No matter how big or small the franchise system, the heart of its success or failure lies with the public’s perception of the system’s brand. That perception comes in large part from the quality of goods and services offered by the franchise. Suppliers chosen or approved by a Franchisor must have the capability of consistently providing the products and services that meet or exceed a Franchisor’s quality standards.
Determining the best method of supplying Franchisees and of developing supplier relationships, raises a number of business and legal issues. In this issue of Franchisor Alert we focus on different supplier relationships and advantages and disadvantages of those structured relationships. In our next issue we will concentrate on the legal implication arising from the supplier relationship chosen by a Franchisor and the legal issues of pricing restrictions, volume commitments, supplier capacity, incentives, rebates, warranties, federal and state disclosure issues and federal (antitrust, intellectual property, trade secrets, trade dress) and state law claims.
In all likelihood the methodology used for supplying products and services to Franchisees will evolve over time. Franchisors should therefore be very careful to make sure all relationships with suppliers and with Franchisees are capable of evolving with the franchise system needs. Both the source of supply and the manner of distribution to Franchisees is sure to change as the franchise system matures.
1.Designated or Approved Vendors
Perhaps the most prevalent model of supplying the franchise system is one where
Franchisees must purchase products and services from designated or approved suppliers. The use of designated or approved suppliers gives a Franchisor control over the quality of those products and services offered by the franchise system and at the same time, enables a Franchisor to take advantage of economies of scale by negotiating lower pricing for the franchise system as a whole. Additionally, Franchisors may use this model as a source of revenue by collecting rebates, commissions or other fees from the vendor. The use of this model may however, increase a Franchisor’s exposure to supply breakdowns, delivery problems, disruptions and product quality issues. Consequently Franchisees may attempt to hold a Franchisor legally accountable. Franchisors may also find themselves in the middle of a Franchisee/supplier dispute. When Franchisees become disgruntled they look for ways to challenge the legality of the supply system and potentially the Franchisor’s system.
2. Supply Standards – No Supplier Restrictions
Another model used is the very basic system which requires that products and services alone, meet the standards set by a Franchisor. Unlike the first approach there are no restrictions on the suppliers used byFranchisees as long as the products and services meet the Franchisor’s standards. While this model is much easier to administer it does not allow a Franchisor to have much control over the quality and consistency of products and services, nor can the franchise system take advantage of the economies of scale or potential rebates.
Normally parties participating in a purchasing cooperative agree to purchase products and services from certain suppliers, enabling the cooperative to take advantage of greater volume purchases and thus, the ability to negotiate pricing and other terms. A Franchisor who establishes a cooperative has the ability to make participation optional or mandatory. In some franchise systems the cooperative is owned and operated by Franchisees which has the advantage of designating the administration of suppliers to Franchisees and also, limiting the potential liability of a Franchisor from supplier disputes.
4. Blended Approach
Perhaps the most common method of supplying the franchise system is the blended
approach. Usually two or more of the 3 models listed above are combined or merged together requiring Franchisees to purchase certain products and services, normally proprietary products at a minimum, from designated or approved suppliers. A mandatory or optional purchasing cooperative may also be present under this arrangement for some or all of the products and services required for use in the franchise system.Frequently the blended approach is developed over time and joins the best features from each model. Often the determining factors used to structure a blended model include:
i. The industry in which a Franchisor operates;
ii. The number of products and services to be offered;
iii. The proprietary nature of the products and services essential to the franchise;
iv.The age of a franchise system; and
v.The size and geographical area of the franchise system.
Although the method chosen by a Franchisor to get its goods and services into the marketplace plays a substantial role in the success of the system chosen, it is often the Franchisor’s navigation of legal issues which results in the ultimate success or failure of a Franchisor’s chosen supply system. In the next month’s issue of Franchisor Alert we will explore many of the legal issues faced by a Franchisor supplying the franchise system, as well as resulting disclosure requirements.