The good and bad of franchise rebates

Rebates are often considered to be a grey area in franchising where franchisors and franchisees can easily differ on the need for rebates, their amount, and their purpose.

Potential franchisees are given information about rebates in a franchisor’s disclosure document, but this is limited to a list of suppliers who pay rebates to the franchisor.

When undertaking their due diligence, potential franchisees should also seek information about the amount and purpose of the rebates in their assessment of a franchise offer.

The very existence, nature, size and extent of rebates can be a potential source of conflict between franchisees and franchisors.

Firstly there is the question of whether or not rebates should exist at all. If the payment of a rebate has the effect of increasing the cost of goods to franchisees and which correspondingly decreases margins, profitability or competitiveness, then rebates will not be good for the overall health of a franchise network.

If, however, the collective buying power of a group can generate discounts for franchisees that are greater than the rebate amount, the cost of goods to franchisees will decrease, which improves margins, profitability and competitiveness in the open market. This is a good outcome for franchisees.

The issue of whether or not rebates are charged at all is often philosophical and will vary from one franchise system to another. Some systems will negotiate group pricing and receive rebates. Other systems will negotiate group pricing and pass all the savings direct to the franchisees. The choice of approach may be determined by other factors, such as the industry in which the franchise operates, the administration cost of managing a rebate program, the type of royalty applied in the franchise system, and the willingness of suppliers to even consider the payment of rebates.

However, if the choice is made to receive rebates from suppliers, the next issue then is how should the income be applied, how much should it be, and across what range of purchases should it be sought?

The application of rebate income

Once a determination has been made about whether or not to seek rebates from suppliers, the next question is what to do with the income received.

Franchisors may choose to retain part or all of the rebate income as a contribution to the running costs of the business above and beyond any royalty income received. (It should be noted that not all franchisors charge royalties, and in some rare instances, rebates may be their only form of income).

Franchisors who already receive royalty income and augment this with rebate income risk the perception among their franchisees of “double-dipping”. In this regard, rebates may be considered a reverse or stealth royalty, because the amounts are calculated on what franchisees spend, not on the sales they generate.

While some franchisors will retain 100% of the rebates for their own benefit, others will apply some or all of the rebate income to elements of the system which may provide a benefit to both franchisor and franchisees. For example, rebates might be allocated to the franchise marketing fund, the annual conference fund, research and development programs, or even distributed to social and charitable causes supported by the network.

This can provide tangible benefits to franchisees through increased marketing activities, lower costs to attend the annual conference, new product releases, or alignment with a cause that has a commercial benefit to the network.

How much should a rebate be?

There are no hard and fast rules about rebate amounts, but in simple terms, a rebate should be no greater than the value it can deliver.

If a rebate is paid on goods or services where the total cost is still cheaper than the price and terms the franchisees could achieve for themselves, the negotiation by the franchisor of the group rate (including the rebate) adds value to the franchise relationship.

However, if the rebate has driven up the cost of goods or terms of supply to franchisees such that they can achieve better terms or prices on exactly the same goods or services elsewhere themselves, the rebate detracts value from the franchise relationship (and risks causing conflict, as well as creating an incentive for franchisees to seek alternative suppliers which are not endorsed by the franchisor).

The amount of the rebate, expressed as a percentage, will largely depend on the volume of goods and services purchased by franchisees from the supplier, and the size of the margin on these goods or services. Additionally, the amount of rebate will also depend on how keen the supplier is to deal with the franchise network or to dislodge a competing supplier.

The percentage amounts can vary significantly from one supplier to another and from one franchise system to another, but can range from fractions of a per cent to as much as 10% (or even more).

Regardless of the amount of the rebate, the worth of any rebate will be determined by the value it delivers to the franchise network as a whole, and in particular to the franchisees who ultimately pay for it.

On what goods or services should rebates be sought?

The list of goods or services on which rebates might be paid is almost endless.

Goods or services that are consumed in high volumes on a very frequent basis are the most likely candidates for rebate arrangements. For a retail fast food business, this might include component food items (e.g. meat items, bread products, drinks, etc) or non-food items such as packaging, cleaning or security services, credit card merchant services, and so on. For a service business, goods or services on which rebates might be received could include insurances, telecommunications, maintenance services, goods, etc.

On high-volume, high-frequency purchases, rebates (as a percentage of the sale amount) are likely to be smaller compared to low-volume, low-frequency purchases where the rebate percentage may be much greater.

Suppliers which are medium to large sized companies are more likely to offer rebates in the normal course of business, while smaller organisations may have little if any experience in offering rebates and initially struggle with the concept.

Government bodies are unlikely to offer rebates unless these are publicly advertised and available to both franchised and non-franchised entities (e.g. solar power rebates for the initial installation of solar panels, and then ongoing rebates for the energy produced).

The bottom line

Negotiating and administering rebates is a minefield for the unwary franchisor, and an important consideration for a potential franchisee. Where rebates fail to add value to a franchisee’s business, the amount and need for rebates will become a source of conflict in a franchise system. Any consideration of the introduction or variation of rebates should be done in the context of the value proposition to the system as a whole.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.