Purchasing Cooperatives: A Second Look
Even though a purchasing cooperative can produce significant savings for many product-based franchise systems, many franchisors remain skeptical of purchasing cooperatives because of their historical association with strife between a franchisor and its franchisees. But, as is apparent from the recent trend of franchisors participating in and supporting the formation of purchasing cooperatives, a franchisor's input can positively influence a purchasing cooperative and result in greater supply chain efficiency, savings, and quality improvement.
A cooperative is a member-owned and -controlled enterprise that is formed to serve the needs of its members. Franchise system purchasing cooperatives are typically owned by the franchisees and the franchisor that own the individual businesses that make up the chain (for example, restaurants or retail outlets). A purchasing cooperative will often produce cost savings for, and return patronage dividends to, its members, while simultaneously serving as a tool to improve the quality of the goods that flow through the franchise system and to improve the franchisor-franchisee relationship.
For most franchisors, the decision whether to support a purchasing cooperative is influenced by the franchisor's perception of its ability to influence decisions of the cooperative. If a franchisor supports the formation of a purchasing cooperative, the franchisor has multiple opportunities to build franchisor influence into the cooperative structure, including through: 1) voting rights as a member of the cooperative; 2) participation in the governance of the cooperative; and 3) an agreement with the cooperative that delineates the responsibilities of the cooperative and the franchisor. With proper planning during the formation of a purchasing cooperative, a franchisor can also use its avenues of influence to retain current vendor relationships (including vendor contributions to the system) and to retain the flexibility to designate proprietary products for the franchise system.
As a member of the cooperative, the franchisor would receive periodic communications from the cooperative and would be entitled to voting rights. Note that to operate on a cooperative basis for tax purposes, each member of a cooperative is entitled to only one vote, no matter how many units it operates or how much it purchased from or through the cooperative. Direct participation on the cooperative's board of directors also permits a franchisor to have significant input on the cooperative's management and policies. Often, a franchisor will have the right to designate one or more members of the cooperative's board. If the franchisor is willing to support a newly formed cooperative, the franchisor should also be able to negotiate the "veto rights" over certain decisions requiring consent of the purchasing cooperative's board.
Perhaps the franchisor's best opportunity to influence decisions of the cooperative is through the negotiation of a "relationship" agreement. Most franchise system purchasing cooperatives are governed, in part, by an agreement between the cooperative and the franchisor that spells out the terms of their relationship and their respective duties. With planning and creativity, the relationship agreement can serve as an important cornerstone of the relationship between the franchisor and the purchasing cooperative. The relationship agreement should, at a minimum, accomplish the following:
- Designate the purchasing cooperative as the purchasing agent for the franchise system.
- Reserve for the franchisor the same rights that are reserved in the franchisor's form of franchise agreement, such as the right to approve and disapprove suppliers, the right to establish and retain ownership of all formulations and specifications, and the right to require franchisees to purchase specific, proprietary products.
- Allocate specific tasks, such as forecasting, inventory control, and conducting recalls, between the cooperative and the franchisor.
- Provide for proper communication, the sharing of information, and confidentiality between the franchisor and the cooperative.
- Provide for any indemnification that is warranted, along with dispute resolution between the franchisor and cooperative.
- Preserve, to the extent needed to support the franchise system and innovation, the franchisor's ability to maintain independent relationships with vendors, receive contributions from vendors, and to develop and require the cooperative and its members to source and purchase new proprietary products.
A franchisor that plays an active role as a member of the system's purchasing cooperative, has a representative on the cooperative's board of directors, and that negotiates a relationship agreement with the purchasing cooperative is likely to find the purchasing cooperative an unparalleled opportunity to achieve savings for the franchise system while improving quality and continuing to innovate. A franchisor that is skeptical of a purchasing cooperative at first glance should find that with active participation, it is able to influence the formation of a purchasing cooperative that will serve as a valuable tool for franchise system improvement for years to come.
Suzanne A. Loonam is an attorney in the Franchise and Distribution Practice Group of Haynes and Boone LLP and can be reached at email@example.com.