Franchisors often require franchisees to purchase goods or services from nominated suppliers. This is usually perfectly justifiable on the basis of product uniformity, consistency of quality and reliability of supply. There are, however, a number of legal and business challenges in creating supply arrangements for a franchise system in a way which benefits all parties involved.

The advice we give our franchisor clients is that, at the end of the day, if the franchisee is able to get a better deal independently, the supply arrangement has failed and a potential for serious conflict is born.

So, as a prospective franchisee, what should you look for in a franchisor’s supply system?

1. HOW MUCH CONTROL WILL THE FRANCHISOR HAVE?

First, you should understand the level of control a franchisor purports to exercise over your supply arrangements.

Third Line Forcing and the Competition and Consumer Act (“the Act”)

A franchisor that who requires franchisees to purchase goods or services exclusively from a particular supplier or a list of nominated suppliers may be engaging in what is commonly referred to as “third line forcing”. Third line forcing is prohibited outright by the Act irrespective of its effect on competition.

However, a franchisor may lodge a notification with the Australian Competition and Consumer Commission (“ACCC”) which provides it with protection from legal action under the Act.

In the notification, the franchisor must demonstrate the public benefits and detriments of the proposed exclusive dealing arrangement and show that, overall, the arrangement has benefits to franchisees and customers of the franchise system without substantially lessening competition.

When advising prospective franchisees, we usually search the ACCC’s public register of notifications to see whether the franchisor has put in place exclusive supply arrangements. The register can be accessed on the ACCC website.

2. CAN REBATES BE ETHICAL?

Some franchisors may enter into arrangements, where a nominated supplier will provide the franchisor with a rebate payment when franchisees purchase goods or services from that supplier.

There is generally no legal prohibition on franchisors to enter into rebate arrangements with suppliers, provided the rebates are disclosed to franchisees.

The Franchising Code of Conduct requires franchisors to disclose whether they will receive a rebate, the name of the supplier providing the rebate, and whether such rebate is shared with franchisees. There is no requirement for franchisors to share the rebate(s) reeived with their franchisees, although many franchisors choose to do so by adding the rebates received to the marketing fund.

There is no requirement for franchisors to disclose the amount of rebate received or how it is calculated.

Many franchisees genuinely feel hard done by franchisors who select a supplier due to the expected value it will receive through the rebates, rather than by having regard to whether the supplier will deliver the best value for franchisees. Often, rebates increase the cost of goods or services that the franchisees are required to buy, which is actually the opposite effect sought to be achieved.

Evaluating whether or not a particular supply arrangement is beneficial to a franchisee can be difficult. We advise our clients to:

1. Speak to existing franchisees to work out whether they are happy with the price, quality and service provided by nominated suppliers
2. Obtain the suppliers’ price lists and compare such price lists with those of competitors’ and the competitors’ prices
3. Check the relevant sections of the disclosure document, franchise agreement and operations manual to determine, if possible, the extent of the particular supply arrangement.

Exclusive supply arrangements should deliver benefits to the whole franchise system.  So, despite franchisors reaping the financial rewards from receiving rebates, the benefits to franchisees should outweigh the terms otherwise available to a franchisee independently of the group.

If done right, both franchisor and franchisee can make more money from well-negotiated supply systems.

Franchise Legal has offices in Adelaide, Brisbane, Melbourne and Sydney. Contact: 1300 798 501.