On Re-Using Knowledge: The Consequences of

On Re-Using Knowledge: The Consequences of Adaptation of Franchising Knowledge for Local Network Growth

by Gabriel Szulanski, Robert J. Jensen and Tanya Lee WP 2001-10

A Working Paper of the Reginald H. Jones Center

The Wharton School University of Pennsylvania

ON RE-USING KNOWLEDGE: THE CONSEQUENCES OF ADAPTATION OF FRANCHISING KNOWLEDGE FOR LOCAL NETWORK GROWTH

Gabriel Szulanski Wharton School, University of Pennsylvania Department of Management 2033 SH-DH Philadelphia, PA 19104-6370 Tel: (215) 573-9627 e-mail: [email protected]

Robert J. Jensen Wharton School, University of Pennsylvania Department of Management 2055 SH-DH Philadelphia, PA 19104-6370 Tel: (215) 898-1224 e-mail: [email protected]

Tanya Lee University of Pennsylvania Department of Computer Sciences

November 8, 2001 Preliminary draft for purposes of Jones Center Brown Bag, please do not cite without exp licit agreement from the authors

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ON RE-USING KNOWLEDGE: THE CONSEQUENCES OF ADAPTATION OF FRANCHISING KNOWLEDGE FOR LOCAL NETWORK GROWTH Abstract

The issue of knowledge utilization is a fundamental societal and practical concern that has received considerable attention in many branches of the social sciences. In the field of strategy there is widespread agreement that the ability to leverage, or re-use knowledge assets could be a fundamental source of competitive advantage. Such issue has been especially prominent for the management of the multinational corporation where the possession of idiosyncratic knowledge has long been offered as a key explanatory factor for the existence and success of MNCs. A key issue that arose in that context is to what extent should firms attempt to adapt those resources to fit local conditions. There are cogent arguments and suggestive evidence in both directions. However, much of the debate has thus far examined the issue of standardization versus local adaptation in terms of products and brands leaving a gap where processes and knowledge is concerned. This study intends to partially fill that gap. We explore this issue in the context of a naturally occurring, repeated measures quasi-experiment. The setting is Mail Boxes, Etc. (MBE), the largest non-food franchise organization in the world, with over 4000 outlets in the US and over 700 outside of the US. The experiment unfolded naturally from August 1995 when the MBE franchise network in Israel was established until July 2001. We document the extent to which Israel’s Master Licensee significantly adapts knowledge transferred from MBE headquarters during that period. The specific ‘manipulation’ in the natural experiment is the adaptation of key principles or pieces of knowledge MBE headquarters transfers to Master Licensees. Specifically, we observe three different phases. In the first phase, the Israeli Master Licensee attempts to create a unique approach to building the network that departs in important ways from the proven one recommended by MBE. Lack of growth forces the Master Licensee to revise the approach motivated by the success of the Italian Master Licensee who follows the original system quite closely. Following that approach the Israeli operations become the second fastest growing Master Licensee within MBE, going from 2 to 17 stores in two years. In a third stage, a second attempt to deviate from MBE’s business model to accelerate business unit growth halts network growth once again. While the network was projected to reach 24 stores by July 2001, it actually shrinks to 14 stores. We conclude by drawing implications for the management of knowledge assets across borders. In particular, we argue that the seemingly accepted wisdom that knowledge assets must be adapted before they are deployed in other environments could be too simplistic and perhaps inappropriate when it comes to managing knowledge assets.

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ON RE-USING KNOWLEDGE: THE CONSEQUENCES OF ADAPTATION OF FRANCHISING KNOWLEDGE FOR LOCAL NETWORK GROWTH

Introduction The issue of knowledge utilization has continued to garner significant interest in many of the basic disciplines (Broner, Franczak, Dye, & McAllister, 2001; Demsetz, 1988; Glaser, Abelson, & Garrison, 1983; Hayek, 1945; Nelson & Winter, 1982; Polanyi, 1962; Teece, Pisano, & Shuen, 1990; Zander & Kogut, 1995). Indeed, in the field of Strategy there is widespread agreement that leveraging, or re-using, knowledge assets is a fundamental source of competitive advantage (Argote & Ingram, 2000; Eisenhardt & Martin, 2000; Gupta & Govindarajan, 2000; Teece et al., 1990; Winter, 1995; Zander & Kogut, 1995). This is perhaps even more visible in the arena of the Multinational Corporation (MNC) where the possession of idiosyncratic firm resources, especially knowledge (Buckley & Casson, 1976) has long been predicted as the a key for the success of MNCs (Dunning, 1977; Hymer, 1976; Kogut & Zander, 1993). In this context the One of the key issues in the utilization of firm specific resources across borders is the extent to which the firm should standardize the resource being transferred to international subsidiaries and to what extent the resource should be adapted to fit local conditions (Bartlett & Ghoshal, 1989; Prahalad & Doz, 1987). There are cogent arguments in both directions. However, much of the debate has thus far examined the issue of standardization versus local adaptation in terms of products and brands (Samiee & Roth, 1992; Sorenson & Wiechmann, 1975) leaving a gap where processes and knowledge is concerned. This study intends to partially fill that gap.

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We explore this issue in the context of a naturally occurring, repeated measures quasiexperiment. The setting is Mail Boxes, Etc. (MBE), the largest non- food franchise organization in the world, with over 4000 outlets in the US and over 700 outside of the US. The experiment unfolded naturally from August 1995 when the MBE franchise network in Israel was established until July 2001. We document the extent to which Israel’s Master Licensee makes use of existing templates available elsewhere within MBE during this period. This is the ‘manipulation’ in the natural experiment. We observe how such choices about knowledge re-use impact performance, as captured by the extent of network growth. Specifically, we observe three different phases. In the first phase, the Israeli Master Licensee attempts to create a unique approach to building the network that departs in important ways from the proven one recommended by MBE. Lack of growth forces the Master Licensee to revise the approach to one in which it follows closely the example of the highly successful Italian Master Licensee. Following that approach the Israeli operations become the second fastest growing Master Licensee within MBE, going from 2 to 17 stores in two years. In a third stage, a second attempt to deviate from MBE’s business model to accelerate business unit growth halts network growth once again. While the network was projected to reach 24 stores by July 2001, it actually shrinks to 14 stores. Theory and Hypotheses Importance of Knowledge Utilization in an International Context Knowledge use is a major societal concern. Indeed, many of the major disciplines including Economics (Demsetz, 1988; Hayek, 1945), Sociology (Glaser et al., 1983), Psychology (Broner et al., 2001), Philosophy (Polanyi, 1962), and Management (Nelson & Winter, 1982; Teece et al., 1990; Zander & Kogut, 1995) have considered the issue to be of primary importance. For example, in the field of strategy there is widespread agreement that difficult to 4

replicate knowledge assets are fundame ntal sources of competitive advantage in open economies. The long-term prosperity of firms operating in such environments seems to be increasingly predicated on their ability to identify and mobilize those assets so that the firm can properly exploit them (Argote & Ingram, 2000; Eisenhardt & Martin, 2000; Gupta & Govindarajan, 2000; Teece et al., 1990; Winter, 1995; Zander & Kogut, 1995). This is perhaps even more visible in the arena of the Multinational Corporation (MNC) where technolo gy and corporate know- how are frequently transferred across borders either from the parent firm to subsidiaries, from subsidiaries to the parent, or laterally from subsidiary to subsidiary (Andersson & Forsgren, 2000; Andersson, Forsgren, & Pedersen, 2001). In this context the issue of re- use of knowledge assets takes on even greater meaning. Some scholars even place leveraging knowledge across borders at the center of theories of the MNC (Anand & Kogut, 1997; Kogut & Zander, 1993). Beginning with Hymer (1976) scholars in International Business have characterized the success of MNCs as one of possessing superior idiosyncratic resources or intangible assets, including technology and knowledge, that they le verage by transferring to international subsidiaries. Dunning (1979) includes the “ownership advantage” of idiosyncratic resources as one of the pillars of his eclectic theory of foreign direct investment and Cantwell (1989) extends the concept of the ownership advantage by showing the strong geographic bias of the idiosyncratic resources. Buckley and Casson (1976), in their groundbreaking work, look directly at the role of idiosyncratic assets, especially knowledge, in the growth of MNCs. Other scholars, like Caves (1971) and Teece (1986), have noted that foreign direct investment is driven by firm specific assets and carried out through the leveraging of those assets. The Debate over Standardization Versus Local Adaptation

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One of the key issues in the utilization of firm specific resources across borders is the extent to which the firm should standardize the resource being transferred to international subsidiaries and to what extent the resource should be adapted to fit local conditions (Bartlett & Ghoshal, 1989; Prahalad & Doz, 1987). This debate goes by several names including standardization versus local adaptation (Bartlett & Ghoshal, 1989; Jain, 1989; Lemak & Arunthanes, 1997; Samiee & Roth, 1992; Sorenson & Sorensen, 2001; Szymanski, Bharadwaj, & Varadarajan, 1993), the economic imperative versus the political imperative (Doz, 1980), and globalization versus differentiation (Douglas & Wind, 1987). Standardization consists of re-using firm-specific assets in a single format or a small number of formats across a wide variety of environments. Those who argue for standardization primarily assert that that the nature of competition has changed in many industries due in large part to a change in technology (Prahalad & Doz, 1987; Yip, 1989; Bartlett & Ghoshal, 1989), but also changes in social and economic forces (Yip, 1989), that alter industry dynamics industries and create pressures for cost reduction (Prahalad & Doz, 1987). These changes lead to worldwide economies of scale (Prahalad & Doz, 1987; Bartlett & Ghoshal, 1989; Levitt, 1983) that drive down price (Levitt, 1983) and create conditions for gr eater standardization as part of an oligopolistic reaction (Knickerbocker, 1973). As such, when one competitor begins to standardize its firm-specific assets across its subsidiaries in order to reap economies of scale others have to follow in order to remain competitive (Yip, 1989; Prahalad & Doz, 1987). Bartlett and Ghoshal (1989) call this the need for efficiency. On the other hand, while pressures for standardization may exist there is also general agreement that conditions are different in various localities creating pressure for local adaptation as firms try to maximize their fit with the local environment (Bartlett & Ghoshal, 1989; Lemak

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& Arunthanes, 1997; Nohria & Ghoshal, 1997). These pressures take the form of 1. basic market differences (Douglas & Wind, 1987; Prahalad & Doz, 1987; Kaufmann, & Eroglu, 1998), especially in emerging markets (Ciu & Lui, 2001; Prahalad & Lieberthal, 1998; Yan, 1994), 2. different cultures (Buzzell, 1968; Lemak & Aruthanes, 1997; Adler, 1986; Laurent, 1986; Hannon, Huang, & Jaw, 1995), 3. different consumer preferences and needs (Douglas & Wind, 1987; Lemak & Aruthanes, 1997; Prahalad & Doz, 1987; Bartlett & Ghoshal, 1989; Ciu & Lui, 2001; Kashani, 1989), 4. different distribution channels (Prahalad & Doz, 1987) and marketing infrastructures (Douglas & Wind, 1987), and 5. differences in labor markets (Rosenweig & Nohria, 1993). All of these factors create difficulties for standardized products and strategies. Standardization will tend to result in either over or under standardized assets in any given location (Sangeeta, Timmerman, & Ramarapu, 1999; Douglas & Wind, 1987). While standardization may cut costs (although this is also debated because the increased need for internal coordination may be extremely costly (Bartlett & Ghoshal, 1989)) it will not produce an optimum profit, even with the possibility of a global consumer segment with similar tastes (Ciu & Lui, 2001), and the cost savings may not outweigh the lost profit (Bartlett & Ghoshal, 1989). To produce an optimum profit the assets being leveraged need to be optimally adapted to local preferences and conditions. Bartlett & Ghoshal (1989) call this the need for responsiveness. With mixed empirical results (Kotabe, 1990; Kotabe & Omura, 1989; Zaheer, 1995; Ryans, 1988; Calof & Beamish, 1994; Rosenweig & Nohria, 1993; Robert, Probst, Martachhio, Dasgow, & Lawler, 2000; Szymanski, et al., 1993; Sorenson & Weichmann, 1975; Samiee & Roth, 1992; Walters, 1985; Onkvisit & Shaw, 1987) it has been difficult to determine which approach is most appropriate. Instead the literature seems to have developed a general consensus

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that both standardization and local adaptation are needed (Bartlett & Ghoshal, 1989) and that finding the right balance between the two is the most appropriate strategy (Bartlett & Ghoshal, 1989; Jain, 1989; Kashani, 1989; Yip, 1989). In the end the normative advice is to socialize managers in such a way that they have the right sense of balance and can make an appropriate decision on a case-by-case basis (Doz, 1980; Prahalad & Doz, 1987). Much of the debate, however, has focused on the standardization or adaptation of product and brand specific assets, rather than on complex knowledge assets (Jain, 1989; Samiee & Roth, 1992; Sorenson & Wiechmann, 1975) leaving the question of how re- use affects the transfer of knowledge assets significantly under researched. The few who have specifically addressed the transfer of processes [Griffith, 2000 #1381; Kirkman, 2001 #1393; Morosini, 1998 #1379] tend to echo the conventional wisdom, i.e., that, greater fit with the local environments is worth more than potential loss of efficiencies due to standardization. Anecdotal evidence from a number of firms suggests that the adaptation advice may need to be revised as a normative starting point to manage the utilization of knowledge assets. An alternative heuristic seems to have developed in practice where firms approach re- using by foregoing even the smallest modification, unless it is absolutely necessary. This can be seen in Intel’s “Copy Exactly” philosophy for building semiconductor plants (Iansiti, 1998), Rank Xerox’s policy of forcing country subsid iaries to follow best practice “down to the last detail” until they achieve similar performance (Financial Times, 1997), and Great Harvest’s learning covenant that holds new franchisees to the “tiniest letter” of their promises to follow the original system (Great Harvest, 1999).

These examples suggest that complex knowledge may be different than products and strategies when it comes to the appropriate level of re-use. This study intends to partially fill that

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gap by examining the impact on firm of performance of both a decision to adapt knowledge assets to local conditions and a decision to copy those same knowledge assets exactly. Setting General Setting The general setting for our study is a franchise organization. Franchise organizations are well suited for studying the particular questions raised in the theoretical section in that they compete primarily through growth by transferring knowledge to new geographic locations. They also operate across a market interface and cannot completely control how their franchisees receive and use the knowledge being transferred (Bradach, 1998; Kaufmann & Eroglu, 1998). This allows for variation in the use of knowledge assets as compared to other types of organizatio ns where management may have greater power in enforcing compliance with a particular set of practices. Two of the key aspects of franchising 1 are growing the network (Bradach, 1998; Love, 1986) and managing the franchisor/franchisee relationship (Bradach, 1998; Love, 1986). Many franchise organizations develop significant experience and knowledge dealing with these two issues and their successful networks will be working examples of this knowledge. The first is the capability of growing a network. This refers to the set of routines that integrate a host of specific activities in such a way as to enable timely and well- managed growth. This is vital for a franchise organization, including a local organization belonging to a Master or Area 1

Bradach Bradach, J. L. 1998. Franchise Organizations. Boston: Harvard Business

School Press. lists a few other key aspects including site selection, the ability to adapt the entire system, and, the subject of this paper, standardization versus local adaptation.

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Licensee/Franchisee (an individual who has bought the rights to build a franchise network in his/her area), because franchise organizations earn the bulk of their profits from the sale of new franchise units and from royalty payments (Bradach, 1998). Bradach (1998) identifies growth as the most important issue for young franchise networks. Another key area of expertise and knowledge in franchising is managing the franchisor/franchisee relationship (Bradach, 1998). Where many organizations internalize the production and sales of their products, franchise organizations operate across a market interface (Brickley & Dark, 1987; Norton, 1988; Rubin, 1978). In traditional organizations many decisions can be made unilaterally and conflict can be settled via fiat (Williamson, 1975). Franchisees, however, typically see themselves as independent businesspeople (Bradach, 1997) and while franchise contracts are typically very strict in demanding compliance with franchisor standards, franchisors find breaches of contract, except for nonpayment of royalties or heinous departures from the standards, to be nearly unenforceable in the courts (Bradach, 1998). This results in a situation where the franchisor cannot settle things by fiat and usually must negotiate with franchisees in order to secure compliance (Bradach, 1998). At the same time, however, the nature of the bus iness requires fairly close contact and coordination. The franchisor must operate on a relational basis and use persuasion in order to secure cooperation (Kaufmann & Eroglu, 1998). Attempts to control a franchise network as if franchisees were employees typically has negative consequences for the franchisor/franchisee relationship that result in decreased cooperation between franchisor and franchisee, creating difficulties in managing the network as a whole (Bradach, 1998). The networks of successful franchisors will be working examples of the knowledge developed concerning managing the franchisor/franchisee relationship.

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Specific Setting: Mail Boxes Etc. in Israel The specific setting of our study is the Mail Boxes Etc. (MBE) Franchise system in Israel. MBE in the United States was first launched in 1980 in San Diego, California to fill a need for postal services. MBE specializes in primarily in services for individuals and home and small offices including photocopying, color copying, packing and shipping, parcel and express courier, complete mailbox service, Internet access, and office and packing supplies. MBE quickly grew to 250 franchise outlets by 1986, when it went public, to over 1000 centers in 1990, and to over 4000 centers in 1999. After securing a strong foothold in the United States and building a strong foundation of experience, in 1989 MBE decided to sell master franchise licenses abroad. By 1999 MBE was operating, or had licensing agreements, in nearly 60 countries, and had over 700 international outlets. MBE headquarters is very clear concerning the two key elements of franchising discussed above, growth and the franchisor/franchisee relationship. Clearly, having established a strong, growing network MBE has existing routines that effectively encompass these two critical issues. This is part of the knowledge that MBE explicitly attempts to transfer to its international Master Licensees (the key MBE individuals internationally. These individuals generally have significant prior business experience and have purchased the right to build the MBE network in their country). Concerning the growth of the network MBE provides very detailed materials specifying exactly when each phase of the network building process should occur. A major portion of that specification is detailing when new franchise outlets should be sold. This should happen soon after starting in a new country (one month after opening the pilot store) with continued sales of new franchise units every three months at first and then shortening the time in between until they

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are being sold nearly every two months. This detailed specification is the result of MBEs long experience in building networks. MBE is just as specific concerning managing the franchisor/franchisee relationship (a major portion of the Master Licensee’s job is managing this relationship between him/herself and the franchisees in his/her own country). Franchisors are not employers. There is a market interface between them and the franchisee. Franchisees, while bound by law to do certain things, are not bound by law to build the network or to give positive referrals to prospective franchisees (which is the primary key to network growth). As a consequence MBE counsels their Master Licensees to use persuasion and support in helping their franchisees and to nurture the franchisor/franchisee relationship almost as if they were a family (often making that direct comparison). MBE sold the rights to build the MBE network in Israel to Albert Alhadef in August of 1995. He opened the first store in July 1996. We chose to study the expansion of MBE into Israel because of past experience and empirical data showing that, on average, Israeli’s tend to avoid behavior that conforms [cite queue study] and are likely to engage in adaptation. The intent was to find a location that would provide variability in the data. Beyond that the Israeli MBE franchise network is of recent origin, allowing us to examine their decisions concerning the re-use of knowledge from the beginning of the network. Data Collection Data collection occurred primarily through a series of interviews and with all of the major players at MBE headquarters and MBE Israel as well as extensive archival data gathering in both locations. In all cases the interviews were semi-structured with an aim at uncovering the role of the Master Licensee and the process and difficulties of expanding a franchise network overseas,

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specifically the balance between copying headquarter’s business model and adapting to local needs. The interviews with MBE headquarters occurred on site in San Diego, California. Those interviewed included the CEO of MBE, the Executive Vice President, and the head of international operations (as well as various members of his staff). We used these interviews to develop a thorough understanding of the MBE concept and the role MBE headquarters played in building the MBE network worldwide, etc. Following the interviews at MBE headquarters we also spent two weeks in July 1999 on site in Israel interviewing all the major players at MBE Israel. These included Albert the founder and CEO at the time, Eiton his COO, various franchise owners and office staff, and various suppliers. Albert also completed a lengthy questionnair e as part of a wider, but connected study. Follow- up conversations via e- mail and by telephone occurred to clarify details and track the emergence and results of the most current phase of the MBE Israel experience. The period of time tracked in this experiment is 1995 to 2001. Concerning the central issue of adaptation of knowledge at MBE Israel three clear time periods emerge. These are 1995 to the end of 1997, 1998 to 1999, and 2000 to 2001. The three time periods are separated by clear events that signal a shift in the decision of whether or not to adapt the system of building a network advocated by MBE headquarters concerning specifically the issues of timing of sales of franchises and the franchisor/franchisee relationship. The three periods lend themselves well to a repeated measures, quasi-experimental, research design. Research Design Causal inferences made in this paper are based on the results of a quasi-experiment (Cook, Campbell and Perracchio, 1990, p. 542). A research design qualifies as quasiexperimental when it lacks randomization but uses either multiple groups or multiple waves of

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measurement. The repeated-treatment design is justified when the investigator has access to only one population, the program is introduced to the entire population so that no appropriate comparison series is available, the initial treatment effect is presumed to be transient, and the policy or program treatment is introduced abruptly. Beyond that Cook (1991) argues that a quasiexperimental design is aptly suited for studies where the treatment has already happened but the researchers have rich archival data and exact knowledge of when the treatment was implemented. Such is the case in this study. The design is depicted below, and its most interpretable out come is when O1 differs from O2 , O 3 differs from O4 , and the O3 -O4 difference is in the same direction as the O1 -O2 difference. O1 X O2 / X O3 X O4 The repeated-treatment design is generally strong from an internal validity perspective, especially when the introduction of the treatment does not correspond to natural cycles of the organization. Also, the occurrence of unique historical events that mimic the patterning of the treatment introduction and removal is unlikely. In this kind of research design, “lack of control and lack of randomization are damaging to inferences of cause and effect only to the extent that a systematic consideration of alternative explanations reveals some that are plausible” (Campbell, 1988, p. 222). If, as in Campbell’s study of the Connecticut crackdown on speeding, a systematic analysis of alternative explanations does not reveal plausible alternatives, the observed effect can be safely ascribed to the “experimental treatment” (Campbell, 1988, p. 225). The treatment in our study occurs when the Master Licensee in Israel adapts the system received from MBE headquarters concerning building an MBE network. The level of growth for each measurement period, O1, O2, O3, and O4 is ascertained from archival data. If the treatment (a decision to adapt) has an effect on the dependent variable, we will expect that growth will be

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stagnant after each program that adapts the knowledge being transferred from MBE and that growth will accelerate following a decision to copy that knowledge exactly. That is, that O1 will be higher than O2 (O1 represents the initial forecast for growth), O3 will be higher than O2, and the growth rate of O4 will be lower than O3 again. Measuring Cause: The Decision to Adapt The independent variable in this experiment is the decision to adapt the system of building a network recommended by MBE headquarters. This is measured through interview and survey data. An intervention is said to have happened when the leaders of MBE Israel adapted one of the two major principles outlined above. Adapting can be considered to be an exogenous intervention because the leaders of MBE Israel were not aware of the relationship between adaptation and growth. This can be inferred from the fact that they departed from the system recommended by MBE headquarters in Period III, after having copied it exactly in Period II. Of course, at least in the first instance, they were aware that they were not following the MBE timeline in selling franchise units. When they did not get the results they anticipated they correctly surmised that the problem was not following the instructions MBE headquarters gives as to approach to selling franchises. What they were not aware of, however, was the interdependence of the system. Their understanding of the problem was confined to a specific aspect, not the system as a whole. This is seen in the attempt to adapt in time period III followed by disappointing results again. Had the treatment been endogenous and an understanding of the interdependence of the system as a whole been the driver of the results we would not have seen the decision to adapt again in time period III. Measuring Effect: The Impact on Growth of the Network

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As discussed earlier growth, especially in the beginning stages of a franchise network, is considered to be of major importance to a franchising organization (Bradach, 1998) 2 . Growth is one of the primary measures of success within MBE, as well as other franchising organizations, and as such was seen as a suitable measure of performance. Because Master Licensees (as well as MBE headquarters) generate revenue and profits from franchise fees, royalties, and sales of fixtures and equipment to franchisees, growth is a good all around measure of performance in a franchise organization. Admittedly this may become problematic as a franchise organization matures, but in this study Israel was just being opened and growth is considered to be a suitable measure. Growth was measured as the number of new stores opened by the end of each calendar year and was determined using archival data. Part I: Adaptation of the Knowledge Asset, Poor Results Albert bought the right to develop the MBE franchise network in Israel in August of 1995. MBE, as with all Master Licensees, began the process of replicating their successful network in Israel with a series of intensive training sessions spanning multiple weeks. During these training sessions Albert was instructed in both building and operating a network and in establishing and operating a successful MBE store. The training included in-depth field experience. MBE also aided Albert in the transfer of franchising knowledge by providing him with extensive manuals detailing the codified knowledge of both how to build and run a franchise network as well as an MBE store. Finally, to aid in the replication of various successful MBE networks MBE 2

When markets become saturated franchise organizations often turn to maximizing the

units they already have. MBE Israel, however, was at the beginning of its existence and, as Bradach Bradach, J. L. 1998. Franchise Organizations. Boston: Harvard Business School Press. asserts, growth is the most vital component of success early on.

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Headquarters ensured that Albert was introduced to the global MBE network and given access to Master Licensees in various countries to serve as examples and references in establishing the network in Israel. The attempt in both the training, the written materials, and access to the network was to transfer a success-proven system that would work in many environments worldwide. With this wealth of available knowledge Albert opened the pilot store (a model store, the first to be opened in a particular geographic area, which is run by the Master Licensee as an example of how to operate a franchise unit) in July 1996 and began focusing on building the pilot store and perfecting the sale of MBE services in Israel. From the beginning, Albert and the staff members that he hired believed that the MBE approach had to be substantially adapted if it were to be successful in Israel. Many of the business services being offered in the United States were not even defined or established in their small country. The word “mailbox” itself had no meaning and having the mailbox logo in the front of stores meant little for attracting customers. Albert was concerned that the fit of the MBE concept in Israel was not sufficiently tight to provide for excellent network growth. However, he and his partners were attracted by the flexibility of the MBE concept. They believed that not even MBE-USA understood the flexibility capabilities of what MBE could stand for in different settings. They understood this flexibility to mean that even on the local level, each franchisee could adapt to their special area. By picking and choosing flexibly amo ng the various components of the MBE concept Albert and his associates believed they could establish an MBE market in Israel and even out-do MBE’s projections for network growth. The overriding tone during the entire period 1995 to late 1997 was focused on adaptation of the actual store to the local environment.

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“The MBE concept is so flexible that I don’t think MBE home office has all the solutions. There’s no way they can see all the needs of all the world and what is needed because the mission of MBE is that we will personalize a convenient business solution. There is no way you can think about all the system, what [services we] should give where. Each franchisee in each area in Israel also would have to adapt some of the things to these special areas without even consulting me or consulting USA. He will create his own area, own store to adapt it to this location.” - Albert With a focus on adapting the actual store to the local environment Albert spend the majority of his time working on increasing the profitability of the pilot store. The thinking was that if he could show franchisees how well the MBE concept worked in Israel by showing how profitable the pilot store was growth would happen at a much quicker pace. While this was adaptation of the basic MBE business model on the franchise level it also extended to the level of building the network. MBE had very specific instructions on how much time to spend establishing the pilot store, when to begin looking for sites for future franchisees, when to find lawyers to prepare franchise contracts, when to look for general contractors for building franchise units, when to submit drawings for floor plans for possible franchise units, when to begin working with outside suppliers, and when to start looking for franchisees. The instructions are extremely detailed and focused on transferring the knowledge of how to build a franchise network. In a conscious attempt to increase the rate of growth Albert adapted the MBE system. His idea was that if he could perfect the pilot store and make it highly profitable he could use it is a primary means of attracting franchisees. He explicitly hoped to out grow even the fastest growing MBE networks and to do MBE better than even those in the U.S. could do it. This, of course, was a departure from the approach detailed by MBE headquarters. The philosophy during this period is captured in the following two quotations: “We don’t go back to the US. We have our own knowledge here.” – Ari

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“Ask US for help? It might be the proper way, but we have created our own experience.” – Albert According to MBE instructions and the experience of other international Master Licensees, by the end of the first period, December 1997, Albert should have had nearly 14 franchises sold and over half of them already in operation. Instead he hadn’t sold a single franchise yet and he was still struggling to make the pilot store profitable. Part II: Adherence to the System, Good Results In December 1997 Albert decided to send one of his employees, Eiton, his COO, to an MBE International conference in Milan, Italy. Italy was one of the more successful MBE international networks with over 200 stores established in a period of 6 years. At that conference Eton had an opportunity to see a successful network first hand. Eton [sic] returned to Israel with a complete picture of how the network was supposed to be run and the benefits of close adherence to the knowledge assets being transferred. “The trip to Italy was a milestone for me, I think for all of us. I think Albert will agree with this milestone…December ’97. It seems like every franchisor must . . . get to the point where you say, ‘Okay, let’s start listening to others and what they are doing.’” – Eton From December 1997 until the end of the period of observation Albert and his top managers continued to focus on the growth of the network by attempting to follow the detailed timeline that MBE had transferred as part of their expertise and knowledge. This included such activities as taking ads out in local newspapers looking for franchisees, interviewing potential franchisees, holding seminars for potential franchisees, etc. These activities had happened as a sidelight instead of being part of the Albert’s main focus during the period prior to December 1997. With a new focus and compliance with both aspects of the MBE formula for expansion (growth of the network and nurturing the franchisor/franchisee relationship), the Israel network grew from only the pilot store to two pilot stores plus 15 franchise outlets in two years. They

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were among the fastest growing young MBE networks at the time (growth often accelerates with age, but compared with other fairly new franchise networks they were doing very well). At first glance it might seem obvious that focusing on selling would increase the size of the network. While this was the direct result of Albert’s shift in thinking from adaptation to closer adherence to the knowledge assets it was not a shift in Albert’s original intention. His intention from the beginning was to build a fast growing network. The shift, then, wasn’t from a focus on growing the network, but from attempting to adapt the knowledge asset to local conditions in order to achieve better than typical MBE growth rather than follow the pattern established by MBE. As he began to follow the pattern established by MBE he began to achieve the results that MBE had predicted he would when he first bought the rights to build the MBE network in Israel. One alternative explanation for the positive growth in Period II is that Albert was right and perfecting the pilot store before selling franchises resulted in excellent growth. This, however, was not the case, because the pilot stores were never able to consistently break even until after there were sufficient numbers in the network to bring up the average revenue of all the stores in the network. In this case adhering to the system more completely, rather than adapting it to the local environment, was the key to good results. Part III: Adaptation Again, Poor Results Again In period III, however, MBE Israel once again departed from the system developed by MBE Headquarters, this time primarily in the form of neglecting the advice to nurture and maintain the franchisor/franchisee relationship. Maintaining the franchisor/franchisee relationships is a key aspect of franchising. Unhappy franchisees result in negative referrals and referrals are the number one source of positive advertising in selling new franchise units for MBE Israel.

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In late 1999 Albert decided to shift his focus to a new business and promoted Eiton to be the new CEO of MBE Israel. At first glance this appears to be a radical shift that may be responsible for any negative results in this time period. However, Albert had been phasing himself out for over a year before he promoted Eiton and Eiton had been in charge of most of the phases of the business before he became CEO. The only difference with Albert completely gone was that Eiton became the primary interface with the franchisee, instead of Albert. All other aspects of the business remained essentially the same. Typically in a franchise organization the franchisor spends a large proportion of his/her time managing the relationship with the franchisees (Bradach, 1998; Kaufmann & Eroglu, 1998). The relationship between the network headquarters and the franchisees is an important one because, barring gross negligence, the network management has little ultimate authority over the franchisees and has to rely on relationships in order to ensure the cooperation of franchisees in any product or process changes. Beyond that managing the relationship appropriately is vital to the growth of the network because good relationships reflect in positive referrals to prospective franchisees. Albert had always been very benign in his approach to his franchisees, even when there were difficulties in the relationship. The approach changed when Eiton became CEO. One of the specific difficulties that Albert and his top manageme nt team had been having with franchisees was late and/or incomplete royalty payments. The problem was severe enough that it was causing cash flow difficulties for the MBE Israel headquarters. Eiton’s approach to solving the problem, however, was a clear departure from the system advocated by MBE headquarters in San Diego. Instead of putting great emphasis on maintaining the franchisor/franchisee relationship Eiton confronted the franchisees and threatened to withdraw

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all ongoing support from MBE Israel headquarters if royalty payments were not complete and on time. Eiton’s dictatorial style put a strain on the all important franchisor/franchisee relationship which resulted in open disputes between MBE Israel top management and the franchisees and many unhappy franchisees who decided to sabotage network growth by advising prospective franchisees against joining the MBE network. As this problem developed the growth of the network faltered and then stalled with no new stores added between Eiton’s promotion in December 1999 and late 2000. At the end of 2000 the situation became bad enough that Eiton left the company and Albert brought in another CEO. Analysis The success of time period two surprised the owners of the MBE franchise in Israel. The negative growth in time period three disappointed them to the extent that two of the three equity owners decided to withdraw their investments. Table one summarizes the results of the analysis. Figure 2 shows them graphically, plotting both the projections of stores sold during Period I and the actual stores sold during all three periods. The findings support the notion that O1 should be higher than O2 , that O3 is higher than O2, and that O4 is lower than O3. In time period I Albert clearly adapted the system MBE headquarters in San Diego was advocating. The results were disappointing. In time period II, following a visit to the Italian MBE network, he focused on copying MBE headquarter’s approach exactly. This resulted in outstanding growth. In time period III MBE Israel again departed from the system, this time primarily by neglecting the principle of managing the franchisor/franchisee relationship. The result was negative growth. All indicators thus provide support for the need to re-examine the standardization versus local

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adaptation debate in light of the dynamics of knowledge assets. Selective adaptation may not be warranted in the case of leveraging knowledge across borders. [INSERT TABLE 1] [INSERT FIGURE 1] Threats to Validity In using a quasi-experimental design it is critical to discuss any alternative explanations that account for the findings. As long as alternative explanations can be ruled out then the findings can be considered to have validity (Cook, Campbell, & Peracchio, 1990). One of the key threats to the validity of a quasi-experiment is history, the possibility that another event, other than the treatment, is responsible for the result (Campbell, 1988). Could other factors cause the stagnant growth in Period I, the dramatic increase in growth observed in Period II, and the subsequent stagnant growth during Period III? While we cannot rule out the possibility that such an event occurred, it seems highly unlikely. In our study, the treatment, decision to not use a template, was applied, removed, and applied again. We are not aware of any other variable that followed this pattern. There were factors, such as the business climate, that could have independently caused the shift in the dependent variable, but we find that they were either constant across all three time periods or across at least two time periods. Concerning the economic climate of Israel we measured both quarterly economic indicators and average store revenue in the MBE Israel network from the second observational period until the end of the study. GDP increased during the entire period of the study but at a slightly decreasing rate during period III of the study. In order to test the possibility that slowing economic growth was responsible for the difference between time period II and time period III we constructed a measure of elasticity between the

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economic indicators and store revenue. The elasticity during the entire period is very small, ranging from -.025 to .317 and is random with no clear pattern emerging. For the economic climate to have been the cause of the growth it should coincide, to some degree (although there may be a lag) with the pattern of results we find here. At the very least elasticity should be high or becoming significantly higher during the third period but it is not. Instead we find that no major factor other than the local adaptation was applied, removed, and applied again. Likewise, outside the interventions observed in the experiment, the main direction and processes of the organization did not change significantly during the period of the experiment, removing remaining threats to internal validity from maturation issues. Another real possibility is that the change in leadership at the beginning of Period III was responsible for the low results in that period. According the interview data this is precisely what happened. However, the independent variable in this study is the decision adapt. This is clearly what Eiton did. Whether it was Eiton who made the decision or another is irrelevant to the study as long as the decision was made. For issues of personnel change to threaten the validity of the findings we would have to find that turnover changed the fundamental nature of the business or what the business was attempting to do. During Period III the headquarter’s unit of the network continued to apply all of the lessons learned during Period II and continued to attempt to establish a successful MBE network in Israel. Eiton, the CEO, chose to depart from a specific principle of the system that MBE headquarters in San Diego was advocating. Eiton did depart from some of the basic MBE concepts in running individual stores as well, however this was no different than what Albert had done. The key difference between the two was the departure from maintaining the relationship.

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Another possible threat is that the individuals at MBE Israel learned from the application of the treatment the first time and specifically avoided those problems the second time around. While the top management did realize that a lack of growth in Period I was directly due to not “listening to others” and subsequently copied the MBE system for network growth as closely as possible they did not connect network growth with the concept of the system as a whole. Instead they saw it as adherence to a particular part of that system, specifically the timing of selling franchises vis a vis the operation of the pilot store. This is clearly seen by the departure from that same template during Period III. At the time no one, including the observers, realized that departure from the system, as a whole, was the treatment being applied. There was no awareness on the part of the subjects that an experiment was taking place. The fact that the essence of the treatment was recognized retrospectively only enhances the validity3 . Finally, we recognize that there may be instability in the measures or other un- measured factors that might account for the results. This is the case with any experiment or quasiexperiment, however. The repeated measures design ameliorates much of this threat, however, as we know of no other factors, other than the treatment, which were applied, removed, and applied again. Discussion and Conclusion Knowledge utilization continues to be an important topic for a number of disciplines. For organizations, leveraging knowledge assets has emerged as a critical component of competitive advantage. This is even more visible in the International Business arena where possession of idiosyncratic firm resources, especially knowledge (Buckley & Casson, 1976) has long been 3

Campbell (1988) reaches a similar conclusion about the likelihood of social threats to

validity in his study of the Connecticut crackdown on speeding.

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predicted as a key for the success of MNCs (Dunning, 1977; Hymer, 1976; Kogut & Zander, 1993). One of the key issues in the utilization of firm specific assets across borders is the extent to which those assets should be standardized or adapted to more closely fit local circumstances. This debate, however, has primarily looked at the issue in terms of products and brands, overlooking the transfer of knowledge across borders. In this article we explore the issue of standardization versus local adaptation of knowledge assets in a cross-border knowledge transfer. Our analysis relies on data collected from the MBE Israel franchise network as part of a naturally occurring, repeated- measure quasiexperiment. In this study we observe three different phases. In the first phase, the Israeli Master Licensee attempts to create a unique approach to building the network that departs in important ways from the proven one recommended by MBE. Lack of growth forces the Master Licensee to revise the approach to one in which it follows closely the example of MBE USA and the highly successful Italian Master Licensee. Following that approach the Israeli operations become the second fastest growing Master Licensee within MBE, going from 2 to 17 stores in two years. In a third stage, a second attempt to deviate from MBE’s business model to accelerate business unit growth halts network growth once again. While the network was projected to reach 24 stores by July 2001, it actually shrinks to 14 stores. Our findings suggest an important principle in knowledge utilization, that of copying exactly something that is not well understood. This principle has important implications for the standardization versus local adaptation debate, which has come to the general consensus that both standardization and local adaptation are needed (Bartlett & Ghoshal, 1989) and that finding the right balance between the two is the most appropriate strategy (Bartlett & Ghoshal, 1989;

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Jain, 1989; Kashani, 1989; Yip, 1989). We note that most of the debate and empirical evidence pertains to products and strategies, not to the transfer of complex knowledge (Jain, 1989; Samiee & Roth, 1992; Sorenson & Wiechmann, 1975). This distinction is important because focusing on the right level or type of standardization or adaptation presumes that somebody understands the practices being transferred well enough to formulate the degree and nature of change that is necessary. In the case of complex knowledge, that person may not exist. The logic of copy exactly, however, is at odds with the logic of local adaptation, which argues that in order to maximize the value of the location one needs to adapt the knowledge to fit with the local environment. If the knowledge is completely understood it is possible that local adaptation is the most desirable method of reproduction. Given no causal ambiguity there is little value in having the source and its template as a continued reference for problem solving because the source would, ex ante, be able to tell the recipient exactly which pieces of the knowledge were crucial and which could be adapted without endangering the desired results. Further reference would produce no additional insight. Complex knowledge, however, is often causally ambiguous (Lippman & Rumelt, 1982). Under these conditions the source is not able to enumerate the exact na ture of cause and effect nor is the recipient able to determine it from direct observation of the template. This leads to difficulty when the knowledge is adapted before it is fully implemented and operational. When the knowledge is modified or adapted before it is fully implemented, problems may arise because of interactions between the changes introduced to the replica and the other components of the knowledge as well as between the changes and its environment, problems that may not have had counterparts in the original knowledge. In this situation, the implementation of the knowledge in a new location may not work as intended and the firm won’t be able to tell if it is a case of a

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deficient transfer or an interaction between the modifications introduced and the other components of the knowledge or between the modifications and the environment (Winter & Szulanski, forthcoming). An example of this is the Japanese art of sword making, which embodies extraordinarily high levels of craft skill, remained virtually unchanged in form, function and manufacturing process for over 700 years. The process is complex, lengthy and sensitive. At some point, ancient sword makers got it right to a remarkable extent, devising effective methods to create what they thought was a “pure” form of iron, a material that we now know as carbon steel -hundreds of years before the world knew there were elements and that carbon was one of them. The sword must be both hard and tough, properties not normally found together in steels. The strength of the Japanese sword blade is that it combines these two qualities, hardness and toughness in a most successful manner, using steel in its hardest form for the cutting edge, but using steel in its toughest form to back up the cutting edge and to form the body of the blade. Despite their limited understanding of the reasons for their success, Japanese sword smiths were able to produce a remarkably consistent product by observing tiny clues in the process and thoughtfully relating them to the properties of the finished article. That they were able to sustain this success over hundreds of years is a testimonial to the ability of their apprenticeship system to keep re-using existing knowledge by copying exactly. When swords are made by such a perfected process, attempts at variation and innovation are consistently punished with unusable results. In relation to complex knowledge, then, a decision to try and find an optimal balance of conformity and adaptation, in accordance with the current prescription, translates into copying exactly specific parts of the knowledge being transferred while adapting others. We argue that

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this results in neglecting the existing knowledge and experience of the source, in other words in going it alone. Because complex knowledge represents an interrelated system of routines and processes any attempt to adapt parts of the system may be detrimental to the system as a whole. Given causal ambiguity it may be impossible to completely sort out which parts of the interrelated system are important for a particular locale or problem and to discern the effects that changes to the system may have. This leaves basically two practical mindsets, either conform or go it alone. Any attempt to find the right balance, or middle ground, results in going it alone, which is not an optimal strategy for optimizing the utilization of knowledge. As a result, and akin to a competitor trying to imitate the firm’s capability without being able to observe first hand the processes underlying it, one would expect an increase in difficulty in transferring the knowledge as the unit receiving the knowledge adapts it and attempts to make it work without the benefit of the prior experience that was originally contained at the source site (Winter, 1995). Given that complex knowledge develops over time through a costly and difficult process of experience and learning (Winter, 2000), the knowledge being transferred represents learning gleaned from mistakes. Adapting the knowledge before it is fully implemented amounts to a costly rediscovery of the knowledge being transferred and an abandonment of the experience that the source possesses. If the organization has unlimited time and money this may not be problematic. However, given cost and time constraints (Tyre & Orlikowski, 1994) it is doubtful that such a tactic will effectively produce the desired results. The example of both MBE and the Japanese sword smiths teaches us that when you ha ve got it right, you have something valuable and hard won in your hands and you shouldn’t change things. Copy exactly. Some would certainly question this approach to transfer, arguing that the competitive standard is always rising and a business cannot possibly survive by totally giving up

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on adaptation and innovation. We are not arguing, however, that adaptation shouldn’t happen and isn’t desirable. Adaptation is often possible and at some point becomes necessary. However, if the intent is to leverage existing knowledge, the right to adapt should be earned by thorough mastery of that knowledge. Otherwise, valuable knowledge assets are wasted. We conclude, then, that copying exactly imperfectly understood practices seems to be a judicious way to approach the leveraging of complex knowledge assets, of governing knowledge processes. Such implication runs counter to the idea and seemingly established practice of attempting to find the optimal degree of adaptation, ex-ante. It is perhaps one more powerful reminder of the subtlety of knowledge assets. Any conclusions that are drawn from this study, however, are of necessity highly exploratory in nature and by no means conclusive. There are significant limitations to the study. First, quasi-experiments are not as strong as true experiments in establishing causality (Cook and Campbell, etc.). While we believe we have ruled out all identified plausible explanations it is possible that an unidentified explanation is the cause of the pattern we find in the MBE Israel network. While this is a limitation of all studies it can be more acute in quasi-experimental studies where a greater proportion of alternative explanations are ruled out via argument rather than design or through the use of statistical controls. Another limitation is the size of the sample. The current study includes only one case and therefore is significantly limited in its ability to generalize. However, the purpose of the study was to explore the dynamic of standardization versus local adaptation in the realm of knowledge and processes. We believe we have been able to conclusively show that adaptation of knowledge assets is not always desirable. In doing so we show that the current normative guidance of adaptation may not be appropriate when transferring knowledge. The purpose of the

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article becomes, then, not to prove what is but rather to show what is possible (Ilgen). Given the limitations of the current study we encourage future studies to explore the issue with a large sample of firms.

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Table 1 Period I 1995-1997 Knowledge Asset Adapted?

Knowledge Adapted

# New Franchises Sold

0 (2 stores in operation, both owned by Master Licensee)

Period II 1998-1999 Knowledge Copied Exactly 15

Period III 2000-2001 Knowledge Adapted 0 (in addition 3 existing stores are closed)

Figure 1

Growth of the MBE Israel Network 16

Eton’s Promotion, Period III begins.

12 10 8 6 4 2 0

Observation of Italian Network. Period II begins.

3r dQ tr ' 1s 95 tQ tr 3r '96 dQ tr ' 96 1s tQ tr 3r '97 dQ tr ' 1s 97 tQ tr 3r '98 dQ tr ' 1s 98 tQ tr ' 99 3r dQ tr ' 99 1s tQ tr ' 3r 00 dQ tr ' 00 1s tQ tr ' 01

Number of Franchises Sold

14

Projection of Franchises Sold Actual Number of Franchises Sold

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