Choosing the right franchise contract Up and Running is a successful coffee corner chain operating in public places, like train stations, airports and musea. Up and Running's headquarters is planning to expand internationally and is considering extending a franchise contract to Mr. Lacroix, a Belgian entrepreneur.

Sales in Belgium are very uncertain and expectations run from a low of €600 000 to a high of €1 800 000 a year.

The basic problem now is what kind of contract should be given to Mr. Lacroix? In the past, three different franchise contracts have already been used:

● Contract 1: a flat fee of €80 000 a year and an additional €20 for each €1000 sales

● Contract 2: a flat fee of €60 000 a year and an additional €40 for each €1000 sales

● Contract 3: a flat fee of €10 000 a year and an additional €70 for each €1000 sales Required:

1. Management of Up and Running is thinking of three possible future sales in Belgium:

€600 000, €1 200 000 or €1 800 000. Suppose management is pessimistic, which alternative would then be chosen?

2. Suppose Up and Running's management wants to avoid the regret of having chosen the wrong contract. Or put it differently: it wants to minimise opportunity costs. Which contract should then be selected?

3. The management team of Up and Running is known for not taking too many risks, and for not being too risk averse. What contract suits this management team best? (Hint:

use the Hurwicz-scale to depict the level of optimism.)

4. Based on previous experiences in Luxemburg and France, the marketing manager of Up and Running estimates the possibilities of generating the different levels of sales as follows:

● sales of €600 000 (60% probability)

● Sales of €1 200 000 (30% probability)

● sales of €1 800 000 (10% probability).

Given these probabilities, which contract is most attractive?

5. What is the value of perfect information? What does this value mean?

6. As we have seen, it really matters how you look at the decision situation. It would be most helpful if Up and Running could get more certainty about expected sales in Belgium. The marketing manager decides to ask a market research firm to survey prospective clients in Belgium. The marketing firm is known for being reasonably accurate in predicting high sales numbers, but less accurate in predicting low numbers. The following table is drawn from earlier marketing studies by the research firm:

● When predicting €600 000 sales it is 80% right, in 15% it is €1 200 000 and in 5% it is €1 800 000.
● When predicting €1 200 000 sales it is 80% right, in 15% it is €600 000 and in 5% it is €1 800 000.
● When predicting €1 800 000 sales it is 90% right, in 5% it is €600 000 and in 5% it is €1 200 000.
The marketing research bureau is willing to do the market research project for €500 000. Given the accuracy information provided, should Up and Running ask the marketing bureau to do the research?