Virtually all franchise agreements a prospective franchisee would see in Canada will have a section with the heading: “Designated and approved suppliers.” The wording more or less says: “The franchisee shall purchase all equipment, supplies and inventory for the franchised business directly from the franchisor or from the franchisor’s designated or approved suppliers.”
You can’t really talk about this obligation without acknowledging that the franchisor’s designated or approved supplier is often the franchisor itself, or a company it owns or controls. And the franchisor, or its affiliate, normally makes a profit from what it charges franchisees for equipment, product, supplies and inventory.
In cases where the supplier is not the franchisor or its affiliates, the franchisor will often enter into a “supply agreement” or other arrangement with a company or companies, giving the franchisor a volume rebate or other benefit based on the number of items purchased by franchisees and corporate outlets.
With respect to inventory the franchise buys for re-sale, the franchisor may have negotiated a deal with XYZ Widget Co., where the franchisor requires all of its franchisees to buy their widgets directly from XYZ. XYZ would normally sell widgets to the franchisees at a much lower price than on the open widget market but for being part of the franchisor’s “buying group.” The larger the group and the more widgets it buys, the less the group – and therefore each individual – pays per widget.
By purchasing inventory at a lower price than a solo operator, the money saved can be passed on to consumers in the form of lower prices. At least that’s the theory.
There’s something else you should know about buying arrangements that franchisors negotiate with suppliers. Volume rebates are normally paid to the franchisor based on the widgets purchased by it and its franchisees. This sometimes takes the form of cash. Unless the franchise agreement specifically provides that rebates are passed on to franchisees, the franchisor may keep the rebates for its own account, it may decide to share all or a portion of the rebate with its franchisees, or the franchisor can direct the rebate money into its advertising fund, the annual franchise convention, or other purposes that benefit the franchisees.
The ability of franchisees to buy equipment, supplies and inventory at a lower cost than they would pay on their own is arguably the glue that holds the franchise system together. If the franchisor or its supplier cannot provide the same products at competitive prices, franchisees will bend over backward to try to use another supplier, even if the contract forbids it.
Now that you’re all armchair experts on buying groups and volume rebates in franchise systems, here are a few related questions to consider if you’re thinking seriously about buying a franchise:
These aren’t all the questions to consider when evaluating whether to buy a franchise, but as a franchisee you’ll only make money if you’re able to reduce your expenses.
Negotiating the ability to buy the same product from elsewhere because the franchisor or its supplier is too expensive or too slow is one way to reduce the risk of expenses getting out of hand. If the franchisor can contractually commit to supplying the product and equipment you need to purchase at a lower cost and quicker than anyone else, it sounds like a pretty good franchisor.
By:Tony Wilson http://www.theglobeandmail.com