Franchisors controls the sources from which their Franchisees purchase operating assets (equipment, fixtures, furnishings, and signs) and goods and services required to operate the franchised business for one or more of four basic reasons:
- to control the quality and uniformity of the goods and services sold by the Franchisee,
- to assure sources of high and uniform quality goods at prices that are competitive with or lower than those available from other sources,
- to protect confidential information,
- to be a profit center for Franchisor.
These are legitimate reasons for controlling the sources of supply utilized by Franchisees, provided that the restrictions do not cause the costs incurred by Franchisees to exceed what such costs would be for comparable products without such restrictions. Ideally, and in many franchise networks, supply restrictions are part of supply programs that lower costs to Franchisee.
As a general proposition, Franchisors should limit source restrictions to those products and services that are important to the development and operation of the franchised business and cannot be simply specified by brand, model and/or grade.
A Franchisor also can derive revenue from supply programs. Franchisors evaluate the total revenue produced by a franchised business from:
– Royalties and Continuation fees
– Advertising contributions or National Advertisement funds
– Sales of goods to the Franchisee
– Commissions paid by suppliers
Some Franchisors rely primarily on fee revenue and other Franchisors rely primarily on the sale of goods to their Franchisees.
The aggregate revenue received from a franchised business must be sufficient to support essential Franchisor services that maintain the system, standards and keep the network competitive, and to produce a profit for the Franchisor. The aggregate of the revenue a Franchisor derives from a franchised business must allow the Franchisee to realize a sufficient rate of return on its investment. Several franchised networks have reduced or eliminated royalties and advertising contributions. Such networks rely on the sale of products to their Franchisees and the sale of services at the Franchisee’s option. If Franchisees elect not to buy such services, the network’s competitiveness could be jeopardized.
When a Franchisor relies primarily on product sales to its Franchisees, its revenue base may be less secure and competitors may target its franchised network, but it is less dependent on monitoring its Franchisees to insure proper royalty calculation and payment or may not charge any royalties at all.
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