In many franchise systems, particularly within the food or retail sectors, the product supply chain is integral to the operation of the franchised business.

Having access to consistent, quality products and reliable suppliers is crucial to achieving customer satisfaction and ultimately, profitability.

Who dictates the supply arrangements?

More often than not, franchisees are obliged to purchase, use and sell only those products and services which meet the franchisor’s approval and to buy only from the approved suppliers specified by the franchisor.

Sometimes, the franchisor itself directly supplies franchisees with some or all of the key products or services of the franchise system.

Both the franchise agreement and disclosure document should clearly indicate whether the franchisee is free to source its own suppliers, and if so, whether there are any limitations to the franchisee’s discretion, or whether the franchisee must avail itself of the supply arrangements established by the franchisor.

Further details, including the names of approved suppliers and lists of approved products/services should be available in the franchisor’s manuals and supplementary documents.

What are the benefits (if any) to having a controlled supply chain?

In general, having a tightly controlled supply chain is intended to ensure the uniformity and high standard of the products and services offered across the franchise network, which ultimately boosts the reputation of the franchise brand as a whole, and to secure a dependable, quality channel of supply for all franchisees, to improve profitability and business efficiency.

Franchisees may find that utilising the franchisor’s preferred supply arrangements provides some or all of the following advantages:

• certainty as to pricing, payment terms and delivery timeframes;
• access to group discounts, rebates or competitive arrangements negotiated by the franchisor (which the franchisee may not have been able to secure on its own);
• products and services that are homogenous with those of other franchisees of the system, which may lead to increased custom and/or customer satisfaction;
• more time to devote to running the business, because the franchisee is not bogged down with sourcing its own supplier network; and
• confidence in knowing that the products and services purchased comply with any prescribed standards or requirements imposed by the franchisor and are not at risk of placing the franchisee in breach of the franchise agreement.

What are the drawbacks to having a controlled supply chain?

Occasionally, using the franchisor’s preferred suppliers can be detrimental to a franchisee, especially if the franchisor has made poor decisions in selecting suppliers, for instance by favouring suppliers that offer greater rebates to the franchisor over those with superior product quality or customer service arrangements.

In such cases, franchisees may be disadvantaged because the approved suppliers are more expensive, less competitive or less reliable than those the franchisee is able to source for itself or because their products are inferior.

Sometimes, franchisees would be able to procure other benefits if they were permitted to acquire their own locally-sourced products, such as rebates, marketing opportunities, reduced storage requirements or increased custom.

Additionally, in national franchise networks, some franchisees are disadvantaged by using the franchisor’s approved suppliers; for instance, where a franchisee is in a rural or remote region they may be required to pay substantially greater freight costs or delivery surcharges which may negate any reduced pricing negotiated by the franchisor.

Franchisees must also beware that, if they fail to use preferred suppliers, they risk breaching their franchise agreement. This could ultimately result in termination of the franchise agreement and/or legal action by the franchisor, even if the franchisee had legitimate reasons for using alternate suppliers.

What rules must be followed in establishing supplier arrangements?

When franchisors determine the suppliers for the franchise network, they should take care to ensure that the compulsory supply arrangements are clear, reasonable, sustainable for the franchisees and most importantly, lawful.

In particular, franchisors should ensure the supply arrangements do not constitute third-line forcing, which is illegal conduct in breach of the Competition and Consumer Act 2010 (CCA).

Third-line forcing may occur where a franchisor effectively forces franchisees to use a specified third party supplier (who is not the franchisor or a related entity), and the franchisor has not obtained permission, known as a notification or authorisation, from the Australian Competition and Consumer Commission for imposing such requirements.

This conduct is prohibited by the CCA, irrespective of its effect on competition in the marketplace.

Franchisors must also be careful that the franchise agreement provisions relating to supplier arrangements are not considered unfair and therefore in breach of the unfair contract terms sections of the Australian Consumer Law.

What should franchisees be wary of in selecting their own suppliers?

If franchisees can select their own suppliers, it is likely the chosen suppliers, and their products or services, will need to meet the franchisor’s quality standards and criteria.

Franchisees should also ensure these supply arrangements will sustain their compliance obligations, such as maintaining minimum stock levels or ensuring there is sufficient supply of stock and consumables to properly service customers of the franchised business at all times.

Additionally, franchisees will be concerned with the usual criteria for selecting suppliers, including ensuring that their chosen suppliers are reliable, prompt, cost-effective and are able to provide premium product quality, customer service and warranties.

Before signing up to a franchise all franchisees should discuss with the franchisor (and carefully review the franchise agreement, disclosure document and supplementary material such as operations manuals) to ensure they are aware of any mandatory supply arrangements that may be in place.

If these exist, the franchisee should obtain detailed information regarding the supplier arrangements, including all relevant terms and conditions of supply and assess whether the supplier arrangements will be suitable for their particular business.

In systems where franchisees are permitted to source their own suppliers, franchisees should exercise caution and make sufficient enquiries to ensure they are able to select suppliers that best meet their needs while also satisfying any franchisor requirements.