Purchasing Cooperatives: Opportunities and Challenges

Operations & Training

By Suzie Loonam 
  
Attention franchise executives: During your next franchise convention, you may be able to walk into a room of franchisees and tell them that next year, you will help them save money every time they purchase goods for their business, perhaps 5 percent, 10 percent or more, you will give them a simplified way to procure goods and services, and at the end of the year, they may very well get cash back for participating. Would you have their attention?
  
When prices for raw materials and commodities rise sharply, businesses respond with innovation and often, advancements in collective purchasing. Purchasing cooperatives have been successfully used to provide discounts and innovation in the delivery of health care, electricity, goods and services for governments, school districts and franchise systems. Purchasing cooperatives are certainly not a new idea, but with commodity costs spiraling upward and businesses’ success dependent more than ever upon their ability to realize profits from thin margins, franchisors and franchisees alike are giving cooperative purchasing renewed attention.  
  
What is a Purchasing Cooperative? 

A purchasing cooperative is a member-owned, member-controlled business, devoted exclusively to purchasing and other supply-chain issues, that distributes benefits to members on the basis of their use. The cooperative distributes benefits to members in two ways: everyday savings on goods and services; and, often, patronage dividends. Patronage dividends are the cooperative’s excess capital that is not needed to meet projected operating expenses that is returned to members via an annual distribution. Franchise purchasing cooperatives are commonly owned by franchisees, and the franchisor may also hold an ownership interest and utilize the cooperative to support its company-owned units.
  
Independent purchasing cooperatives make the most sense for chains comprised primarily of franchised units. For chains with a large number of company-owned units, or in situations where the franchisor has proprietary recipes and products or other reasons to maintain greater control of the supply chain, a wholly-owned purchasing division or a purchasing organization with some, but not all elements of a cooperative may make sense.  
  
The Opportunities 

There are significant opportunities for a franchise system that invests in a purchasing cooperative.
  
Cooperative Purchasing Works

As highlighted by supply-chain expert Ron Cegnar of CEO Partners at the recent IFA annual convention, franchise purchasing cooperatives have been enormously successful of the restaurant franchise purchasing cooperatives that have been established, all are still in existence. As many franchise systems have found, a purchasing cooperative can jettison the most basic buying system into a leading supply chain by allowing the system to achieve economies of scale, decrease costs, share strengths, promote innovative processes, and obtain a return on investment beyond product cost savings.
  
Purchasing Cooperatives Save Time and Money While Adding Value

Purchasing cooperatives provide a centralized hub that save both the franchisor and franchisees time. The purchasing cooperative can address initial requests by franchisees for alternative suppliers or distributors. The franchisees are provided with immediate access to supply-chain professionals to answer their questions, while the franchisor is responsible for addressing inquiries from a single entity rather than many franchisees. Purchasing cooperatives create efficiencies that save a significant amount of money. Members will almost certainly find that their cost of goods and services is lower, and may also find that the cooperative is able to provide their businesses with other types of support (for example, IT support and inventory control methods) to reduce costs. Finally, purchasing cooperatives add value to a franchise system by providing uniform, high-quality goods and services. As successful franchising is based on uniform, high- quality goods and services, purchasing cooperatives naturally augment franchise systems.    
  
Purchasing Cooperatives Allow Focus on Strengths

Franchisors are in business to build, protect and strengthen their brands. They may excel at many parts of the business, but inevitably, the focus of time and resources on supply chain matters reduces the resources that a franchisor has available to continue to build the brand.
  
Franchisees are in business to operate successful units, market their goods and services within their local communities, and to supplement the franchisor’s brand-building activities by establishing and maintaining businesses in compliance with the franchisor’s standards. Franchisees must purchase goods and services in accordance with the franchisor’s specifications and from approved suppliers, but on their own, lack significant bargaining power or perhaps the time to pursue the very best deals on the very best goods and services.
  
Purchasing cooperatives bring supply chain innovation and professionals to a franchise system. With the supply chain covered, a franchisor is free to turn its attention to continuing to build the brand.  With the assurance that an organization in which it holds an ownership interest is pursuing the best bargains day after day, a franchisee is free to turn its full attention back to the operation and marketing of its units. Purchasing cooperatives allow each party to focus on, and continue to build, their strengths.  
  
The Challenges

Purchasing cooperatives present significant opportunities, but are not without challenges, many of which can be traced back to underlying tensions existing between a franchisor and franchisees long before the cooperative is formed.
  
Purchasing Cooperatives Improve Franchisor Effectiveness

Many early franchise purchasing cooperatives were formed by franchisee groups in response to discontent with the franchisor. But the most successful franchise purchasing cooperatives know that to be the most effective, the cooperative needs the support of the franchisor. The purchasing cooperative and the franchisor must be able to work side by side to provide goods and services for the franchisees.
  
A purchasing cooperative can provide significant knowledge to help the franchisor. For example, if a franchisor is developing a limited time promotion that will require all of the units to carry a particular product, the cooperative needs to know well enough in advance to seek out the very pricing and other terms for products to support the promotion. Or, if the cooperative knows that a slight change to the specifications for a product will produce significant savings, the franchisor would benefit from knowing that fact early on, as it may be able to substitute a different product, which will in turn allow the franchisor to suggest a lower price for the product and therefore increase sales volume.
  
Often, despite the benefits of a franchisor and purchasing cooperative working together and the franchisor supporting the establishment and operation of a purchasing cooperative, old “skeletons in the closet” prevent a franchisor and a franchisee-owned or operated purchasing cooperative from working together effectively. The franchisor and cooperative must be able to present a unified front to suppliers and distributors that are part of the system. If there is tension and the franchisor does not support the purchasing cooperative, relationships with suppliers are going to be more difficult for both the franchisor and the purchasing cooperative.
  
Franchisees Must Support the Purchasing Cooperative

Franchisee support is key to the success of a purchasing cooperative. Franchisees must decide that they will become members of the cooperative, will purchase as many goods and services as possible from the cooperative and will support the cooperative as active members and potentially, as board members.  
  
Franchisees are the best encouragement for other franchisees to join a purchasing cooperative. Franchisee board members and representatives can distribute information to other franchisees about the purpose, function and potential benefits of a purchasing cooperative. A franchisor and its legal counsel should review statements and information that is distributed about the membership benefits of a purchasing cooperative to ensure clarity and accuracy.
  
“Maverick” purchasing by franchisees undermines the effectiveness of a cooperative. A purchasing cooperative will expect (and may contractually require) its members to purchase significantly all of the goods and services used in their businesses through the cooperative’s arrangements or programs. If a franchisee feels that it can get a better deal by purchasing goods and services elsewhere, such as through a local supplier, the effectiveness of the purchasing cooperative will be undermined for every other franchisee.
  
The success of a purchasing cooperative over a long period requires active oversight. While much of this oversight may come from the franchisor, involved, educated franchisees are key to spotting supply chain issues and making improvements.    
  
Purchasing Cooperatives’ Legal Issues Must be Addressed

A purchasing cooperative benefits from an engaged franchisor and engaged franchisees. Each can contribute the best of their talents and improve the cooperative. But at some point during the life of most franchise purchasing cooperatives, the cooperative may appear to bring out the worst in its owners and board members. Franchisors and franchisees may find themselves working together closely to address supply chain issues through the purchasing cooperative, which often brings to the surface relationship issues that may have been present for several years or even decades, but never addressed. For that reason, the franchisor and the franchisees should each determine, at the outset, what their values are. What do they hope to achieve through the purchasing cooperative? What roles will each have? How will problems be resolved? Determining their values and working through any issues that may arise at the beginning will lead to a mutually beneficial relationship for the franchisor and franchisees.
  
Determining the roles that each the franchisor and the franchisees will have during the formation and operation of a purchasing cooperative is also important to help the cooperative prepare for and avoid any legal pitfalls. Both the franchisor and franchisees will want to ensure they are adequately represented on the cooperative’s board and through voting rights. In addition, patronage dividends are subject to complex statutes and regulations that require legal expertise and the very success of a cooperative can lead to an attack by its competitors on antitrust grounds. The franchisor and franchisees must be able to work together to address such challenges.  
  
Getting Started 

As with any business, starting a purchasing cooperative requires time, resources and diligence. A franchisor or group of franchisees considering a purchasing cooperative should take three initial steps:
  
Research: Engage an expert to conduct a feasibility study. Talk to executives, members and franchisors involved with other franchise purchasing cooperatives about their experiences and what they would do the same and what they would do differently. Examine what has worked   and what innovations the new cooperative might undertake.
  
Assemble the teams: Forming a successful purchasing cooperative requires teamwork. The best coalition to form a purchasing cooperative would include three teams consisting of franchisor representatives, franchisee representatives, and expert consultants with past experience in the formation of a purchasing cooperative.
  
Determine available resources: Although a purchasing cooperative will quickly become a self-sustaining business, like any start-up, it will not get there overnight. The franchisor should consider what resources it has and is willing to contribute to the cooperative. Does the franchisor have extra office space that the cooperative’s personnel can use? Is the franchisor able to make an initial cash infusion? Franchisees should also consider what resources they have to contribute to the cooperative. Can franchisee members afford to make loans to the cooperative?
  
Delegate tasks and structure a timeline: Once a feasibility study has been completed, teams are assembled and the parties have an idea of the resources available, it is time to make a plan. The   teams should meet to delegate tasks and to structure a timeline to completion, which may take over a year.
  
Communicate: The franchisor and franchisee representatives should keep open lines of communication throughout the formation process. Keeping open communication lessens the chance that a misunderstanding or old problem will derail the purchasing cooperative from being formed.
  
Purchasing cooperatives present significant benefits to their owners and to the franchise systems that are fortunate to benefit from the expertise and quality goods and services they can provide. Though the challenges may seem daunting at first, franchisors and franchisees alike should look to the successful examples of franchise purchasing cooperatives and should keep in mind the benefits that cooperatives provide over the long term.

Suzie Loonam is an attorney with the law firm Haynes and Boone, LLP.