LAUSR

Abstract Many franchisors employ regional clustering as an expansion strategy and benefit from it financially in its early stage. However, the positive effect of regional clustering tends to reach its maximum at a certain point, and franchisors may be forced to slow down expansion because of the escalating intra-brand competition within the cluster. What governance mechanisms should firms employ to mitigate the negative effects of regional clustering and reap more financial benefits from it? Building upon agency theory and emerging literature on regional clustering in marketing, we postulate that the density of regional clustering of franchised outlets has an inverted U-shaped impact on franchisor financial performance. To mitigate the negative effects of regional clustering, we hypothesize that franchisors can employ more flexible contracts that allow franchisees to engage in local innovation. In addition, the services provided by the franchisor help enhance the competitiveness of the franchise system and serve as a buffer for the negative effect of regional clustering. The results from an analysis of 84 franchise systems over a 10-year period (2003–2012) have largely supported our hypothesis. Hence, our findings offer actionable managerial insights on how firms may minimize the negative effects of regional clustering by deploying governance mechanisms properly.