Volume Purchasing Arrangements – Misplaced Fear By Franchisors Causes Lost Opportunity

I was speaking with a CEO of a national restaurant franchisor recently about his company’s approach to leveraging the buying power of its franchisees and corporate units in order to negotiate sustainable attractive production, pricing and delivery terms for products sold to the franchise system. His approach was to integrate a purchasing council made up of representatives of existing franchisees into the franchisor’s buying process and obtaining direct input on suppliers and supply terms and, in some cases, permitting the council to veto certain deals based on pre-determined parameters.

While this franchisor does not impose a mandatory requirement to purchase from the selected suppliers, the franchisor believes that the attractiveness of the pricing available and engagement of the franchisees through the council process has resulted in many franchisees consistently agreeing to buy all of their requirements for certain products from the sole supplier (or limited group of suppliers). And the franchisor has negotiated price and supply terms based in large part on the volume of orders from these participating franchisees. In these types of arrangements, often each of the participating franchisees executes a participation agreement that obligates it to purchase in accordance with the negotiated terms with a particular supplier. The franchisor bears that cost of this arrangement as part of its overall overhead (‘G & A’).

The foregoing is a much looser version of buying group and purchasing cooperative arrangements utilized by other franchisors to facilitate attractive pricing and other supply terms of necessary products. Other types of arrangements permit the franchisor to shift G & A to the buying group of franchised and company-operated units in exchange for greater control by franchisees over things like the criteria for and selection of suppliers, the direction and use of supplier rebates and the governance of the buying group.

Typically a buying group is a creature of contract where all the participating franchisees agree to order and purchase all products in accordance with the terms negotiated by the governing body of the buying group and its personnel. Normally, both franchisee and franchisor representatives serve on the board or other governing body of the buying group. Experts and other advisors play an ex-officio (non-voting) role providing guidance to the board. The participating franchisees normally pay dues to be members of the buying group and the dues are used to cover the costs associated with the buying group. These costs include supporting a dedicated ordering portal and an electronic catalogue of product offerings, as well as employment of expert procurement personnel or advisors. Because it is purely a contractual relationship, the participating franchisees do not have an equity or other ownership interest in the buying group entity. Under some circumstances, the members will have a vote on certain governance matters.

 Another approach to purchasing arrangements is a purchasing cooperative. This arrangement contemplates members having an ownership interest in the cooperative entity (normally facilitated by a member subscription agreement), voting by members on key issues relevant to the operation of the cooperative, a representative board primarily consisting of elected franchisee representatives and a monetary return to the participating franchisees (often referred to as ‘payment of patronage’) which is taken from a portion of the revenue remaining after deduction for the product purchase price and a margin intended to cover the cooperative’s infrastructure and budget. This arrangement contemplates that all member franchisees and company units must purchase from the selected suppliers in accordance with the terms negotiated by the cooperative with those suppliers. There are important and sometimes complicated legal issues that drive a lot of the advantages of a purchasing cooperative and compliance with the requisites in these areas is critical. These legal issues include securities (to avoid the obligations associated with securities offering requirements), tax (to obtain the beneficial tax treatment that purchasing cooperatives can obtain for revenue received by the cooperative) and antitrust (to ensure the participating members do not run afoul of legal restrictions applicable to a consolidated purchasing organization).

Whatever the format of a purchasing arrangement, there is no doubt a franchisor with disparate purchasing arrangements is losing the opportunity to obtain more attractive pricing and terms for all franchisees. This can have a direct and often substantial impact on unit economics across the system. It is an easy mistake for a franchisor not to consider these beneficial economies of scale for a system, often out of fear of losing control over franchisees or the supplier arrangements. These proposed arrangements involve true engagement by the franchisees in the process. But those franchisors who think that way are missing the opportunity to have more control over the relationship through the best of mechanisms – alignment between franchisors and franchisees on a mutually-beneficial arrangement that promotes success for all involved. Without one of these approaches, franchisors normally find that their franchisees are not happy with their purchasing arrangements, are involved in ad hoc, uneven and inconsistent negotiations and believe their franchisors should have provided these purchasing benefits in consideration of being a franchisee.

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As Co-Chair of a Global Franchise and Supply Network practice group, I specialize in representing franchisors, franchisees, manufacturers and distribution companies in d...