Wednesday, November 16, 2011

What are franchisees and contractually where do they stand?

I had a comment left on a prior post asking be to address franchisees, so here it is.

A franchisee is an independent company that has an agreement with a company (the Franchisor) that will include many things. As a franchisee is licensed to use the Franchisor’s name and logos in the operation of their franchise, the company will have many controls in their agreement about what the franchisee can or can’t do. There can be requirements on the purchase of goods, and services from the Franchisor. They may be required to purchase certain services from the Franchisor or participate in regional or country-wide programs or advertising campaigns run by the Franchisor. The franchisee as part of the agreement may be granted exclusive rights to certain locations, areas, or even countries. The franchisee paid the Franchisor a fee to purchase those franchise rights. They may make additional payment similar to royalty fees based on their performance and sales and they will pay for any products or services the Franchisor requires them to purchase. As long as the franchisee operates their business in accordance with their agreement they get the rights to continue to operate the business and use the Franchisor's name. If they breach their agreement, the Franchisor could stop selling the what they need to operate and seek an injunction against their using the Franchisor’s name or brand in the future.

From a contractual perspective, the Franchisor has no ownership interest in the Franchisee. There could be a financing agreement between the two companies where the Franchisor would be a secured creditor, but any ownership interest in a franchisee by the Franchisor is not common. A franchisor may operate their own locations and when they do those would be subsidiaries. A franchisor could potentially repurchase the franchise rights with the intent of operating it as a subsidiary or reselling the franchise rights to a third party. Any rights to repurchase would either need to be included in the agreement or would require mutual agreement.

Since the franchisee is an independent company, the Franchisor has no liability for the franchisee. If the Franchisor, as part of the sale of goods or services to the franchisee, provided warranties or indemnities that the franchisee could pass on to their customers, a customer could enforce those. Barring that the only liability that a Franchisor could have would be tort liability claims for personal or property damage that was caused by the Franchisor’s product.

This means that a franchisee from a contracts standpoint would be equivalent to a minority owned subsidiary or an affiliate that the company did not have control over with one difference.
In both the minority owned subsidiary or affiliate lacking control the Company would still
lose based upon their ownership share in those companies and that would effect the profits they could return to the company. In a franchisee situation, unless it’s a product liability clam, all losses and damages would be borne by the franchisee.

From a sourcing perspective this means that even though they may have the franchisor’s name on their business, for anything other than product liability you could only look to the franchisee and you should qualify them as a compete separate company before buying from them.

If you learned from this post, think about how much more you could learn from the book.
The book is only US$24.95 plus shipping. The hot-link to is above the date.

Step pricing versus bill-backs

Every buyer wants to get the price for a quantity of 100,000 units without making a firm commitment to purchase that quantity. Suppliers that are use to dealing with this will usually counter with a proposal of either step pricing or discounted pricing with bill-backs if quantities are not met.

The concept of step pricing is simple.
The first X units are at _______________
The next X units are at _______________
The following are at _______________
Etc, etc, etc.

Under a bill-back approach the price would be provided at the highest quantity, but is you failed to purchase the entire quantity that the price was based upon, you would be obligated to pay the difference between the price you received and the price that you would have actually earned based upon your actual quantity purchased.

The major advantage of step pricing is there are no bill-backs if you fail to purchase the quantity. You earn the reduced price based upon the quantity of purchases that you have made. The major advantage of the bill-back approach is you get the low price throughout. A second advantage of the bill-back is you have the use of the that money difference in payments until you have to pay the bill-back amount. The major disadvantage is that if you fail to purchase the quantity, while you are not obligated to purchase the remaining quantity you are subject to the bill-back on the difference between the price you actually paid versus what you would have at that quantity.

Both approaches are good in that they are not making firm commitments to purchase the high quantity. The major issue you should be concerned about in negotiating a deal with step pricing or bill-backs is the cash flow and the time value of money. With step pricing scenarios you pay the supplier at a higher rate earlier so in the interim they have the use of the money. With the bill-back approach you have the use of the difference in the amount until you have to make a bill-back payment. Suppliers who are aware of this impact will usually structure the prices as specific
volumes differently depending upon whether its a step price or a bill-back approach. The prices for step pricing would usually be lower than the bill-back prices at the volumes as the supplier is having the use of the money in the interim period.

If you have a supplier propose either method calculate what your unit costs would be at various levels to determine which is the best approach to follow. If you agree to use the bill-back approach you need to be prepared to have to pay the bill-back if you do not meet the required quantities, One way to do that would be to work with your accounting people to establish a reserve where you pay the supplier the estimated quantity price and sell transfer the product to the internal customer at a higher price with the difference being placed in a reserve. If you don’t meet the needed quantity you pay the bill-back out of the reserve, if you do meet the needed quantity the reserve can be paid to the internal customer to reduce their cost.

If you learned from this post, think about how much more you could learn from the book.
The book is only US$24.95 plus shipping. The hot-link to is above the date.