In Short
- Franchise agreements often require franchisees to use approved suppliers to maintain brand quality and consistency.
- This requirement is generally lawful, but it may raise issues under competition law if it significantly reduces market competition.
- Franchisees can request approval to use alternative suppliers, but the franchisor must act reasonably when assessing such requests.
Tips for Businesses
Before signing a franchise agreement, review the supplier requirements carefully. Ask whether the franchisor has ACCC notification in place and whether any supplier rebates or financial benefits are passed on to franchisees. Consider the practicality, pricing, and quality of supplies, and discuss the process for seeking approval to use alternative suppliers if needed.
Franchisors provide many franchisees with franchise agreements that require the franchisee to purchase goods or services from a particular supplier. This is not uncommon, and many franchisees fail to think twice about this requirement. The franchisor benefits from consistent quality because franchisees use approved suppliers, which supports the franchise system’s effectiveness. However, franchisees should know it is not always lawful for a franchisor to require purchases only from approved suppliers. This article explains why and provides common issues to address with the franchisor.
Why Approved Supplier Arrangements are Common Practice
Approved supplier arrangements are standard in franchising, and most franchise agreements require franchisees to use specified products, services, or suppliers. These requirements help maintain consistent quality, standards, and compliance with the franchisor’s operational procedures and brand specifications. They can also enable bulk pricing and protect the franchisor’s intellectual property by controlling supplied goods and services. From the franchisor’s perspective, these arrangements help preserve brand uniformity and reputation across all franchise locations.
Exclusive Dealing and Third Line Forcing in Franchising
Exclusive dealing occurs when one business restricts another’s choice of trading partners, business activities, or business locations. Under Australian competition law, exclusive dealing is prohibited only if it substantially lessens competition in a relevant market. Exclusive dealing is usually lawful, but it becomes problematic when the imposing business has market power or alternatives are limited.
This is called ‘third line forcing’ because the franchisee is required to use the franchisor’s chosen suppliers rather than their own. Such practice can support quality and consistency, but it is problematic if it substantially lessens competition in the relevant market. The Australian Competition and Consumer Commission (ACCC) is the national regulator that monitors compliance with competition and consumer law. The ACCC is concerned third line forcing can restrict suppliers, reduce competition, and limit franchisees’ ability to secure better terms.
Franchising is often seen as an exception to third line forcing. Franchisors may require approved suppliers to ensure quality, consistency, and protect trade secrets. The key issue is whether the anti-competitive effects outweigh the pro-competitive benefits to the market and consumers overall.
Continue reading this article below the formNotification Requirements
Businesses can lodge notifications with the ACCC for conduct that might otherwise contravene competition law, including third line forcing arrangements.
The notification process allows the ACCC to assess whether the potential anti-competitive effects of the arrangement are outweighed by the public benefits it may provide.
ACCC approval of the franchisor’s notification gives legal protection for requiring purchases from approved suppliers. Where supplier rules apply and you have concerns, request confirmation of any ACCC notifications or approvals. Without ACCC notification, supplier requirements may breach competition law if they substantially lessen competition in the market.
Opportunity Cost: Benefits and Detriments
The ACCC assesses statutory protection by weighing public benefits against costs to the general public. Some factors to consider include:
- reliance of the general public on consistency with the franchise brand;
- efficiency of the operation of the franchise model that may have positive flow-on effects to the general public; or
- increased bargaining power within the franchise.
Conduct thorough investigations before entering a franchise agreement. Ask the franchisor about supplier arrangements to assess whether they benefit or disadvantage your business. You can check the disclosure document to see whether any rebates or financial benefits will be passed on to you. Franchisees may request an updated disclosure document once every 12 months to ensure they have current information.
Other important considerations when evaluating supplier arrangements include the quality of products and services, the affordability of supplies and materials, the availability and reliability of suppliers, product quality warranties, and business considerations such as ease of use and integration with franchise systems.
You should also assess whether you will save time and improve efficiency by following the franchisor’s supply system, compared to the cost benefits you may receive from choosing a supplier on your own.
Alternative Supplier Provisions
Most franchise agreements recognise that there may be legitimate circumstances where a franchisee needs to source goods or services from suppliers outside the approved list. To address this, franchise agreements typically include provisions that allow franchisees to request approval for alternative suppliers, subject to the franchisor’s consent. These provisions typically require the franchisee to demonstrate that the proposed alternative supplier can meet the franchisor’s quality standards, specifications, and operational requirements.
The franchisor will usually assess factors such as product quality, consistency, reliability of supply, pricing competitiveness, and compliance with brand standards before granting approval. While the franchisor generally retains discretion to approve or reject such requests, they are typically required to act reasonably and not withhold consent arbitrarily. This flexibility helps balance the franchisor’s need to maintain system standards with the franchisee’s operational requirements and potential cost savings. However, it is important to note that the approval process may take time, and franchisees should plan accordingly when introducing alternative suppliers into their operations.
This publication offers guidance on managing your franchise network effectively to achieve success, ensure franchisee satisfaction, and maintain legal compliance.
Key Takeaways
Although the requirement to use the approved suppliers list is a relatively minor part of the franchise system as a whole, understanding how it may impact your business will be important when reviewing and negotiating the terms of the franchise documents.
If you need help in reviewing your franchise documents, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Yes, if the arrangement does not substantially lessen competition and the franchisor has lodged an ACCC notification.
Yes. Franchisees can request approval if the alternative supplier meets the franchisor’s required quality and operational standards.
We appreciate your feedback – your submission has been successfully received.
