Abstract
A common agency model describes the production franchise in the carbonated soft drink industry as a contractual device between an upstream agent (the franchisor) and downstream principals in a duopoly (potential franchised firms). Process and product innovations are formalized as the subject matter of the contract, which is observable at no cost by downstream firms, together with local conditions. The latter are unknown by the upstream firm. Anti-complementarities in network co-ordination costs are demonstrated to be necessary and sufficient for the franchisor to obtain strictly positive profits. Upstream profitability is found to decline in favour of franchised firms when the content of the contract is decreasingly proprietary, when local cost or demand conditions harmonize and when co-ordination costs fall. Implications for the explanation of vertical integration are discussed.