Its economies of scale allow the firm in that position to rise price or to decrease costs without too much risk, as it can anticipate the entry of a new competitor and adapt its policy. Franchising is a response to the lack of competition, which leads natural monopolies to take advantage of its position. The originality of this concept is that it sets the competition for the market instead of in the market. This competition for the market takes place in the bidding process, which preludes the attribution of the market. So franchising is some kind of mechanism, which ensures the market contestability that lacks in the natural monopoly, contestable markets being those which are easily entered by new competitors. Franchising allows the companies interested by a market available for just one firm to bid for it, and by doing so, to avoid buying the necessary and extremely expensive capital to provide this market. This market, which would have in normal time put off new entrants because the cost of initial capital, the uncertainty bounded to the fact that just one firm can survive, is now reopened. .
There are two main bidding processes;.
The classical auction process awards the contract to bidder who offers to pay the most for it. The bidders are assumed to set their offers in function of the gains they expect to make during the length of the contract if they are given the market. This option is the one that helps the most the treasury of the state. The attribution of the G3 licenses has been done after that model in the UK and it raised a fair amount of money. This form of auction is also often used for attributing oil exploration licenses. However, this option faces some kind of moral hazard as the bidder may offer enough to win the bid, but to much to be price efficient later.
The alternative solution is known as the Chadwick/Demsetz auction in which the contract is awarded to the bidder offering the lower consumer price or the best price/quality combination.
