operational Units in
Australia, 2 FRANCHISING RESEARCH: AN INTERNATIONAL JOURNAL 32, 34 (1997) (“The propensity for free-
riding to occur is lower where repeat customers form a large part of an outlet’s sales”); Robert Dahlstrom &
Arne Nygaard, A Preliminary Investigation of Franchised Oil Distribution in Norway , 70 J. RETAILING 179,
184 (1994) (“In repeat selling situations the owner of a specific outlet is interested in maintaining high
quality”); Larry E. Ribstein, Choosing Law by Contract, 18 J. CORP. L. 245, 275 (1993) (“Operators who rely
on local repeat business are less able to free ride off the franchiser’s brand name”); Rajiv P. Dant & Nada I.
Nasr, Control Techniques and Upward Flow of Information in Franchising in Distant Markets:
Conceptualization and Preliminary Evidence, 13 J. BUS. VENTURING 3, 12 (1998) (“In repeat purchase
industries, there are fewer opportunities for reputational abuse and a lesser incidence of the free rider problem 10
travelers, are served, the risk of franchisee free-riding is relatively high.31 This is because most
unsatisfied customers are anyway unlikely to return to the same location with similar needs in
the foreseeable future, and therefore no significant harm has occurred from the perspective of the
free-riding franchisee.32 The risk of losing customers in these situations is borne by the entirety of
the franchise chain, affecting the free-riding franchise only marginally.33
B. Constraining Free-Riding by Threat of Termination
‘At will’ termination – allowing a swift termination of a free-riding franchisee’s contract – is
generally thought to be the premier (if not only) method of controlling franchisees’ incentive to
free-ride. As the late Professor Larry Ribstein proffered: “Termination at will can be an
important right for franchisers, since it may be the only way they can effectively monitor their
franchisees to prevent franchisees from free-riding on and decreasing the value of the
by the franchisees”); Bruce H. Kobayashi & Larry E. Ribstein, Contract and Jurisdictional Freedom, in THE
FALL AND RISE OF FREEDOM OF CONTRACT 325, 340 (F. H. Buckley ed., 1999) (“Operators who rely on local
repeat business are less able to free ride off the franchisor’s brand name”).31 Klein, supra note 24, at 359, n. 2; Brickley et al., supra note 24, at 104 (“[T]he incentives to shirk on quality are
highest in units where the level of repeat customer is low”); See also Robert W. Emerson, Franchise Contract
Clauses and the Franchisor’s Duty of Care Toward its Franchisees, 72 N.C.L. REV. 905, 951, n.224 (“Free-
riding is potentially most severe at locations [..] where the probability of repeat sales to that same customer is
quite low”); Hess, supra note 1, at 343 n. 74 (“A franchisee at a location with low probability of repeat sales to
the same customer has the greatest incentive to free ride”); Brickley et al., supra note 23, at 29 (“The incentives
to free ride are particularly high at units where the level of repeat customers is low”); Mick Carney & Eric
Gedajlovic, Vertical Integration in Franchise Systems: Agency Theory and Resource Explanations, 12
STRATEGIC MGMT. J. 607, 610 (1991) (“The danger of free riding is greatest where repeat customers constitute
a small proportion of the unit sales”); Section Members from the ABA Section of Antitrust, A NTITRUST LAW
AND ECONOMICS OF PRODUCT DISTRIBUTION 16 (2006) (“Free-riding is a particular problem when a franchisee
serves mainly nonrepeat customers”).32 You-Ta Chuang & Joel C. Baum, It’s All in the Name: Failure-Induced Learning by Multiunit Chains, 48
ADMIN. SCI. QUART. 33, 36 (2003) (“Because travelers are unlikely to return to the same hotel repeatedly and
are unable to gauge its service quality without prior experience, hotels have no inventive to provide good
service in order to attract future business”).33 Frazer & Stokes, supra note 30, at 34.
11
franchiser’s brand name.” (emphasis added).34 Similarly, Professor Erin Ann O'Hara states: "The
only way to ensure that [the franchisee] complies with her obligations is to enable the franchisor
to threaten immediate termination" (emphasis added).35 In this, scholars are mirroring what
franchisors themselves say when arguing for their right to terminate contracts at will as a control
mechanism.36
The conventional argument that at-will termination is an indispensable control mechanism
against franchisee free riding is based on the assumption that when a franchisor has the ability to
terminate a contract at will, the franchisee will know that detection of free riding results in swift
termination and loss of lucrative business opportunities within the chain.37 Any franchisee lured
34 Ribstein, supra note 30, at 248. 35 Erin Ann O’Hara, Economics, Public Choice, and the Potential Conflict of Laws, 90 GEO. L.J. 941, 945
(2002); See also Paul H. Rubin, The Theory of the Firm and the Structure of the Franchise Contract, 21 J.L. &
ECON. 223, 228 (1978) (“The franchisor wants to eliminate any operations not maintaining the quality of the
franchise. Contracts calling for easy termination of franchises make it possible to avoid the period of quality
deterioration”); Martin E. Loeber, A DTPA Cause of Action for the Terminated or Nonrenewed Franchisee: A
Jack in the Box for the Unfair Franchisor, 43 BAYLOR L. REV. 809 (1991) (“…[E]conomists argue that broad
termination clauses are necessary for the franchisors to protect the franchise from the inherent tendency of
franchisees to undermine the value of the trademark”). 36 David A. Eisenberg, Balancing a Relationship – ’’Good Cause’’ Termination of Franchise Agreements in
Michigan, 72 U. DET. MERCY L. REV. 369, 372 (1995) (“Franchisors argue that the threat of arbitrary
termination is the only means by which they can protect themselves from franchisees engaging in potentially
opprobrious behavior”); Hess, supra note 1, at 343 (“Franchisors claim a need for an unrestricted termination
power to protect the value of their trademark and to insure a uniform standard of quality among all franchises”); 37 J. Howard Beals III & Timothy J. Muris, The Foundations of Franchise Regulation: Issues and Evidence, 2 J.
CORP. FIN. 157, 160 (1995) (“The existence of the clause that has caused so much trouble and given rise to so
much sympathy for franchisees - the franchisor's right to terminate 'at will' – becomes understandable. When
such clauses are enforced, the franchisee would know that detection results in swift termination. The clause is
thus a lower-cost method than litigation of reducing the franchisee incentive to cheat”); Brickley et al., supra
note 24, at 104 (The franchisees’s incentive to free ride “will be lower if franchisees who are caught cheating
are punished by contract termination and thus lose any remaining quasi rents on firm-specific investments”);
Byers, supra note 1, at 657 (“The franchisor's termination power is therefore essential--as both a threat to
encourage franchisee compliance and a means to actually purge noncomplying franchisees from the system--to 12
by the quick profits of skimping on investment in quality would be forewarned that if the
franchisor deems performance sub-par, swift termination would result, with the accompanying
economic loss borne by the offending franchisee. Beyond loss of future business stemming from
the brand name, franchisees would then lose all relationship-specific investments sunk into the
site and adaptation to chain procedures. These could be substantial, and impossible to use outside
of the specific franchise chain, including physical fixtures such as floor plans, signs, light
fixtures, floor coverings, and the like – but also process-related, such as business methods,
employee training, expertise in specific types of food preparation, and more. Beyond the
obvious, one should take into account the lost franchise and legal fees paid at the outset of the
relationship, loss of inventory, supplies and contracts committed to but deemed irrelevant, and
more. Such sunk costs could easily run into hundreds of thousands of dollars, and are
irredeemably lost for the franchisee once his contract is terminated, thus creating a considerable
threat-point for franchisors able to commit to terminating an offending franchise.38
In contrast, under a ‘good cause’ regime courts (or arbitrators) must determine what constitutes
‘good cause’ based on the facts as proven before them. Franchisors, in order to prove ‘good
cause’, must rely on verifiable information, which is often lacking. For example, the franchisor
can be certain that cleanliness is not fully maintained in the franchised unit, yet still find it
prohibitively costly to prove this in third-party proceedings. Franchisees are thus able to reduce
costs by shirking their duties while relying on protection from courts and arbitrators if the
franchisor attempts to terminate his contract with them. The difficulties in disentangling a ‘good
cause’ contract are attested to in oft-repeated claims by frustrated franchisors: “you need a dead
rat in the kitchen, and preferably three or four, if you want a chance of winning”.39 Examining
actual franchise litigation might mislead the casual observer, as it mostly revolves around
royalties rather than operational details, but this attests not to where the central problem of
ensure that goods and services of requisite quality are supplied to consumers.”).38 On franchisee’s sunk costs see generally, Uri Benoliel, Rethinking the U.S. Supreme Court’s Abandonment
Requirement in Mac’s Shell Service Inc. v. Shell Oil Products, 43 RUTGERS L.J. 77, 83–86 (2011). 39 See, JEFFREY L. BRADACH, FRANCHISE ORGANIZATIONS 35 (1998), quoting Ken Williams, COO of Jack in
the Box.13
franchising lies, but to what courts are best at determining. As Adam Badawi shows, franchises
are governed by a combination of formal and informal mechanisms, where reliance on contract
enforcement to facilitate investment in quality by franchisees is difficult at best.40 Using courts to
enforce quality-control is problematic due to unverifiable information, thus ‘at will’ contract
termination is an effective threat looming over franchisees’ heads.
In short, the classic law and economics analysis claims GCSs disrupt the irreplaceable at-will
control mechanism against franchisee free riding. 41 These statutes require increased payments to
the franchisee in the case of termination unless “good cause” can be proved in court, which is
costly.42 GCSs are thought to harm not only the franchisor unable to terminate contractual
relations with an offending franchisee, but also the other franchisees in the network whom he is
unable to protect from rampant free riding. Ultimately, according to this view, GCSs forbid the
main contractual mechanism which protects the network as a whole from a multi-participant
Prisoner’s Dilemma, as each franchisee sees free riding as bestowing immediate and internalized
benefits while creating delayed and externalized harms. Ex ante, the argument goes, all
franchisees would choose ‘at will’ contracting in order to ensure competent management of
brand reputation and quick removal of offending parties from the network.
40 Adam B. Badawi, Relational Governance and Contract Damages: Evidence from Franchising, 7 J.
EMPIRICAL L. STUD. 743, 746 (2010)41 Cf. Klein, supra note 23, at 30 (GCSs “entail the associated cost of making the self-enforcement
mechanism more difficult to use”); Jonathan Klick et al., Federalism, Variation, and State Regulation of
Franchise Termination ,3 ENTREPRENEURIAL BUS. L.J. 355, 364 (2008) (GCSs “may be costly for franchisors
because state regulation of termination […] of franchisee limit a franchisor’s primary means of deterring
shirking or free-riding on the franchisor’s trademark by franchisees”); Ribstein, supra note 30, at 275
(“Consider the example of a statute that limits termination-at-will of franchisees…Limitations on termination
reduce the franchiser’s ability to discipline shirking or free-riding franchisees”); Byers, supra note 1, at 657
(“Good cause limitations on termination are the primary manner in which lawmakers have attempted to protect
the franchisee's nonrecoverable investment. However, such laws can hinder the franchisor's ability to effectively
police its franchise system”); Pruitt, supra note 16, at 569 (“By disrupting the essential control component of
franchise contracts, relationship statutes [namely, GCSs] undermine the very benefits to be achieved through the
franchising method of distribution”). 42 Brickley et al., supra note 24, at 104.
14
IV. THE MISSING CONTROL MECHANISM: REVIEW SITES
A. Review Sites: A General Description
The classic economic analysis of GCSs should be revisited to take into account the Internet
Revolution. The Internet potentially offers various electronic word of mouth (eWOM)
mechanisms that can overcome the problems associated with the prevalence of non-repeat
customers, essentially transforming almost every industry into one where each consumer matters
– due to their ability to effectively communicate dissatisfaction. The types of electronic
communication that have become commonplace and seem to be ever-present in modern society
have the potential to solve free-riding in franchise operations (among other things) in a way not
contemplated by the classic debate between ‘at will’ and ‘good cause’ proponents. Consider the
most common types of eWOM mechanisms: email, instant messaging, homepages, blogs, online
communities, discussion forms, boycott web sites, news groups, chat rooms, and social
networking sites.43 All are characterized by the one missing link in effective consumer-initiated
discipline of substandard business offerings – the wholesale dissemination of negative feedback
to the business’ potential customers. In this article we focus on one specific such mechanism,
most suited to the realm of franchise operations: online review sites.44
43 Hennig-Thurau et al., Electronic Word-of-Mouth Via Consumer-Opinion Platforms: What Motivates
Consumers to Articulate Themeselves on the Internet, 18 J. INTERACTIVE MKTG. 38, 39 (2004); Kyung Hyan
Yoo & Ulrike Gretzel, What Motivates Consumers to Write Online Travel Reviews, 10 INFORMATION
TECHNOLOGY & TOURISM 283, 285 (2008); Thorsten Hennig-Thurau & Gianfranco Walsh, Electronic Word-of-
Mouth: Motives for and Consequences of Reading Customer Articulations on the Internet , 8 INTERNATIONAL
JOURNAL OF ELECTRONIC COMMERCE 51, 52 (2003); Ronald E. Goldsmith & David Horowitz, Measuring
Motivations for Online Opinion Seeking, 6 JOURNAL OF INTERACTIVE ADVERTISING 3, 3 (2006).44 Review sites, also known as Web-based consumer-opinion platforms, are the most widely used eWOM
platform, by consumers who consider buying a product or service. Hennig-Thurau et al., supra note 43, at 39-
40. 15
A review site is defined as a website which allows customers to post reviews about products or
services provided by a business, including by franchisees.45 Review sites often offer customers
the opportunity to post open-ended customer-authored comments, along with numerical (or
‘star’) ratings, usually ranging from 1 to 5.46 A very low rating (usually one star) indicates an
extremely negative view, and a very high rating (normally five stars) reflects an extremely
positive view of the franchisee. The move from using the Internet to access content to using it as
a communication device, essentially allowing all users to add and distribute content of their own
is often referred to as “Web 2.0”, which has become the premier method of mass-produced
communication available today.47 The result is a collaborative community, where individual self-
expression is fostered together with a ‘wisdom of the crowds’ which transforms businesses and
societies alike.
Focusing, as a case study, on the hotel industry, this article argues that review sites may serve as
an effective control mechanism against franchisee free-riding thereby serving as a substitute for
at-will termination. More specifically, in the following parts of this paper, we will argue that
there are four cumulative and interrelated conditions necessary for review sites to serve as an
effective control mechanism against franchisee free-riding - all being met in this case. First, that
customers be sufficiently motivated to write reviews. Second, that review sites facilitate the
cognitive process of analyzing the extensive number of reviews on franchisees, thereby reducing
information overload. Third, that review sites be sufficiently trustworthy. Ultimately, that review
45 Akshi Kumar & Teeja Mary Sebastian, Sentiment Analysis: A Perspective on its Past, Present and Future, 10
I.J. INTELLIGENT SYSTEMS AND APPLICATIONS 1, (2012); Parmar Mitixa & Arpit Rana, A Survey on Opinion
and Sentiment Analysis With Applications and Issues, 2 INTERNATIONAL JOURNAL OF COMPUTATIONAL
LINGUISTICS AND NATURAL LANGUAGE PROCESSING 237, 238 (2013); Vrushali Yogesh Karkare & Sunil R.
Gupta, A Survey on Product Evaluation using Opinion Mining, 6 INTERNATIONAL JOURNAL OF COMPUTER
SCIENCE AND APPLICATIONS 306, 307 (2013); M. Saravanakumar & T.SuganthaLakshmi, Social Media
Marketing, 9 LIFE SCIENCE JOURNAL 4444, 4448 (2012).46 Hennig-Thurau & Walsh, supra note 43, at 52.47 Karkare & Gupta, supra note 45, at 307; Saravanakumar & SuganthaLakshmi, supra note 45, at 4448; Kaplan
& Andreas M. Kaplan & Michael Haenlein, Users of the world, unite! The challenges and opportunities of
Social Media, 53 BUS. HORIZONS 59, 61 (2010).16
sites influence customers in their purchasing decisions, rendering these sites effective
disciplinary mechanisms against franchisee free-riding.
B. Customers’ Motivation to Write Reviews
For review sites to serve as an effective control mechanism against franchisee free-riding a
preliminary condition must be fulfilled: customers must be sufficiently motivated to inform
review sites of franchisees’ performance. Given that customers are not financially remunerated
for writing reviews on review sites, it is not obvious that they do so. We argue, however, that
although customers are not financially rewarded, they are sufficiently motivated to contribute
data on franchisees’ performance.. First, we explain why customers are motivated to write
reviews on franchisees. Second, we provide some empirical data showing that such reviews are
commonplace and sufficient to inform potential customers of specific quality attributes of a
franchisee-operated venue.
Customers have four central motivations to write to reviews on franchisees:48 (1) helping other
customers; (2) venting frustration caused by a bad experience with a franchisee; (3) rewarding
franchisees for good customer service; (4) enjoying sharing travel experiences.
48 For literature on the motivation of customers to write online reviews see e.g., Hennig-Thurau et al., supra note
43; Yoo & Gretzel, supra note 43; Beverley A. Sparks & Victoria Browning, Complaining in Cyberspace: The
Motives and Form of Hotel Guests’ Complaints Online, 19 J. HOSPITALITY MKTG. AND MGMT. 797 (2010);
Huang et al., Exploring Motivations of Travel Knowledge Shgaring on Social Network Sites: An Empirical
Investigation of U.S. College Students, 19 J. HOSPITALITY MKTG. AND MGMT. 717 (2010); EunHa Jeong &
SooCheong (Shawn) Jang, Restaurant Experiences Triggering Positive Electronic Word-of-Mouth (eWom)
Motivations, 30 INT’L J. OF HOSPITALITY MGMT. 356 (2011); Christy M.K. Cheung & Matthew K.O. Lee, What
Drives Consumers to Spread Electronic Word of Mouth in Online Consumer-Opinion Platforms , 53 DECISION
SUPPORT SYSTEMS 218 (2012); Fred Bronner & Robert de Hoog, Vacationers and eWOM: Who Posts, and
Why, Where, and What?, 50 J. TRAVEL RES. 15 (2011). 17
Online reviews about a franchisee are often written by customers because of the subjective utility
that they derive from helping peer customers.49 Customers often obtain intrinsic satisfaction from
helping others through sharing their experience.50 Helping other customers is achieved by online
reviews in two central forms. First, customers share their positive experiences and help others
attain similar satisfaction.51 For example, an online review about a Super 8 franchisee states:
"Overall, if you're looking for an affordable hotel that is close to Disneyland, give this one a
try".52 Likewise, another review on a different Super 8 franchisee states: “If you want just the
basics for a reasonable price, than you should stay here” [sic].53 Second, customers may share
negative experiences they had, thus warning other customers against the free-riding franchisee
and saving them from similar disappointment.54 To illustrate, a detailed online review regarding a
Ramada Limited Hotel franchisee states, among other things: “Don't come here!!!! Even for $5 a
month...I warn you”.55 Similarly, an online review on a Days Inn franchisee states: "walls are
thin and street noise is very high…If you have any type of sleep insomnia this isn't the hotel for
you. I hope this helps".56 Likewise, an online review on a Knights Inn franchisee warns: "Be
Careful Swimming at the Corbin Knights Inn…the hotel pool turned my hair green".57
49 Hennig-Thurau et al., supra note 43, at 42; Yoo & Gretzel, supra note 43, at 287.50 Cheung & Lee, supra note 48, at 221.51 Hennig-Thurau et al., supra note 43, at 42; Jeong & Jang, supra note 48, at 360; Bronner & de Hoog, supra
note 48, at 18. 52 http://www.expedia.ca/Orange-County-Hotels-Super-8-Anaheim-Near-Disneyland.h18921-p8.Hotel-Reviews
(last visited Feb. 12, 2014).53 http://www.expedia.com/Pocatello-Hotels-Super-8-Pocatello-Id.h440203.Hotel-Reviews (last visited Feb. 12,
2014).54 Hennig-Thurau et al., supra note 43, at 42; Yoo & Gretzel, supra note 43, at 287; Sparks & Brwoning, supra
note 48, at 801.55 http://webcache.googleusercontent.com/search?q=cache:CdtMxd0iWdIJ:www.expedia.com/Washington-
Hotels-Ramada-Limited-College-Park.h49756-p34.Hotel-Reviews+&cd=1&hl=iw&ct=clnk&gl=il (last visited
Feb. 12, 2014).56 http://www.expedia.com/Chicago-Hotels-Days-Inn-Chicago.h22993.Hotel-Information (last visited Feb. 12,
2014).57 http://www.expedia.ie/Corbin-Hotels-Corbin-Knights-Inn.h123412-p2.Hotel-Reviews (last visited Feb. 12,
2014).18
Customers have another motivation to write reviews about franchisees: venting frustration.
Customers having negative experiences with commercial providers often feel frustrated and
disappointed.58 For example, one online review describing the customer’s stay in a Ramada
franchised hotel states: "It was frustrating, time consuming, disappointing, and definitely not
worth it".59 Such negative emotions motivate customers to seek ways to lessen their frustration
and disappointment, motivating review-writing as a cathartic process.60 This aspiration often
motivates customers to share their negative personal experiences with others, transforming
online-review sites simultaneously into platforms for personal venting and commercial
information accumulators, serving other customers as well as franchisors eager to protect their
brand. To illustrate, an Expedia review about a Days Inn franchise states: “We have just gotten
back from vacation and I need to vent. We had stayed in 2 different Days Inn [hotels]...Both
hotels did not have our rooms cleaned when we arrived” (emphasis added).61
Positive, as well as negative, experiences are recorded on review sites. Customers are willing
(indeed, sometimes eager) to reward efficient franchisees and give them “something in return”
for their good experience.62 When customers have a satisfying experience with a franchisee, they
derive subjective utility from reciprocating the favor.63 As customers are often geographically
removed from the franchised hotel, they might not be able to give back through frequent
58 Yoo & Gretzel, supra note 43, at 287.59 http://www.expedia.at/Concord-Hotels-Ramada-Antioch.h18548-p6.Hotel-Bewertung (last visited Feb. 12,
2014).60 Yoo & Gretzel, supra note 43, at 287.61 http://www.expedia.com/Trenton-Hotels-Days-Inn-Mcguire-Dix.h423044-p11.Hotel-Reviews (last visited Feb.
12, 2014). 62 Hennig-Thurau et al., supra note 43, at 42; Jeong & Jang, supra note 48, at 360. For a general discussion of
altruism and the human need for reciprocity, see Ernst Fehr & Urs Fischbacher, The Nature of Human Atlruism,
425 NATURE 785 (2003). For discussion of economic applications, see Ernst Fehr & Klaus M. Schmidt, The
Economics of Fairness, Reciprocity and Altruism – Experimental Evidence and New Theories , 1 HANDBOOK OF
THE ECONOMICS OF GIVING, ALTRUISM AND RECIPROCITY 615 (2006).63 Yoo & Gretzel, supra note 43, at 287.
19
patronage.64 Therefore, they may reciprocate by writing a positive review about the efficient
franchisee. To illustrate, an online review regarding a Baymont Inn and Suites franchisee states:
“The staff was fantastic. They deserve praise for all their efforts”.65 Similarly, a review about a
Microtel Inn & Suites franchisee states: “The staff was very friendly and helpful. They deserve a
5 star rating from us”.66 Likewise, an online review about a Days Inn franchisee states: "I was
impressed with the hotel and its staff. Thank you very much and I will be recommending you in
the future".67
Finally, customers write on online review sites not only to help other customers, vent their
frustration, and reward efficient franchisees, but also for their own enjoyment purposes. Many
customers enjoy sharing their travel experiences with others.68 Post-trip sharing of information is
often considered one of the intrinsic joys of travel, allowing for recreation of positive
experiences.69 Review sites provide a platform to share travel experiences.
Indeed, empirical data we gathered shows that customers’ various motivations generate a
considerable number of reviews per business. To illustrate, Expedia.com is a review site
encompassing about 4 million reviews, including reviews on hotel and motel franchisees.70
Within Expedia, each hotel is reviewed by a large number of customers, each assessing a
separate stay and cumulatively contributing to a rich dataset regarding distinct hotels and
franchises. For example, Days Inn is a hotel chain consisting of 1,479 franchised hotels that
64 Cf. Yoo & Gretzel, supra note 43, at 287-288.65 http://www.expedia.ca/Tullahoma-Hotels-Baymont-Inn-And-Suites-Tullahoma.h572432-p3.Hotel-Reviews
(last visited Feb. 12, 2014).66 http://www.expedia.ca/South-Bend-Hotels-Microtel-Inn-Suites-By-Wyndham-Elkhart.h2463257-p28.Hotel-
Reviews (last visited Feb. 12, 2014).67 http://www.expedia.com/Chicago-Hotels-Days-Inn-Chicago.h22993.Hotel-Information (last visited Feb. 12,
2014).68 Yoo & Gretzel, supra note 43, at 287.69 Stephen W. Litvin et al., Electronic Word-of-Mouth in Hospitality and Tourism Management, TOURISM MGMT.
458, 459 (2008)70 http://travel.usatoday.com/hotels/post/2011/12/expedia-hotel-guest-reviews-tripadvisor/589698/1.
20
were each reviewed by customers on Expedia. These hotels were reviewed by a total number of
218,623 paying customers, leading to an average of some 150 reviews per hotel. Similarly, for
the Ramada hotel chain, we identified 404 franchised hotels that were reviewed on Expedia by
119,244 paying guests who stayed at the hotels, averaging some 295 reviews per hotel. Likewise,
Super 8 consists of 1,559 franchised hotels that were reviewed by 169,777 customers, averaging
about 110 reviews per hotel.
C. Review Sites as Cognitive Facilitators
The significant number of reviews available online raises concerns regarding the quality of
information processing. When potential customers encounter overly-rich data sources, their
ability to assess them and make informed choices tends to decrease, a problem known as
information overload.71 The generosity of previous customers in sharing their experiences thus
has the potential of harming future customers’ decision-making, as sifting through endless
reviews increases the role of biases, making possible not only mistakes, but also strategic
manipulation of information by interested parties.72 Information overload can thus be a problem
71 Cf. Hennig-Thurau & Walsh, supra note 43, at 52; For a detailed analysis of cognitive overload and cites to the
psychological literature, see generally, Adi Ayal, Harmful Freedom of Choice: Lessons from the Cellular
Market, 74 LAW & CONTEMP. PROBS. 91 (2011); Steven M. Shugan, The Cost of Thinking, 7 J. CONSUMER RES.
100, 108–10 (1980).72 Stephano DellaVigna & Ulrike Malmendier, Contract Design and Self-Control: Theory and Evidence, 119
Q.J. ECON. 353, 393–94 (2004) (examining firm reaction, and exploitation of, consumers biases); Jon Hanson &
Douglas A. Kysar, Taking Behavioralism Seriously: Some Evidence of Market Manipulation, 112 HARV. L.
REV. 1420, 1467–1552 (1999) (examining governmental intervention where such manipulation takes place in
market settings). For arguments to the contrary, that intervention should not protect consumers from their own
biases, see generally, Jeffrey J. Rachlinski, Cognitive Errors, Individual Differences, and Paternalism, 73 U.
CHI. L. REV. 207 (2006); Edward L. Glaeser, Paternalism and Psychology, 73 U. CHI. L. REV. 133 (2006);
Glen Whitman, Against the New Paternalism: Internalities and the Economics of Self-Control, 563 POL’Y
ANALYSIS 1 (2006); Gregory Mitchell, Libertarian Paternalism Is an Oxymoron, 99 NW. U. L. REV. 1245
(2005); Jonathan Klick & Gregory Mitchell, Government Regulation of Irrationality: Moral and Cognitive
Hazards, 90 MINN. L. REV. 1620 (2006).21
for review sites, given that the flow of incoming reviews is constant and potential customers are
cognitively constrained.73 Insofar as such a problem afflicts review sites, this might jeopardize
their role as control mechanisms against franchisee free-riding.
The developers of online review sites are cognizant of the information overflow problem, and
combat it using five central online tools: (1) sorting; (2) filtering; (3) averaging; (4) ranking; and
(5) visual graphs.
First, review sites, in order to facilitate information processing, often allow users to sort reviews
on franchisees by various parameters, including customer rating, date of review, age of the
reviewer, helpfulness of the review as tagged by peer customers, and language of the review.74
Second, in order to assist customers in analyzing reviews, some sites allow customers to filter
reviews based on the type of writer. For example, TripAdvisor.com, Cheaptickets.com and
Priceline.com allow customers to filter reviews by families, couples, solo and business
reviewers.75 Such filtering allows for assessing the content of each review based on the
categories its author belongs to, essentially generating a weighted-average mechanism which
gives more (or less) weight to specific recommendations based on their source. The fact that the
site itself presents the categories and allows for on-line selection of sources based on their
identity is important, given the fact that people rarely are able to discount information based on
73 See Sheena S. Iyengar & Mark R. Lepper, When Choice Is Demotivating: Can One Desire Too Much of a
Good Thing?, 79 J. PERSONALITY & SOC. PSYCHOL. 995, 995–1004 (2000); Rémi Desmeules, The Impact of
Variety on Consumer Happiness: Marketing and the Tyranny of Freedom, 22 ACAD. MKTG. SCI. REV. 1, 1–2
(2002); Jeffrey J. Rachlinski, Gains, Losses, and the Psychology of Litigation, 70 S. CAL. L. REV. 113, 118
(1996) (explaining how a large variety leads to choice in simple alternatives).74 See, for example, Expedia.com, HolidayCheck.com, TripAdvisor.com, Yahoo! Travel, Travelocity, Zoover and
Cheaptickets.com. Relatedly, some review sites, such as HolidayCheck.com, also translate non-English reviews
into English.75 Moreover, several review sites, such as Orbitz.com, provide data on how many results a customer would get if
she applied each filter, which can assist her in choosing filters that will provide an appropriate number of
results.22
(knowingly) inferior sources.76 In a sense, the online tool protects users from their own
deficiencies, similarly to a judge ruling evidence inadmissible and screening irrelevant
information from juries who might be incapable of ignoring such evidence after it was presented
in court.
Third, review sites commonly present average ratings rather than list individual ones, though
customers can also browse individual reviews if they wish. Average ratings allow for quick
assimilation of relevant data, conserving cognitive resources while losing very little of the
information provided.77 Relatedly, some review sites provide comparative data regarding the
average ratings obtained elsewhere.78 Most review sites go beyond average ratings, to detail what
they deem the most meaningful product attributes, facilitating subjective analysis by customers
with distinct preferences. For example, in the hotel industry the most commonplace numerical
ratings include overall satisfaction, room cleanliness, room comfort, service, location, food
quality, value for money, sleep quality and hotel condition.79 Some sites go further, to provide
ratings for detailed sub-categories, deconstructing the “service” category into: reception check-in
& check-out, friendliness and helpfulness, and staff knowledge of foreign languages.80
Fourth, some review sites facilitate customer information analysis by presenting the ranking of
the franchised hotel as compared to other franchised and company-owned units in the same area,
76 See, e.g., Alexander Chernev, Decision Focus and Consumer Choice Among Assortments, 33 J. CONSUMER
RES. 50, 57–58 (2006).77 Susan M. Mudambi & David Schuff, What Makes a Helpful Online Review? A Study of Customer Reviews on
Amazon. com, MIS QUARTERLY 185, 187 (2010)78 For example, Expedia.com and Travelocity.com provide data on the average of ratings in TripAdvisor.79 See, e.g., Booking.com, Hotels.com, Cheapthicket.com, Agoda.com, TripAdvisor, Yahoo! Travel,
HolidayCheck.com, and Priceline.com. 80 See, for example, HolidayCheck.com. For a detailed analysis of the importance of categories (aside from the
information they contain), see Cassie Mogilner et al., The Mere Categorization Effect: How the Presence of
Categories Increases Choosers’ Perceptions of Assortment Variety and Outcome Satisfaction, 35 J. CONSUMER
RES. 202, 207 (2008).23
based on customers’ ratings.81 Relatedly, some review sites provide information as to how costly
the franchised hotel is as compared to other similarly rated hotels.82 For example, according to
the review site Virtualtourist.com, the Days Inn franchised hotel in downtown Indianapolis costs
48% more than other hotels similarly rated.83
Finally, in order to facilitate customer data processing, some review sites provide an easy-to-
understand visual graph detailing its rating distribution for each franchised hotel.84 Graphs allow
for visual representation of count data, facilitating understanding and enhancing memorability
for most customers.85 Graphs also allow for easier conveyance of time-dependent data, such as
showing in one picture the development of ratings overtime, allowing customers to identify
trends in the franchisee's performance level.
D. Trustworthiness of Online Review Sites
For review sites to serve as effective control mechanisms, they must fulfill another condition:
trustworthiness. If free-riding franchisees can write a significant number of fake positive reviews
about themselves, the effectiveness of review sites as control mechanisms is dubious. Similarly,
if rival businesses can write a significant number of fake negative reviews on non-free riding
franchisees, the effectiveness of review sites as a control mechanism is questionable. The risk of
fake reviews should thus be taken seriously. Indeed, the common fear plaguing all online rating
systems is that users will attempt to ‘game the system’ in order to bolster their reputation and
attract potential clients. 81 http://www.tripadvisor.com/PressCenter-i6015-c1-Press_Releases.html (last visited Feb. 12, 2014).82 See, for example, Virtualtourist.com.83 http://www.virtualtourist.com/hotels/North_America/United_States_of_America/Indiana/Indianapolis-
782291/Hotels_and_Accommodations-Indianapolis-Indianapolis_Days_Inn_Downtown-BR-1.html (last visited
Feb. 12, 2014).84 See, for example, Virtualtourist.com. 85 Jill H. Larkin & Herbert A. Simon, Why a Diagram Is (Sometimes) Worth Ten Thousand Words, 11
COGNITIVE SCI. 65 (1987).24
Despite these concerns, close examination of online review sites in the hotel and motel industries
shows that they can be trusted and numerous protections from ‘gaming the system’ are in place.
Numerous review sites, such as Expedia.com, Booking.com, Hotels.com, and Priceline.com,
have inherent protections from manipulation in that random site visitors are not allowed to post
unsolicited hotel reviews.86 Only those who actually booked a hotel through the review site, paid
for it, and had their stay verified, can write a review.87 Consequently, the sheer financial cost of
posting a falsified review by a franchisee on these sites is prohibitive, thus bestowing credibility
on those reviews found online.88 Furthermore, booking a hotel stay through these sites requires
the reviewer to undertake an online credit card transaction. The reviewer thus does not remain
anonymous to the site in question, significantly raising the probability of detection for phony
reviews.89
The existence and popularity of objectively reliable sites (those with inherent protections from
manipulation) facilitates reliability beyond their own (virtual) borders. When such sites offer
easily-available metrics, the incentive of businesses to write fake reviews on other sites is
reduced, as customers are likely to compare ratings, and discount those stemming from less-
86 Cheaptickets.com is a review site with a similar policy, which aims to increase its trustworthiness: although it
allows site visitors to post unsolicited hotel reviews, it allows users to read only those reviews that were written
by guest who have booked the hotel through the website. Similarly, Holidaycheck.com signals reviews that
were written by reviewers who booked with the website or provided proof of booking.87 For information on the Expedia verification process, see Danny King, Expedia Touts ‘Verified’ Reviews,
available at http://www.travelweekly.com/travel-news/online-travel/expedia-touts--verified--hotel-reviews/
((last visited Feb. 12, 2014)). For information on Booking.com verification process, see
http://www.booking.com/reviews.en-us.html?aid=357009;label=gog235jc-index-XX-XX-XX-unspec-il-
com;sid=d8a18301c80d4baf45b6a3dd3702beb6;dcid=1 (last visited Feb. 12, 2014); For information on
Hotels.com verification process see, http://customercare.hotels.com/app/answers/detail/a_id/46 (last visited Feb.
12, 2014).88 The same is not true for all review sites, such as Tripadvisor, where multiple reviews can be posted by the same
(non-paying) individual. Dina Mayzlin et al., Promotional Reviews: An Empirical Investigation of Online
Review Manipulation, available at http://www.nber.org/papers/w18340.pdf (last visited Feb. 12, 2014).89 Mayzlin et al., supra note 89, at *2.
25
trustworthy sources. Thus, sites such as Expedia are a likely binding constraint for sites such as
TripAdvisor, since the former allows for detection of (significant) cheating on the latter. Given
that travel-assisting sites depend on their online reputation, site owners and managers are likely
interested in preventing brand deterioration which is likely to accompany any online discussion
of prevalent cheating. Furthermore, given that online discussions of such sites are ongoing, the
possibility of negative comments on non-travel-related social media (such as Facebook) is a
strong incentive for site-owners to control reputation manipulation.
Ultimately, posting fake reviews can prove costly for a business. First, fake reviews may cause
the levying of government fines. For example, the New York State Attorney General has recently
imposed $350,000 in fines against 19 companies for writing fake reviews on sites like Google,
Yelp, Citysearch and Yahoo.90 Second, false reviews may instigate private lawsuits by the
review site itself. To illustrate, Yelp.com, a leading review site on local businesses (mainly
restaurants), recently sued a San Diego law firm for more than $25,000, for allegedly planting
fake reviews from non-existent clients on its Yelp page.91 Third, governmental penalties and
private lawsuits caused by fake reviews are likely to cause associated reputational costs. 92 In the
context of franchising, a local branch seeking to bolster its business might harm not only itself,
but the chain as a whole. Due to such spillover effects, many franchisors contractually constrain
the social media practices of their franchisees, thereby increasing the franchisee’s forging costs
to include the possibility of contract termination and tortuous litigation.93
90 http://www.nytimes.com/2013/09/23/technology/give-yourself-4-stars-online-it-might-cost-you.html?_r=0 (last
visited Feb. 12, 2014); Besides using their own employees to write and post the reviews, the companies hired
freelance writers from as far away as the Philippines, Bangladesh and Eastern Europe for $1 to $10 per review.
See http://www.ag.ny.gov/press-release/ag-schneiderman-announces-agreement-19-companies-stop-writing-
fake-online-reviews-and (last visited Feb. 12, 2014).91 http://abcnews.go.com/blogs/business/2013/09/yelp-sues-firm-over-allegedly-posting-fake-reviews (last visited
Feb. 12, 2014); Yelp was suing for alleged “breach of contract, intentional interference with contract, unfair
competition, and false advertising”. Id.92 Mayzlin et al., supra note 89, at 14.93 Mayzlin et al., supra note 89, at 15.
26
E. Review Sites Impact Customer Purchasing Decision Making
For review sites to serve as effective control mechanisms against franchisee-free riding they
must impact customer purchasing decision making. Otherwise, they are unlikely to adequately
deter franchisees from free-riding. Given that review sites allow customers to easily process the
extensive number of reviews, and that they are sufficiently trustworthy, it is not surprising that
online reviews indeed impact customer purchasing decisions. Empirical studies systematically
show that online hotel reviews written by travelers influence other travelers’ booking decisions.
For example, Ulrike Gretzel, Kyung Yoo and Melanie Purifoy conducted a survey among 7,000
Tripadvisor.com users in order to examine several factors, including the impact of travel reviews
on travelers’ trip-planning processes.94 According to the survey, 91.8% of respondents avoided
places or services due to the content of online reviews posted by other travelers.95 Similarly, an
experimental study conducted by Aurelio Mauri and Roberta Minazzi tested, inter alia, whether
travelers consult comments of other travelers before booking a hotel.96 The experiment showed
that respondents’ hotel purchasing intentions increased where there was a prevalence of positive
comments, and decreased when observing negative comments. Additionally, one of the many
findings of an experimental study conducted by Beverley Sparks and Victoria Browning shows
the significant impact of positive and negative online reviews on travelers.97 In the same vein, an
empirical study conducted by comScore and the Kelsey Group,98 based on a survey of 2,078
94 Ulrike Gretzel et al., Online Travel Review Study: Role and Impact of Online Travel Reviews *4, available at
http://www.tripadvisor.com/pdfs/OnlineTravelReviewReport.pdf (last visited Feb. 12, 2014).95 Id. at *25. 96 Aurelio G. Mauri & Roberta Minazzi, Web Reviews Influence on Expectations and Purchasing Intentions of
Hotel Potential Customers, 34 INT’L J. OF HOSPITALITY MGMT. 99 (2013).97 Beverley A. Sparks & Victoria Browning, The Impact of Online Reviews on Hotel Booking Intentions and
Perception of Trust, 32 TOURISM MGMT. 1310 (2011).
98 “comScore” is a leading internet technology company that measures what people do as they navigate the digital
world. See http://www.comscore.com/About_comScore (last visited Feb. 12, 2014). The Kelsey Group is a
leading research and strategic analysis firm focused on local media and advertisement. 27
Internet users, revealed that 87% of users reported that hotels’ online reviews bore significant
influence on their booking decisions.99 Furthermore, the survey revealed that consumers are
willing to pay 38% more for hotels receiving an “Excellent” or 5-star rating than for a hotel
receiving a “Good”, or 4-star rating.
Beyond the influence of online reviews on travelers’ booking decisions, empirical studies also
show that online reviews ultimately have significant impact on hotel revenues. For example, an
empirical study conducted by Ye, Law & Chen examined the impact of online travel reviews on
hotels' online sales.100 The data, which consisted of consumer-generated reviews, were retrieved
from www.ctrip.com, a major online travel agency in China. The study shows that online
reviews have a significant impact on the online sales of hotel rooms, with a 10 percent increase
in travel review ratings boosting online booking by more than five percent.101 Similarly, Chris K.
Anderson showed that a one-percent increase in a hotel’s online reputation score, measured by
hotel online reviews, leads to a 0.54 increase in occupancy and an increase of up to 1.42 percent
in hotel revenue for each available room.102 Furthermore, an empirical study conducted by
MICROS eCommerce,103 based on a random sampling of its client base, reveals that hotels that
http://www.comscore.com/Insights/Press_Releases/2007/11/Online_Consumer_Reviews_Impact_Offline_Purch
asing_Behavior (last visited Feb. 12, 2014).99 Online Consumer-Generated Reviews Have Significant Impact on Offline Purchase Behavior, available at
http://www.comscore.com/Insights/Press_Releases/2007/11/Online_Consumer_Reviews_Impact_Offline_Purch
asing_Behavior (last visited Feb. 12, 2014).100 Qiang Ye et al., The Influence of User-generated Content on Traveler Behavior: An Empirical Investigation on
the Effects of E-word-of-mouth to Hotel Online Bookings, 27 COMPUTERS IN HUMAN BEHAVIOR 634 (2011).101 Id. at 638. See also Qiang Ye et al., The Impact of Online User Review on Hotel Room Sales, 28 INT’L J. OF
HOSPITALITY MGMT. 180, 181 (2009)102 Chris K. Anderson, The Impact of Social Media on Lodging Performance, 12(15) CORNELL HOSPITALITY
REPORT, (November 2012).103 MICROS is a leading provider of enterprise technology solutions to the retail and hospitality industries
worldwide. http://www.micros-ecommerce.com/about-us/ (last visited Feb. 12, 2014).28
improved the quantity, quality and frequency of their online reviews on TripAdvisor saw an
increase in their directly-booked room nights.104
Given that online review sites dramatically impact hotel revenues, hotels are directly disciplined
by travelers if they free-ride on franchise reputation and skimp on expenses needed to provide
expected quality. More concretely, a hotel that provides travelers with poor customer service, or
unkempt rooms, will receive negative online reviews by travelers. These reviews are likely to
deter prospective travelers from visiting the free-riding hotel. The free-riding hotel, therefore, is
disciplined by experiencing a decrease in revenue, obviating the need for contractual threats of
termination. Franchisors (and franchisees) in industries where review sites are common and
effective, are thus protected from the threat of free-riding, weakening traditional claims that
GCSs impair chain management.
V. CONCLUSION
According to the classic law and economic analysis, ‘at will’ contracts are an essential control
mechanism against franchisee free-riding and GCSs impede chain management, ultimately
harming most franchisees. While this claim might initially be convincing, the advent of online
review sites created a novel control mechanism limiting wayward franchises and their incentive
to free-ride. Negative reviews thus serve as a substitute for threats of contractual termination,
while avoiding the pitfalls of excessive bargaining power in the hands of potentially
opportunistic franchisors.
Our article calls for a novel mode of analysis: in industries subject to effective customer
interaction via review sites, such as the hotel industry, the risk of free-riding is relatively low. In
such industries, the necessity of an at-will contract as a control mechanism against free-riding is
questionable. Once such mechanisms are in place, franchisors are no longer alone in seeking to
punish franchisees who offer sub-par performance. Past customers have essentially been enlisted
104 MICROS eCommerce, How a Higher TripAdvisor Ranking Can Help Hotels Book More Room Nights,
available at http://blog.microsecommerce.com/index.php/uncategorized/how-a-higher-tripadvisor-ranking-can-
help-hotels-book-more-room-nights/ (last visited: Nov. 10, 2013).29
in the quest for quality control, and future customers get part of their information from review
sites, rather than relying merely on the brand name and accompanying reputation. A potential
traveler deciding where to reside, no longer needs to decide between chains, based on her own
(limited) past experiences, but can now access directly the pertinent information regarding the
specific venue. Generalized knowledge regarding the chain is still relevant as a first
approximation, but modern-era information has become more location-specific, allowing
individual franchises to prove their worth by providing quality service which will be attested to
by satisfied customers.
The revolution in customer assessment of franchisee quality thus transforms the way business is
done, not just by those making purchase decisions, but also by franchise chains enlisting novel
mechanisms to constrain free-riding. In the debate regarding the enactment of GCSs, a once-
powerful argument that ‘at will’ termination is necessary to combat free-riding and give
franchisors an effective threat against wayward franchisees, loses much of its clout. Where
online review sites are prevalent and effective means of customer communication, ‘at will’
termination may no longer be necessary.
While the arguments against GCSs are considerably weakened in industries subject to effective
review sites, the arguments for these statutes are very much in force. Franchisors may very well
use the threat of termination to extort current franchisees by raising their fees or demanding the
purchase of bundled products. They may also terminate franchise contracts in order to re-assign
the location to a higher-paying franchisee or run the local business themselves, as a branch
within the chain. Online review sites thus tilt the balance of claims regarding GCSs in favor of
their enactment, revitalizing the argument and reinvigorating the case for franchisee-protection.
Of course, not all industries are subject to effective review sites, thus the implied support for
GCSs is not universal. One might argue, then, for context-specific GCSs, applying to some
industries but not others. On the other hand, the explosion of consumer-generated content within
online social media might make the arguments made here more widely applicable. Further study
will thus be necessary to shape the contours of the claim against ‘at will’ contracting in the 30
online world, but the classic formulation decrying GCSs as an impediment to effective franchise
operations is obviously inappropriate. Online review sites, prevalent in many large-scale
operations, have changed the nature of the franchising game.
31