Mandatory Franchise Purchases: Checking Supplier Requirements and Pricing Before You Sign

When choosing a franchise brand, some costs have a longer-lasting impact than the initial franchise fee. These include ongoing payments for ingredients, packaging and consumables that you must buy from the franchisor or designated suppliers. Purchasing standards may be necessary to maintain consistent quality across a franchise network, but unclear obligations and pricing structures can reduce your expected profits. Before signing, review separately what you must buy and how its price is determined.

1. Check the actual purchasing obligation, not just the label

Do not judge your purchasing obligations solely by labels such as ‘mandatory items’, ‘exclusive items’ or ‘recommended items’ used during discussions. An item may be described as recommended even though buying it elsewhere carries a penalty or other disadvantage. Start by reviewing the agreement alongside the item list to establish whether you can buy from other suppliers.

Ask the franchisor to set out the following for each item:

• The exact name and specification of any goods or services you must purchase
• Whether you must buy from the franchisor or a separate designated supplier
• Which items you may buy elsewhere and which require prior approval
• The conditions for using alternatives that meet the required quality standards
• The measures that apply if you fail to comply with designated purchasing requirements

For example, the need to require purchases of a brand’s signature sauce can be assessed separately from the need to require purchases of ordinary cleaning products. Ask how each requirement relates to maintaining distinctive taste or quality. However, finding a similar product on the open market does not automatically make a designated purchasing requirement unlawful. The purpose of the restriction, quality-control needs and contractual terms must all be considered.

Do not limit the list to ingredients. Packaging containers, uniforms and IT services may also be subject to designated supplier requirements. Separating one-off opening purchases from recurring purchases during operation will help reveal the long-term burden.

2. Check the information the law requires in the agreement

South Korea has specific legislation governing franchise transactions: the Fair Transactions in Franchise Business Act. Article 11(2) sets out the matters that must be included in a franchise agreement. Where a franchisor requires a franchisee to deal with a particular counterparty, the agreement must also specify the types of goods, services, equipment, property, leases and other relevant transactions involved, along with the method used to determine supply prices.

A quotation showing current unit prices may therefore be insufficient. ‘What does it cost today?’ and ‘How is the price determined?’ are different questions. If the main agreement refers to an annex rather than setting out the details itself, check that the annex has actually been provided and is clearly identified as part of the agreement.

Also cross-check the purchasing costs and trading conditions stated in the disclosure document. This is a statutory document containing information such as the franchisee’s financial obligations and operating conditions. If the agreement describes a purchase as mandatory but sales materials present it as optional, obtain written clarification of which terms apply before making your decision.

The existence of statutory disclosure requirements does not guarantee that every designated purchasing arrangement or price level is reasonable. Equally, insufficient explanation does not necessarily mean the entire agreement is invalid. If you suspect an omission or an unreasonable restriction, it is safer to have the relevant clauses and annexes reviewed together by a qualified franchise transaction specialist in South Korea or a lawyer.

3. Turn the pricing method into an explanation you can calculate

Start with the main items you will buy repeatedly. Ask what the franchisor’s pricing method is based on and which costs it includes. The supporting information you need will differ depending on whether the price is calculated by adding specified costs to the purchase price or by applying a separate pricing schedule.

Use the following questions to make vague answers more specific:

• What price or cost forms the basis of the calculation?
• Does the unit price include logistics, processing and packaging costs?
• Is VAT included or charged separately?
• Does the actual amount invoiced vary by order quantity or delivery area?
• If the quoted pricing unit differs from the ordering unit, how are they converted?

If the wording says only ‘the price set by the franchisor’, ask for further explanation of the actual calculation basis. Conversely, do not assume you have an unrestricted right to obtain cost and internal profit data for every item. Focus on the explanations you need to understand the pricing method in the agreement and estimate what you will be charged.

If possible, obtain worked examples applying the pricing method to one or two major items. If the calculated amount differs from the current supply price, check whether the difference arises from discounts, delivery terms or the date from which the price applies. The more exceptions there are, the harder it becomes to assess actual purchasing costs from a quotation alone.

4. Compare monthly purchasing costs across brands on a consistent basis

Simply placing unit prices side by side can be misleading when comparing brands. Even ingredients with the same name may differ in pack size, dilution ratio or the quantity required per menu item. First, convert prices into the purchasing cost per unit actually sold.

For your internal comparison spreadsheet, use ‘quantity used per sale × supply price for that unit’ as the starting calculation, then add packaging and any consumables supplied with the sale. In practice, preparation losses and waste may mean you need more than the theoretical quantity, so record those assumptions in separate fields.

A useful sequence for building the comparison is:

1. Choose representative menu items or service packages to compare.
2. Identify the designated-purchase items required for each.
3. Assume the same sales volume and calculate the monthly purchasing quantities needed.
4. Add separate delivery charges and any extra costs arising from ordering conditions.
5. Examine how the results change when usage quantities and the sales mix vary.

This exercise compares purchasing terms; it does not establish a reliable sales forecast. Do not rely solely on the franchisor’s recommended sales mix. Apply the calculation to your own planned operating model too. This can reveal whether selling more of a particular menu item substantially increases spending on designated consumables.

Large minimum order quantities can also increase the amount you must pay before you actually use the stock. Distinguishing the cost of items consumed each month from the purchases you must pay for helps explain how a business can show a profit on paper while running short of cash.

5. Resolve all outstanding purchasing terms before signing

Bring together the agreement, the item-by-item purchasing obligations, the supply pricing method and the current price list for your final review. Recording when each document was prepared and when it takes effect will reduce the risk of comparing terms from different periods.

Classify the answers to your questions as ‘confirmed’, ‘further explanation needed’ or ‘must be reflected in the agreement’. Avoid relying solely on verbal explanations for matters that directly affect monthly spending, particularly whether substitutes are permitted and which charges are billed separately. Do not treat unresolved items as having no cost in your calculations.

Action summary: Before signing, prepare a one-page overview of the main mandatory items, where you must buy them, your purchasing obligations, the pricing method and the amount you will actually pay. If you cannot explain what you must buy and at what price, clarifying the purchasing terms should come before choosing the brand.