A stochastic dynamic programming model for valuing exclusivity from encroachment in franchising

Valuing territorial exclusivity in franchising is difficult because of the uncertainty associated with variables such as future franchise sales and brand strength. We present a stochastic dynamic programming model to value the exclusivity option from the perspective of both the franchisor and the franchisee. When there is positive value to the franchisor of including the exclusivity option in the contract, and to the franchisee of purchasing this option, the likelihood of franchisor‐franchisee encroachment‐related conflict is reduced. We also discuss structural results and explain our results using a numerical example.