Fair Franchising and Vendor Exclusivity

Part 4 of the Series: Consultant Stan Turkel Explores AAHOA's Fair Franchise Standard of Franchisees Having Freedom to Choose Vendors

In 1998, the Asian American Hotel Owners Association (AAHOA) identified a set of standards called the 12 Points of Fair Franchising by which to judge the actions of franchise companies. Now, nine years later, AAHOA has updated the 12 points and has embarked on a survey of franchisors to assess their compliance with these fair franchising standards. In this article, Point 4 is discussed.

Point 4: Vendor Exclusivity

In general, franchisees should be free to buy conforming goods from any vendor, not just those mandated by the franchisor. To the extent a franchisor believes it is necessary to mandate vendors for the purpose of establishing standards and specifications for the hotel brands, the franchisor should strive to ensure that the franchisees are receiving competitive prices by providing a list of three or more approved vendors from which franchisees can purchase conforming goods, or by allowing the franchisees to take advantage of the volume discounts arising from the franchisees’ group purchases of goods and services.

In addition, because the franchisors receive a significant amount of revenues and commissions from the mandated vendors in return for requiring all franchisees to purchase certain goods and services only from such vendors, franchisors should return these revenues and commissions to the franchisees for the good of the franchise system.

Franchisors Need to Ensure Competitive Vendor Pricing for Franchisees 

In the interest of fair franchising, franchisors should strive to ensure that the franchisees are receiving competitive prices on all goods and services that they are required to purchase from mandated vendors. This can be accomplished in a variety of ways. For example, franchisors should identify three or more approved vendors from whom franchisees can purchase the goods or services. Franchisors also can pass on the volume discounts on prices arising from the purchasing power of the franchisees.

Franchisors should not be allowed to pocket the entire amount of revenues and commissions they receive from mandated vendors in return for requiring all franchisees to purchase certain goods and services from such vendors. Franchisors should retain only that amount of revenues and commissions as necessary for the franchisors to cover the administrative costs of managing the mandated vendor program. All other revenues, commissions and related benefits received from mandated vendors should be invested in programs that benefit the franchisees, including allocating the money to marketing and advertising campaigns for the hotel brands or reducing the franchisees’ royalty fees.

Courts Have Ruled Against Exclusivity

It has long been a poorly-kept secret that a major profit center for many franchisors is the sole sourcing requirement that forces franchisees to purchase products only from franchisor-designated vendors. Forbes published in October 2006 its “Ten Good Reasons Not to Buy a Franchise.” No. 7 is “inflated pricing on supplies” because “almost all franchisors receive kickbacks from the vendors.” The practice of franchisors selling products or services at a profit or receiving a commission or rebate from suppliers has also been the cause of many lawsuits. For example, some Blimpie franchisees filed a class action arbitration proceeding against Blimpie’s for allegedly taking “kickbacks” that produced inflated prices for products. A group of franchisees of D’Angelo’s Sandwich Shops filed suit in Massachusetts claiming that “kickbacks” paid to their franchisor on franchisee purchases violated the Robinson-Patman Act.

A few years ago, Dairy Queen found out in the Collins v. American Dairy Queen litigation that allowing franchisees the right to alternative suppliers can sometimes backfire. In a class action, the franchisees claimed that the franchisor so delayed and obstructed the product approval process that it had effectively forced the franchisees to buy from it.

In May 2003, a federal judge in Minneapolis agreed with some Domino’s franchisees that Domino’s breached the franchise agreement by requiring franchisees to purchase a new computer system (called PULSE) only from the company. The judge ordered the company to give storeowners the system’s specific-actions so they could shop for a better deal in the marketplace. Michael Dady, Esq. of Dady & Garner, attorney for the franchisees said, “franchisors that make themselves the sole supplier of equipment in their franchise agreement can run afoul of anti-trust laws.”

--

This is part of a series. Please read:

• Fair Franchising Is Not An Oxymoron, Part 3 
• Fair Franchising Is Not An Oxymoron, Part 2 
• Fair Franchising Is Not An Oxymoron, Part 1 

Related readings:

• Domino's Franchise Association Prevails in "Pulse" Dispute with Franchisor  
• Ten Reasons Not To Buy A Franchise  

--

Stanley Turkel, MHS, ISHC, is a New York-based hotel consultant specializing in hotel franchising issues, asset management and litigation support services. He is also available for due diligence studies for an acquisition, a third-party audit of a marketing or operational problem, an expert review of a management contract or a franchise agreement, or litigation support. Mr. Turkel is a member of the International Society of Hospitality Consultants and can be reached at 917-628-8549 or email at stanturkel@aol.com