Franchising is a business model developed by entrepreneurs for entrepreneurs. To be successful in the long run, the model must offer both the franchisor and franchisee the ability to make more money than if the franchisee was to go it alone.
For a franchisor, the sources of income are typically derived through a franchise fee, management fee, royalties, rebates and advertising fees. For this article, we will be discussing the question of confidential rebates and cost of goods sold to a franchisee.
“Approved Vendors.” Consistent quality goods, volume purchasing power, adherence to contractual agreements and conformance to industry standards and regulations. All good reasons to have approved vendors.
Suppliers will offer franchisors financial incentives (rebates) based on franchisee purchases. And often, franchisors include a clause that states a ”franchisee may only purchase supplies from the approved vendor list” and that “the franchisee agrees to give up any benefits of the volume buying power of the chain to the franchisor”.
A good franchisor understands their responsibility to their franchisees with respect to approved vendors. A good franchisor will disclose confidential rebates received and explain how they intend to apply them. A good franchisor also would not compel a franchisee to deal with approved vendors if they cannot show that this is absolutely necessary to protect the brand or delivers other benefits.
But what happens in real life? Here is a true story. Bill (not his real name) buys an existing coffee shop franchise. In the second month, he realizes he needs a new coffee brewer, so he gets a quote from the approved vendor. He is amazed at the very high price and decides to comparison shop, but there is no competition, since the approved vendor is also the sole distributor. So, he informs his franchisor that he would like to buy a different less expensive and superior machine. The franchisor flatly rejects his request and points him back to the approved vendor; no explanations. The sad franchisee accepts his fate and buys the approved machine. A few months go by, and the valves need to be changed and the other equipment needs to be checked. A service technician does ‘some work’ on the machines resulting in a fried circuit board. The angry franchisee asks the technician to fix it, but the technician blames the franchisee’s staff. To make things worse, the technician not only forced the owner to sign to authorize the work and make payment immediately. A few months later, the franchisee he needs basic maintenance on his expensive espresso machine so he calls Vendor B to fix it. Vendor B sadly informs him that they are not able to help him because the part they need can only be obtained from Vendor A, the approved vendor of the franchise! The moral of the story – don’t deal with a poor franchisor? Why does a franchisor approve and force upon the franchisees a vendor that provides poor service and overcharges? Why couldn’t the franchisor provide any justification for using that supplier? What financial arrangements were in place that caused the prices to be inflated? Did the franchisor receive rebates, or free servicing, or free machines?
A great franchisor would share the confidential rebates with their franchisees or allocate those payments received to mutually agreed projects. Sadly, in B.C., we have no such legislation that compels franchisors to do the right thing for their franchisees. It is no wonder so many coffee shop franchisees have pained looks on their faces when you mention “approved vendors”.
The VCSFA recommends all potential buyers steer clear from a franchisor that promotes business practices that force the franchisees to accept approved vendors that do not supply clear demonstrated benefits: better/faster service for the same price as the competition, lower pricing, superior products, etc. Ask what existing franchisees pay for their core supplies (milk, coffee, bottled drinks, sandwiches, etc) against an independent cafe. If the franchisor avoids talking about this, or even acknowledging that they receive rebates, then run away. The franchisor is receiving a financial benefit, and they don’t want you to know. And if you cannot trust the franchisor on the most basic questions, how can you trust them with the more complicated questions?
And a last thought: what happens when a franchisor decides to make money on approved vendors that do not relate to supplies? What if a franchisor wants to be the SOLE supplier of EVERYTHING related to the franchisee operation: renovations, equipment, supplies. And naturally, make money on each of those aspects?
As always, do not hesitate to email us with any questions or comments.