Before Franchising in China: Setting Purchasing Requirements and Supply Disruption Procedures

When turning an existing business into a franchise network, a franchisor may be tempted to make its company-owned outlets’ purchasing practices compulsory for franchisees. Yet ‘you must buy from head office’ leaves key questions unanswered: what happens if supplies are interrupted, who approves substitutes, and who bears the loss if goods are defective? Clarifying these boundaries before signing helps ensure that consistent quality and viable outlet operations support one another.

1. Define which goods require centralised purchasing

Start not with a list of suppliers, but with the materials and supplies that affect the customer experience and operational safety. Assess each item: would changing its source affect the formulation, equipment compatibility, product safety or brand identity? The fact that company-owned outlets have always bought from a particular supplier is not, on its own, enough to justify requiring every franchisee to do the same.

Consider dividing the purchasing catalogue into three categories:

• Mandatory sources: For items with a significant impact on core quality or safety, specify the supplier, specifications and batch traceability requirements.
• Approved suppliers: Allow franchisees to choose between vetted suppliers, and set out the conditions for applying to add a new supplier.
• Independent purchasing: For generic items with little impact on brand consistency, prescribe only the necessary performance or quality standards.

Each restriction should have a specific justification, with a named reviewer and a clear procedure for making changes. Mandatory sourcing is not inherently unlawful, but nor does it give a franchisor unrestricted authority to limit trading choices. Arrangements that exclude alternative suppliers, tie purchases together or otherwise restrict competition should be reviewed individually under the Anti-Monopoly Law of the People’s Republic of China and other applicable rules.

2. Include purchasing terms in pre-contract disclosures and the contract

Mainland China has a specific regulatory framework for commercial franchising. Article 11 of the Regulations on the Administration of Commercial Franchising requires written franchise agreements to include product or service quality requirements, standards and assurance measures. Purchasing rules should therefore not be buried solely in an ordering portal that can be changed at any time.

Article 21 of the Regulations requires franchisors to provide the prescribed information and the contract text in writing at least 30 days before entering into the agreement. Article 22 and the Measures for the Administration of Information Disclosure in Commercial Franchising cover information such as the prices and terms on which products, services and equipment are supplied to franchisees. Designated suppliers and purchasing restrictions should also be explained as required by the applicable rules, rather than introduced only after a franchisee has paid.

The purchasing schedule to the contract should answer, at a minimum, the following questions:

• Who accepts orders, supplies the goods and issues invoices, and to whom should quality complaints be addressed?
• Do prices include transport, installation and taxes, and how are minimum order quantities determined?
• What is the procedure for notifying price changes, and which price applies to confirmed orders?
• How are deliveries inspected and accepted, and how are latent defects handled differently from ordinary visible defects?
• Can the franchisor or related parties benefit from mandatory sourcing, and when must those benefits be disclosed by law?

Existing orders and future orders should be treated separately. Do not use ‘head office reserves the right of final interpretation’ as a substitute for clear price adjustment and dispute resolution procedures. For standard-form terms that materially affect franchisees’ interests, the relevant duties under the Civil Code of the People’s Republic of China to draw attention to and explain those terms should also be fulfilled.

3. Give alternative purchasing a clear process, deadlines and evidence requirements

A mandatory sourcing system should include an exceptions procedure. For example, the agreement can allow franchisees to submit an emergency purchasing request when a supplier confirms that it cannot deliver on time, goods fail inspection, or transport disruption threatens to force an outlet to close. Triggers should be based on verifiable evidence, such as orders, logistics information and test results, rather than a vague reference to ‘special circumstances’.

The emergency request form need only cover the information required for a decision: the item in short supply, current stock levels, the expected date of stock depletion, the proposed substitute, the supplier’s credentials, and any applicable testing or conformity certificates. The franchisor should designate an approver, a deputy and a response deadline.

A lack of response from head office should not automatically be treated as approval of a substitute. Products subject to specific safety requirements, such as food and cosmetics, must still comply with the relevant law. A safer approach is to vet backup suppliers in advance and specify which items may be temporarily substituted and which require sales or the relevant services to be suspended.

Approval records should also specify the outlets, batches, quantities and period covered, so that a one-off emergency permission does not become an ongoing purchasing authorisation. Franchisees should retain purchasing and usage records to help identify affected goods if a problem arises.

4. Test the allocation of responsibility with a supply disruption exercise

Before formally recruiting franchisees, simulate a failure to deliver a core item at a company-owned outlet. Check whether stock alerts are issued in time, whether backup suppliers can deliver, and whether the approval process gets held up by dependence on a single decision-maker. The purpose is not to check that every form exists, but to establish whether the outlet can safely continue trading.

Costs and responsibilities should also be written into the contract: who pays emergency freight charges upfront, how defective goods are set aside and returned or replaced, who leads the response to consumer complaints, and what evidence is needed to support claims for outlet losses. Distinguish between breach by the franchisor, breach by a supplier, a franchisee’s failure to hold the agreed stock, and force majeure. The agreement should not place every supply disruption risk on the franchisee.

Where franchisees buy directly from third parties, the franchisor should also check that the supply contracts and franchise agreement align. For example, if the franchisor promises to help arrange replacements but the supplier’s contract contains no corresponding provision, there may be no workable way to fulfil that promise when a problem occurs. Internal allocations of responsibility cannot exclude businesses’ statutory liability to consumers.

Practical takeaway: Complete the categorised purchasing catalogue, the purchasing schedule to the contract and the supply disruption procedure first, then test them in a real outlet. A mature franchise network should explain not only ‘what you must buy’, but also ‘what to do when you cannot get it’.