When Franchisee Effort Affects Demand: An Application to the Car Radiator Market

Consumers respond not only to the price and the product attributes, but also to the service effort provided by the seller. Empirically quantifying or measuring the service effort is difficult because it is often unobservable. This paper proposes an empirical framework of the role of service effort in demand, along with other traditional marketing mix instruments. The model allows us to measure the unobserved effort level without data on effort, which is hardly available in most empirical settings. The paper also presents an application to a unique data set obtained from a franchise in the car radiator market. This framework can be useful in examining various aspects of service-intensive industries. In particular, this study investigates a much-debated public policy question regarding resale price ceiling in franchising. A policy evaluation shows that resale price ceiling lowers franchisees’ profit and weakens their incentive to exert effort, which reduces consumer welfare. However, I find that, overall, resale price ceiling is consumer welfare enhancing in the car radiator market due to the lower price generated by the price ceiling.