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Item 8: The True Cost of Required Purchases

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Item 8 of the Franchise Disclosure Document (“FDD”) requires franchisors to disclose any restrictions on the sources you may use to purchase required products and services.  This Item provides such information as obligatory purchases, restrictions on sources of products and services, the amount of any revenue franchisors may receive from required purchases, and the existence of any purchasing or distribution cooperatives.  It is important to fully understand what purchases you will be required to make and from whom, as well as, the fact that the franchisor may generate revenue from your required purchases.

On the one hand, requiring all of its franchisees to purchase certain products from the same supplier, or from the franchisor itself, ensures uniformity and consistency across the system.  This allows the franchisor to maintain and protect the brand, which after all, is one of the reasons you are buying into the franchise.  In many instances, being required to buy from the franchisor is not a problem because the franchisor can negotiate lower prices for the products than you could on your own since it is much larger with many more units operating under it.  On the other hand, when the franchisor generates a significant percentage of its revenue from required purchases, it could be a cause for concern and a sign that the franchisor expends much of its energy selling franchises to collect revenue from franchise fees and required purchases, as opposed to providing back end support to its franchisees to help them succeed.  If this is the case, then you will want to make sure to discuss the topic with current and former franchisees before purchasing the franchise.  It is also important to note that some states, including Indiana, have laws that restrict the franchisor’s ability to require its franchisees to make purchases solely from it or a source designated by it when access to comparable products or services are available from other sources, unless the products are proprietary.

If the franchisor does require that you make certain purchases, you should inquire into the reasoning behind the requirement that purchases be made from the franchisor or a designated source and whether or not the products are available from other sources.  Being required to make purchases from the franchisor or its affiliate isn’t necessarily a bad thing, depending on the circumstances, but it is a restriction on your ability to purchase certain products in the open market.  Therefore, you need to review these restrictions carefully and determine whether it is something you are okay with before purchasing a franchise.