Recommended Vendors And Cost Of Goods: The FSC


In the late 90s, as many franchisees will recall, a class action was commenced by several franchisees against the Southland Corporation (the predecessor company of 7-Eleven, Inc.) which alleged many wrongdoings by the franchisor, chief among them being that Southland breached the store agreement by failing to give franchisees credit for the value of rebates, discounts, and allowances received from vendors, and that Southland marked up and earned a profit on goods sold to franchisees through the distribution centers.

From that litigation, commonly called the OFFF lawsuit, was born the 2004 version of the store agreement which all then existing franchisees were entitled to sign regardless of the scheduled date of termination of their individual agreements.

For you newcomers, believe it or not, there was a time not so long ago when there was no such thing as “recommended vendors” or “designated vendors.” In those days, pre-2004, you could purchase all inventory from any bona-fide vendor providing only that the merchandise be of “a type, quantity, quality, and variety consistent with the 7-Eleven Image.” The definition of “7-Eleven Image” was, and still is, an ever-changing phenomenon. The 2004 agreement introduced the concept of requiring franchisees to purchase 85 percent of purchases and, separately, 85 percent of cigarette purchases from recommended vendors. The 85 percent requirement continues to this day in all agreements and imposes a penalty of an additional two percent on your 7-Eleven charge if you fail to meet the requirement for three consecutive months.

But with the 85 percent requirement, it became necessary to somehow make certain that SEI’s recommended vendors were not taking advantage of a “recommended status” and charging prices higher than their competitors. What to do? The answer: create the Franchise Selection Committee to make certain that, in negotiating with recommended vendors and manufacturers, SEI makes “a commercially reasonable effort to obtain the lowest cost for products and services available from such vendor to 7-Eleven stores on a Market Basket Basis by identifying all available discounts, allowances and other opportunities for price adjustments.”

The provision then goes on to state a formula in which discounts and allowances, advertising allowances, and other available allowances will, to the extent possible, be declined in favor of a lower cost of goods. If a lower cost of goods is not available in lieu of discounts and allowances, then the discounts and allowances will be credited to cost of goods that results in the sharing of these credits.

The Franchise Selection Committee, as defined in Exhibit J of the store agreement, consists of five members, each of whom are presidents of local FOAs and who are empowered to select a Third Party Reviewer (accountant or other person having experience in reviewing and identifying discounts and allowances) for which SEl will pay $75,000 annually, adjusted for inflation. The process permits the Committee and the Reviewer to review vendor agreements, but under a strict agreement of confidentiality.

The process is rather convoluted and, for those wishing to inflict pain on themselves, can be fully found in Exhibit J to all agreements. It is noteworthy that if SEI is found to have violated its obligations to obtain the lowest cost of goods, after mediation and/or arbitration, then (get this) “no damages, including money damages, specific performance, injunctive relief, or attorney’s fees and costs may be awarded.” Only discounts and allowances not properly credited to cost of goods can be rectified. Talk about a toothless tiger.

The Review Committee has an almost impossible job and only limited funds under which to operate. It requires shopkeepers to assume the mantle of experts in reviewing contracts to determine if any violations occur, and under SEI’s shield of confidentiality. To the best of my knowledge, the Committee has not found any violations to this date.

Much confusion surrounds SEI’s obligation, quoted above, to make reasonable efforts to obtain the lowest cost of goods, because that obligation is limited by the phrase “Market Basket Basis.” That phrase is defined in Exhibit E as follows: “Market Basket Basis” means a vendor’s standard product mix that meets our Stores’ purchase needs (excluding Proprietary Products), and is sold under terms that include a balanced comparison of payment terms and methods in store services, product mix, service area, frequency of delivery and delivery windows.”

The long and short of it is that demonstrating that milk or any individual product can be bought for less from a non-recommended vendor will not make that purchase includable in the 85 percent requirement. What is needed is the impossible task of finding a vendor with the same basket of goods that meet the payment and distribution criteria as your CDC or McLane, and which charges a lower cost for all goods sold and which also has similar distribution methods, payment terms, etc. Who writes this stuff?

Sorry if I gave a headache.