Franchising supply arrangements and the ACCC

Dr Michael Schaper, Deputy Chairman, ACCC

This article appears in the January/February 2014 issue of Business Franchise Australia & New Zealand

Exclusive supply arrangements are common place in the world of franchising. Having control over the way in which franchisees operate is central to the success of a franchise system.

From secret spices through to software systems and cleaning products, supply arrangements enable franchisors to maintain consistency and efficiency across the network.

But supply arrangements can also be a source of friction. Franchisees often question why they are required to purchase a product from an approved supplier when they can buy the same product cheaper elsewhere. Franchisees may also become  disgruntled if seemingly reliable supply arrangements are changed by a franchisor without consultation.

Franchise supply arrangements come in many forms, and must comply with the requirements of the Franchising Code of Conduct and not breach the Competition & Consumer Act, both of which are enforced by the Australian Competition and  Consumer Commission.

In some cases, franchisors set quality standards and allow individual franchisees to source goods or services from any supplier which are up to scratch. Arrangements of this kind will only raise concerns under the Act if they have the purpose or likely  effect of substantially lessening competition. This is generally unlikely to occur where there are a number of businesses who compete with the franchisees or the suppliers to the franchisee.

However, in many other systems a franchisor will require franchisees to purchase goods or services from a particular supplier or from a list of nominated suppliers. These types of ‘exclusive dealing’ arrangements may be ‘third line forcing’ which will  breach the Act even if the conduct will not harm competition.

In general, requirements to purchase from a certain supplier are often part and parcel of a franchise. After all, customers will expect that the goods they buy are of the same standard and type, right across the same franchise system. To ensure this, it  is commonly accepted that minimum standards will often be imposed by a franchisor.

A franchisor who wishes to engage in third line forcing can formally ‘notify’ the ACCC of its arrangements, which provides it with protection from legal action under the Act.

The ACCC may only remove this protection if it believes that the public detriments arising from the arrangements outweigh the public benefits. A decision about this is based on the impact of the exclusive dealing on the entire community, and not just on the franchisees themselves.

What may be an annoying restriction to an individual franchisee, such as a requirement that you only buy your raw material from a certain supplier, can also be a benefit to consumers who are then assured of always getting the same quality end product or service.

For these reasons, it is rare for the ACCC to take action to revoke these arrangements. Of course, if there was a substantial public risk or detriment – such as a franchisor requiring franchisees to purchase products that didn’t meet minimum safety thresholds – then the ACCC will revoke them.

Another issue is that of rebates. Some franchisors may enter into arrangements where a nominated supplier will provide the franchisor with some kind of financial benefit when franchisees purchase goods or services from that supplier.

This is not illegal: there is no outright prohibition under the Act against rebate arrangements. And when an exclusive dealing arrangement is notified to the ACCC, the mere receipt of rebates by a franchisor is not automatically deemed to be a public
detriment when the ACCC assesses the matter.

Nevertheless, the receipt of rebates by a franchisor can be a contentious issue in some franchise systems. Many franchisees object to rebates, as they consider the franchisor may select a supplier based on the expected value of the rebate rather than whether the supplier will deliver the best value for franchisees. Franchisees also argue that rebates may increase the cost of goods or services they are required to buy.

Franchisors consider that rebates are an essential part of their operating model. They often point out that these financial payments can be used to support national marketing campaigns or reduce other fees that franchisees would otherwise need to
pay. The receipt of rebates by a franchisor from nominated suppliers is a complex issue, and it can be difficult to establish whether these arrangements provide net benefits or detriments to the franchise system or the general public.

The Franchising Code of Conduct requires franchisors to disclose whether they will receive a rebate or financial benefit from the supply of goods or services to franchisees, as well as the name of the business providing the rebate or financial benefit, and whether the rebate is shared directly or indirectly with franchisees. However, there is no legal requirement for franchisors to disclose the value of the financial benefit or to distribute that benefit amongst franchisees.

If you are in the process of signing up to a franchise system, study the franchise agreement and disclosure document carefully. Make sure that you are fully aware of and comfortable with the requirements regarding suppliers and any rebates that
franchisors may receive.

The ACCC also encourages franchisees, including prospective franchisees, to speak with franchisors regarding any concerns they have about the supply arrangements for their franchise system.

The ACCC has recently published a new guide to help franchisors and franchisees better understand the ACCC’s role under the Competition and Consumer Act 2010 in assessing certain types of franchising supply arrangements.

The ACCC’s website contains information about the notification process and the obligations of franchisors under the Franchising Code of Conduct and the Act. We also maintain a public register of all notifications we receive which is also available on our website. Franchisors and franchisees can also call the small business helpline on 1300 302 021.

Dr Michael Schaper is Deputy Chairman of the Australian Competition and Consumer Commission.