How to change your supply chain – what franchisors should know

Inside Franchise Business: changing your supply chainFranchising is a system of doing business. As a franchisor, you have achieved a proven system for success through your brand and product consistency, and you have opted to duplicate that system by franchising.

An inherent element of franchising is that customers expect to receive identical goods and service-levels across all franchises within a franchise system. For example, an expectation that the same burger at any store in a chain will taste the same.

Successful systems often have established arrangements for the supply of products, ingredients or services to all franchisees within a network. Most franchisors will require their franchisees to only source products from a nominated or approved supplier.

Franchisors will often secure special wholesale rates with their suppliers, resulting in cost savings to franchisees. Using a single or select few suppliers ensures consistency.

Just like any business owner, franchisors must ensure that supply arrangements continue to remain beneficial to the system. Changes in the marketplace or the introduction of new suppliers offering competitive rates may prompt franchisors to consider changing their nominated supplier.

If you’re considering changing your supply chain, then there are a few key things you should consider:

9 tips for changing your supply chain

1. Due diligence

Due diligence enquiries into the prospective new supplier. Do they have the capacity to fulfil the needs of your entire franchise network and deliver a standard of consistency in both product and service comparable or better than your current supplier? Can you leverage the existence of this new supplier to negotiate a better deal with your current supplier?

2. Exit rights

Do you have a formal supply agreement with your existing supplier? If so, what rights do you have to exit the agreement? You don’t want to place yourself in breach of your contractual obligations to your existing supplier by engaging with a competitor.

3. Franchisee obligations

 Check your existing franchise agreements and disclosure documents for any specific obligations you may have to franchisees. Most franchise agreements will generally give franchisors flexibility to change suppliers at their discretion.

However, sometimes there are guidelines that must be followed, such as giving a certain period of notice to franchisees regarding the change, or only implementing a change if a majority of franchisees agree.

4. Are benefits real?

What are the benefits of changing the supplier? If it’s solely a monetary benefit for the franchisor and will diminish the profitability of franchisees, then franchisees could allege you are breaching the Franchising Code of Conduct by acting in bad faith. If the new supply arrangements prevent franchisees from making a profit, they could also accuse you of acting unconscionably.

5.  Communicating to franchise network

How will you communicate the change to your franchise network? Franchisors must ensure that any proposed supplier change is clearly communicated to franchisees with reasonable notice, along with full details on why the change is being proposed and what the benefit will be. Be prepared to justify your decision and communicate your proposal in a positive way.

Franchisees will also need a grace period to run down any current stock they have at hand before they begin purchasing from a new supplier.

6.  Third line forcing

Speak to your lawyer about whether the change could constitute third line forcing.

Third line forcing is a form of exclusive dealing, where a business will only supply goods or services, or give a particular price or discount, on the condition that a person buys the goods or services from a nominated third party.

If the person does not comply with the condition, then the business will refuse to supply the goods or services. If this conduct has the effect or likely effect of substantially lessening competition in the marketplace, then a notification must be lodged with the ACCC before engaging in the conduct.

While the laws on third line forcing were loosened on 6 November 2017, the ACCC will continue to tightly monitor any actions which may infringe anti-competition laws.

7. Updating information

Update your approved supplier list, which will often be contained in your franchise system’s operations manual. The updated manual should then be provided to all franchisees.

8. Disclosure

If you’ll be receiving a rebate from a supplier, ensure that this is disclosed in Item 10.1(j) of your disclosure document. Rebates can help to supplement a franchisor’s head office costs and reduce the fees you would otherwise need to charge franchisees.

9. Finally, have a backup plan.

As KFC’s recent chicken-shortage debacle in the UK has shown, changing suppliers can have drastic effects on a franchise system. KFC’s new supplier was unable to supply enough chicken to franchisees, resulting in the temporary, and somewhat embarrassing, closure of many stores. Fortunately, KFC saw the humour and irony in the situation, apologising to its customers on social media with a cheeky ad.

Changing supply chains can achieve long-term benefits for an entire franchise system. By expecting the best but planning for the worst, franchisors can minimise disruptions and ensure a smooth transition.

By Luke McKavanagh and Peter Rouse, Rouse Lawyers