Planning Mandatory Purchases Before Franchising: Purchasing Obligations and Supply Responsibilities

Materials and equipment routinely used in company-owned outlets are not necessarily essential for franchisees. You need to distinguish between suppliers chosen for the owner's convenience and those needed to maintain brand quality. If you are converting an existing business into a franchise, clarify what franchisees must buy and from whom before drafting your first agreement. Trust across a franchise network comes from more than using identical products. It develops when the franchisor explains purchasing obligations and accepts corresponding responsibility for supply.

1. Divide your current purchasing list into mandatory, specification-based and unrestricted items

Start by collecting order histories and transaction statements from your company-owned outlets to build a list of actual purchases. Looking only at core ingredients means overlooking recurring costs for franchisees, such as packaging, cleaning products, consumables and equipment parts. For each item, record its purpose, supplier, possible substitutes, order quantities and storage requirements. Include items that franchisees must buy from a specified supplier, even if the franchisor does not sell them directly.

The following three categories can help you assess the list:

• Candidates for mandatory purchasing: Items whose replacement would alter core quality or brand identity, such as a sauce made to a proprietary recipe.
• Specification-based items: Items that can be bought from multiple suppliers, provided they meet performance, material and hygiene standards.
• Unrestricted purchases: Items with little direct bearing on brand consistency, allowing franchisees to choose based on price and convenience.

These categories are an internal assessment tool, not statutory classifications. Having used an item in your outlets for years does not, on its own, justify requiring franchisees to buy it from a designated source. For each item, try explaining in one sentence what would go wrong if franchisees could buy freely. If the explanation is vague, consider setting quality specifications rather than restricting suppliers.

2. Use evidence to establish the need for mandatory purchasing

Franchise transactions in South Korea are governed by the Fair Transactions in Franchise Business Act and its Enforcement Decree. The Act prohibits unfair trading practices, including unjustified restrictions on trading partners. Simply including a purchasing obligation in the agreement does not make every designated-supplier arrangement legitimate. You must consider whether it is necessary to maintain quality and operational consistency, and whether the restriction is excessive.

In practice, prepare a short assessment for each candidate item. Record why a designated source is needed, what differences arise when other products are used, why specifications alone would not provide adequate control and what burden the requirement places on franchisees. If you conduct comparative tastings or performance tests, retain the test conditions and results. The key is to distinguish personal preferences from verified differences in quality.

For example, a drinks outlet may need cups of a particular specification to work with its sealing equipment. That does not automatically mean the cups must be purchased from a single seller. Check whether other products meeting the same specification also work safely. By contrast, a proprietary drink concentrate may require a designated source to reproduce the flavour consistently and protect manufacturing information.

If the franchisor or an affiliated company is involved in supply, review the reasons for its selection and how it earns revenue. The concern is not supply revenue itself, but compulsory purchasing without a clear justification and charges that lack transparency. Have the final scope reviewed by a Korean franchise transaction specialist (gam geo rae sa) or a lawyer, providing both the relevant legal requirements and details of the actual trading arrangements.

3. Set the pricing method and trading terms before drawing up a price list

Where a franchisor requires franchisees to deal with a particular trading partner, South Korea's franchise legislation requires the franchise agreement to specify the types of property, services, equipment, goods, raw materials or ancillary materials involved, together with the method for calculating supply prices. Do not stop at a clause stating that franchisees must buy designated items at prices set by the franchisor. Franchisees need to understand both the items covered and how their prices are determined.

The calculation method must work in day-to-day accounting and supply operations. If the price consists of purchase cost plus logistics costs and a set supply fee, first define the basis of the purchase cost and which expenses count as logistics costs. Check for double charging, such as packaging costs included in the purchase cost and also billed separately. If the calculation is complex, prepare worked examples.

Trading terms beyond the unit price also affect the total cost. Set minimum order quantities, delivery charges, island-area surcharges, return criteria, arrangements for short-dated products and payment timing as a coherent package. Even a low unit price can leave franchisees worse off if excessive order quantities lead to more waste.

Also establish a review process for changes in raw material prices. Check the statutory duty to consult over changes that make trading terms less favourable, and distinguish notification from consultation. Sending a price increase notice does not necessarily fulfil all consultation requirements. Put a system in place to record the reasons for changes, supporting calculations, proposed implementation dates, franchisee feedback and the franchisor's responses.

4. Pair purchasing obligations with responsibility for shortages

Requiring franchisees to use a particular supplier means supply disruptions directly affect outlet operations. The franchisor must do more than impose contractual purchasing obligations: it must also establish who is responsible for order processing, delivery, handling reports of defective goods and arranging substitute supplies. Check that supplier commitments support the service levels promised to franchisees.

In particular, you need a substitute approval process before outlets open. If a shortage leaves franchisees waiting indefinitely for head office to respond, they may buy without authorisation or stop selling affected products. The people responsible should be able to answer these questions:

• Who informs franchisees of shortages or delivery delays, and when?
• What criteria are used to assess temporary substitutes, and who approves them?
• How are additional costs arising from emergency purchases handled?
• How are instructions to stop using or recall products communicated when quality problems arise?

Do not test only routine ordering at company-owned outlets. Simulate delayed deliveries and the arrival of defective goods as well. Check whether substitutes change preparation times, equipment operation or the information customers need. For food products, also review any changes to allergens or labelling information. Specify the permitted uses and end conditions for approved substitutes so that temporary measures do not become indefinite practice.

5. Cross-check three documents before signing the first agreement

At the final stage, compare the franchise disclosure document, franchise agreement and actual ordering materials side by side. The disclosure document must accurately describe restrictions on trading partners, costs borne by franchisees and other relevant matters in line with the applicable preparation requirements. The agreement must include statutory particulars, such as designated items and supply price calculation methods, while ordering materials must translate those provisions into actual ordering terms.

Different item names across documents can create disputes over whether they even refer to the same product. Use shared item codes and align the names in the agreement's attached schedules with those on the ordering screen. Check that items described as unrestricted during discussions are not set up as mandatory purchases in the ordering system. If the disclosure document changes, check the applicable amendment registration or reporting obligations and deadlines.

Finally, ask a staff member to act as a franchisee and prepare an ordering plan using only the purchasing terms. If they cannot independently work out the quantities needed, total cost or whom to contact during a shortage, the explanations or documents may need improvement. This does not replace legal review, but it helps test whether the arrangements are usable in practice.

Practical takeaway: Start today by identifying which items on your company-owned outlets' purchasing list genuinely need a designated source. You are ready to propose purchasing obligations to franchisees only when you can explain why each item is necessary, how its supply price is calculated and what alternatives are available if supply stops.