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Barriers to Entry and Franchising

Co-blogger Phil Miller has recently written on his own blog,

Increasing the size of a league imposes [negative] externalities on existing team owners. The new team draws some fans away from the existing teams and it draws some national media revenue from incumbents as well. It also increases the demand for playing talent. To limit entry into the league, the league sets up barriers to entry (expansion fees, and league-wide approval votes, for instance) that effectively keep other teams out.

But the barriers to entry serve another purpose: Las Vegas does not have a team in part because it provides leverage to the few teams left (namely Minnesota and Florida) who are still seeking public money for a new stadium in their existing regions.

In addition, James Quirk and Rodney Fort have also written here about the barriers to entry and local monopolies created by the league system in North American professional sports. And Rod Fort has also written about the topic in his Sports Economics text. And it appears that Stefan Szymanski and Andrew Zimbalist are recommending in their new book that world soccer leagues could become more profitable by increasing the barriers to entry into their leagues.

I expect I will be eaten alive by these powerhouses for asking this, but in what ways and to what extent are professional sports leagues different from McDonald's or any other fast-food chain?

Opening another McDonald's outlet might have the same negative externalities Phil describes for existing franchisees; as a result, franchisees are not willing to pay much for franchises unless they have some contractual guarantees, similar to the territorial restrictions in major league sports, that new franchises will not be located near their existing franchises. It is in McDonald's interest as a franchisor and in the interest of existing franchisees to create these barriers to entry, restricting the entry of new franchisees into the franchisor's overall organization (or firm?).

But in what sense can or should these contractual agreements about territories be called barriers to entry? What is the relevant industry from which new franchisees are being restricted? In fast foods there are plenty of close substitutes; similarly in professional sports there are plenty of entertainment alternatives.

Also, and as I recall, this was a major issue in the Raiders-NFL anti-trust suit, what is the firm? If we think of McDonald's as the firm, the firm is merely restricting the number of outlets for its output. Similarly, if MLB limits the number of franchises, all they are doing is limiting the number of outlets for their product.

Finally, fast food franchises also play one city off against another. Readers who live in large cities may not believe franchisors do this, but I live in a small town where such behaviour is readily apparent. The competition between small towns to get a McDonald's or Tim Horton's [coffee and donuts] franchise is very intense, and the franchisors do indeed play the towns off against each other, just the way Phil describes what happens in MLB.

In the end, you may want to call these territorial restrictions "barriers to entry" but I am not convinced (yet) that doing so yields useful analysis. And I see nothing wrong with the local "monopolies" that are created when franchisors include territorial rights in their franchise agreements.