Buying Power

With the cost-of-living crisis high in people’s minds we thought it timely to revisit one of our founding editor Simon Lord’s most popular articles from a few years ago. Businesses which are part of a franchise system can find a significant edge over others when it comes to ‘buying power’.

But what does this term mean, how does it work and what advantages does it give you?

Although franchises are made up of independently-owned businesses, the franchise group as a whole uses the same brand name, the same operating systems and, crucially, offers the same products or services. This means that the franchisor can negotiate volume discounts on supplies based on the needs of the whole group, rather than each individual franchisee having to do their own deals.

For example, a café franchise with 75 outlets which buys all its milk from the same supplier will be able to get better prices for its franchisees than an independent café can get, even from the local wholesaler. A reduction of, say, 5c per litre might not seem like much, but when you apply the same principles across a whole range of ingredients, it starts to add up – and when you look at other areas where buying power can be put to good use, the value becomes obvious.

Getting started

When you’re first getting started, for example, buying power applies to one-off expenses such as:

• Equipment
• Fit-out
• Signage
• Vehicles

That can make a big difference to the cost of getting up and running. Apart from the fact that you’ll pay less than an independent business would, the franchisors’ experience should mean that you are buying exactly what you need when you first get started. That saves you spending your much-needed capital on the wrong things: equipment that won’t last or isn’t up to the job as you grow.

Another area where the size of the group can make a big difference when you first set up is funding. A well-established franchise with a strong track record will be able to access better funding options for franchisees from its preferred banks. These may include funding against the value of the business itself.

Ongoing advantage

Buying power is even more important on an ongoing basis. Every day, it can affect the price you pay for essentials such as:

• Products
• Ingredients
• Packaging
• IT
• Telecoms
• Marketing
• Insurance
• Accounting
• Leasing
• Finance
• Fuel

As a franchisee, this can make a considerable difference to your bottom line. Having group rates on all these things benefits your margins, profitability and – vitally – competitiveness. It gives you an advantage over independents and enables you to compete with the corporates while still owning your own business.

Examples

So how is buying power actually applied? Stuart Deeks, the former franchisor who took Esquires Coffee around the world, explains: “Let’s say that in your sector the industry standard gross margin is 70 percent – that’s before all the fixed overheads such as wages, rent, rates and so on. As a franchisor, my job was to ensure that franchisees could achieve at least that margin (after franchise fees) and beat it where possible, while still getting all the other benefits the franchise offers – marketing, support, systems, training and so on.”

Matthew Everest, the former managing director of Pack & Send New Zealand, now travelling the world playing cricket, told Simon, “Pack & Send receive significant discounts on our freight rates otherwise we would have been out of business pretty quickly. But with regard to consumables and equipment, we ensure a certain standard, rather than just always buying the cheapest. Obviously volume helps with negotiations, but building good solid relationships with suppliers is also really important.”

Grant McLauchlan provides an example from the commercial cleaning industry. “CrestClean franchisees use chemical systems manufactured in New Zealand, and licensed by Eco Choice Aotearoa, so they have proper environmental accreditation,” says Grant, who is CEO of the franchise. “These are supplied at wholesale prices, as there are no middle men and franchisees can order online and receive by courier nationwide.

“The total cost is significantly cheaper than if they were to procure chemicals on the open market. They also receive a quality product, best in class, which helps increase the productivity of their business.”

And it’s not just about consumables. “CrestClean provides its franchisees with individual Public Liability Insurance cover of $20 million via a master policy with Gallagher (formerly Crombie Lockwood NZ Ltd). This comes at an annual cost of around $510 including GST a year per franchise business – similar standalone policies can cost more than five times this amount and often provide less coverage.

“Crest also has relationships with finance companies for for vehicle or equipment purchases at favourable rates, as well as approved franchise status with the main banks for the initial franchise purchase.”

More than just money

Andy Lucas, co-director of The Coffee Club New Zealand, emphasises that buying power isn’t always just about money. “As a percentage we would get a minimum 10-15 percent discount for franchisees on ingredients and equipment, and that would apply to things like insurances, banking, IT and other services, too.

“We also negotiate firmly on other parts of supply agreements which focus on support, training, equipment supply, event sponsorships and innovation – these are the areas which will also assist franchisees to grow their business and remain competitive in their market.

“For example, most of our national food suppliers have sales and training reps on the road who are dedicated to looking after our business, training staff in each store, assisting with product queries, etc. At a top level, suppliers also spend a lot of money on innovation sessions with us which is a great source of information when it comes to planning menus, looking at trends and so on.

“One of our franchisee conferences was fully paid for by suppliers through licence fees and sponsorships, which meant there was no cost to franchisees. In fact, we were even able to provide a significant travel subsidy to regional franchisees to assist them to attend conference.  This would not be possible without the support of suppliers.

“In addition, all our new menu projects/launches are paid in full by suppliers, including menu and menu board printing, point of sale printing, new glassware, crockery, etc. This is made possible through our key national suppliers.

“From a marketing perspective, when we launch national campaigns which utilise a specific supplier product we look to the supplier to provide free product or a subsidy paid to stores as a goodwill gesture – showing their support in the supply partnership. As an example, we run free coffee digital campaigns paid for by Fonterra who also give us a credit on every franchisee’s account for significant dollar value.”

Size matters

It’s worth noting that the sort of support Andy is talking about generally only becomes possible when:

 a) the supplier is itself a large company rather than a niche provider or a wholesaler of other people’s products; and

b) the franchise has reached a certain size itself. This is an important point: if you join a newer franchise, it may offer more opportunities for growth in terms of location, market share and potential, but don’t expect it to offer the same buying power as an already-established brand.

As the business grows, so does its ability to negotiate in other areas. Franchisors work hard to get good prices for their franchisees and the more units they get the better buying power they have – not just for products, but for quality service providers too.

As one franchisor told Simon, “We do get some great rates on insurance and banking services but, it’s not just about money. We find the biggest benefit in these areas is having access to key people. This makes it easier for our franchisees to get good advice which helps them make the right decisions as they grow.”

Dealing with landlords

Another area in which the power of an established franchise name can make a big difference is in site and lease negotiation when a new franchisee is first setting up. Landlords want big franchise brands to increase the appeal of their investment, but there are plenty of traps for the unwary.

One franchisor told Simon that a landlord had offered him a contribution of $200,000 towards fit-out costs to take his brand into a new development. As Stuart Deeks points out, “That would be an enormous incentive – it means that a franchise which would normally cost $250,000 to set up would only cost $50,000, which is attractive for both the franchisor and the franchisee. In addition, if the area is growing fast, the franchisor will want to see their brand established before the competition.

“But it’s a new development in a new area, so how long will that franchisee take to reach break-even – how long before they’ve burned through the $200,000 while trying to build the business? If you are a big corporate, you can afford to take the hit for a while because the losses in that store are being subsidised by other profitable outlets, but as a stand-alone franchisee, you’re reliant on the area taking off fast – and landlords make no promises.”

Nonetheless, Stuart found that a popular franchise brand gives you considerable muscle when negotiating on premises, location, fit-out contribution and terms, even with the major mall operators. "Landlords are keen to get franchise brands in because their name will help build foot traffic, whereas an independent is more of a risk so they won’t offer such good terms. And the better the brand, the more you can ask for."

What goes where

Fit-out support, supplier contributions, product training and marketing assistance all sound wonderful, but they can also be a source of friction if franchisees are not fully aware of what is involved. If a franchisee can buy that bottle of milk at 2c per litre less because it’s on special at Pak’n’Save this week, they might understandably feel aggrieved – but in the long term, a trusted supplier should offer better pricing, better quality, delivery to the door, continuity of supply (a major advantage) and many of the other benefits as well.

The real issue comes if franchisees feel that the suppliers are offering volume rebates to franchisors that are not being passed on to franchisees in some form, especially if the franchisees suspect prices are being inflated as a result.

“It’s a matter of balance and transparency,” suggests David Steytler, an advisor who works with a number of well-known franchise brands in New Zealand. “A franchise is a complicated business model and very few can operate on the revenue from fees and royalties alone. Supplier contributions often fund a number of important services and also strengthen the franchisor’s overall revenue stream, much of which is typically reinvested back into the development of the franchise system.

“But it does have to be explained up front. Franchisors need to tell franchisees, “I make my money via a, b, c, d, e … There’s nothing to be ashamed of in having built a business model that works, as long as franchisees know how it works and still feel that they are getting a good deal.”

Andy Lucas agrees. “In our disclosure document and franchise agreement it is declared that we receive licence fees and payments from suppliers, but we don’t declare individual amounts because suppliers don’t want commercially-sensitive details to be generally known.

“Most suppliers have wholesale price lists so we can see what benefit we are getting for our franchisees. It’s about making sure licence fees and support are not so large that they make the final price to franchisees higher than “standard” pricing.”

Of course, different industries require different approaches. While the hospitality sector has big brand suppliers whose best offers come in the form of more complex deals, at Pack & Send Matthew Everest said, “If suppliers offer incentives we tell them that we would prefer any benefits to be reflected in the best rate back to our franchisees.”

And Grant McLauchlan is firm that, “CrestClean does not receive any rebates from suppliers. We prefer to negotiate the best prices, quality and service from suppliers of any equipment, services or insurance for our franchisees.”

Finally

Specialist franchise accountant Philip Morrison has investigated many different franchise models and says that buying power is critical to success. “As Andy has demonstrated, supplier contributions come in all forms and a well-funded and well-resourced franchisor can use them to build a better business for its franchisees.

“It’s really a matter of balance. Where the franchisor makes their money is where they will focus their efforts, so it’s important that they are reliant upon their franchisees being profitable rather than just selling lots of product.

“A good, well-established franchise has a lot of buying power. Used wisely in all sorts of ways, this offers both franchisor and franchisees bottom-line financial benefits, better promotion, better resources and significant competitive advantages. It’s yet another reason why good franchises work so well.”