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).

1

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

2

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.

3

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.

4

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.

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