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Purchasing Cooperatives: Increased Franchisee Profitability, Improved Franchise Relations

September 2009 Franchising World

Purchasing cooperatives can provide a vast benefit when used properly. 
 
By Keith Miller and Barry Miller
     
It can be argued that the key to the long-term success of a franchise system is the profitability of its franchisees, which, in turn, leads to better franchise relations. Let’s face it, winning teams get along better.
  
A key strategy to increasing franchisee profitability and long-term franchise success can be the formation of a purchasing cooperative for the materials to operate the franchised outlet. While purchasing co-ops have most often been associated with the larger franchise systems, smaller concepts can also form national or regional co-ops, or at a minimum, implement some of the best practices commonly used by the purchasing co-ops.
  
First, the structure must be created, and depending on the franchise   concept, its goals. For a franchise concept, the members of the co-op will be the outlet operators. This can include the franchisor, in addition to the franchisees, if the franchisor also operates units. Traditionally, the co-op members will elect a board of directors that will guide the direction of the co-op, including the hiring of key staff that actually completes the purchasing process and the administration of the co-op.  
  
Money, Money 
Of course, to run a co-op, there must be a source of funding. That funding is normally garnered by “taxing” some of the products the co-op is negotiating. It may be a penny a pound or 10 cents a case on certain products. While on the surface it may seem that franchisees would balk at the thought of paying extra for a product to fund the co-op, they soon find that having a team of purchasing experts to run the co-op will pay back many times over. In accordance with co-op law, all excess collections must be returned to members. This rebate check will often feel like a windfall to the co-op members. Knowing that any excess collections must be returned to the members also takes away any suspicion that is often unfairly directed at the franchisor.   
 
In many franchise concepts, the franchisor will negotiate prices for the franchisees. However, the franchisor is often unable to make contractual commitments for product quantity or time periods. Co-ops will sign contracts that commit to purchase quantities over a specified time period. Since it is really an extension of its members, the co-op can assume the risk if product quantities are not met. While the co-op does execute the purchases, it must work very closely with the franchisor.  
  
The franchisor still has ultimate responsibility for the brand and must set the standard for each product the co-op is purchasing. There must be a strong team effort between the franchisor, usually the research and development department, and co-op to ensure reasonable specifications are written, agreed to, and met. Ongoing teamwork and testing will make sure the products continue to meet the specified requirements.
  
Depending on the products purchased, the co-op must draw on specific expertise. The purchaser may need to monitor commodity futures to understand the best time to complete the negotiation. If raw materials are less expensive at a specific time, and the co-op commits to a quantity purchase, the supplier/manufacturer can buy those raw materials at the best possible price, and therefore be able to reduce the end-product cost.
  
From the franchise relation’s perspective, franchisees will be more likely to trust the co-op’s motives, as they are the owners of the co-op. While it is not uncommon for part of the royalties to be part of the product costs, and there is nothing inherently wrong with that, it often creates distrust between the franchisees and franchisors. Every time prices go up, franchisees assume the franchisor must be making more money. Or they may feel that the franchisor executes certain promotions that maximize its profits on purchasing. Of course, these assumptions are often unfair, but we know those thoughts exist.
  
Start Slowly
As the co-op gets started, it is important not to try to do everything at once. Start with the low-hanging fruit: those items that can make the biggest impact and are the easiest to accomplish. For a fast-food system, the protein items (burger patties, sliced turkey, etc.) typically make the most sense. You may start with a short-term contract in the beginning, but wait until the best time to negotiate the long-term contract. For example, you probably don’t want to negotiate turkey during November. Early success stories give the co-op momentum and gain the trust in the system. This will make it easier as you start to work on the more difficult products.
  
Suppliers are sometimes threatened by the creation of co-ops. However, in a very short period of time, they learn that many non-value-adding selling, administration, and distribution costs are eliminated from the process, allowing them to lower costs and become more efficient. This creates a stronger partnership between supplier and customer and allows both parties to focus on value-adding segments of the business, i.e., research and development.  
  
Seek Efficiencies 
Now that you have implemented, through your purchasing co-op, the best possible prices, what’s next? Besides staff maintenance of the existing contracts, the co-op can start to look at maximizing other efficiencies in the system. Distribution costs have become extremely high in the last few years. Improving the logistics of how products move from the supplier to the end user can be a complicated process, but can pay substantial dividends in the end. For example, making sure products have the shortest possible distance to be shipped is an obvious first step. The use of consolidation warehouses is another possible solution. Each truck has a weight and cube capacity. If you are shipping Styrofoam, you quickly fill up the cube space, but have little weight. If you   are shipping bricks, the weight limit is quickly reached, but cube space is wasted. Having suppliers send shorter distances to consolidation warehouses, and then having those warehouses combine products from multiple suppliers to send to local distribution centers gives you the opportunity to optimize the shipping expenses.
  
A final step in the co-op’s growth could be to provide both business and personal services to its membership. This may be in the form of discounts at office supply stores, promotional services, payroll and accounting services, telephone services, janitorial services, etc. The list is endless, and all can help the franchisees become more profitable.
  
One successful example of a purchasing co-op is the Independent Purchasing Cooperative, or IPC, which purchases for the Subway Restaurant chain. IPC is just over 10 years old, and its primary goal is to achieve the lowest-landed cost of goods to its franchisees. In Subway, the IPC initially reduced costs to the system by 2 percent to 3 percent. With food costs in the 30 percent range, that was nearly a 10 percent reduction of food costs. Since that time, IPC has further streamlined the whole distribution process with savings that give it a huge advantage over many key   competitors. Everyone has seen the success of Subway’s $5 Footlong promotion, but without what IPC has accomplished, the profitability of the promotion would not have been achieved, and product demand would not have been met.
  
While purchasing cooperatives are not for every system, they can provide a vast benefit when used properly. They can become a key member of the team that makes the franchise concept, the brand, successful. In the end, they can significantly increase franchisee profitability, which will lead to greater expansion from within, and a healthier franchise system. 

Keith Miller has been a Subway franchisee for 22 years and is a director on the North American Association of Subway Franchisees, serving as its president and chairman in 2000-2001. He serves on IFA's Franchisee Forum and is co-vice chairman of IFA's Franchise Relations Committee. He can be reached at 530-906-3988 or millerk@jps.net.

Barry Miller is president of NBM Management Inc., a Sylvan Learning Center franchisee and serves as chairman of the IFA Franchisee Forum.  He can be reached at barrymiller@sbcglobal.net

Both authors serve on IFA's Franchise Relations Committee. For more perspectives on franchise relations, visit  www.franchise.org and select Member Resources, Publications.