Rebates rhubarb

"The evidence shows that A&P has engaged in a course of conduct that is intimidating, threatening and coercive," Winkler said in his decision. Winkler barred the company from communicating any further with its franchisees about the lawsuit.

The Toronto Star
April 4, 2004

Rebates rhubarb
Fulfilling a dream, Lorne Petterson bought a Food Basics franchise in 1996 and the profits rolled in
Dana Flavelle

Lorne Petterson thought he was buying himself a good business when he invested in a Food Basics store, one of a chain of discount grocery stores launched by A&P Canada in 1996.

A long-time A&P employee, Petterson grabbed the chance to flex his entrepreneurial muscle, do some wheeling and dealing, and in his word "make things happen." And for the first few years they did.

Like many other Food Basics franchisees, Petterson soon turned around what had been a struggling A&P store. Sales doubled. Profits rolled in.

Then A&P changed the rules.

Now, many Food Basics franchisees say their losses are mounting, while A&P Canada's bottom line grows fat, according to a lawsuit Petterson and 30 other Food Basics franchisees have filed in an Ontario Superior Court of Justice.

A spokesperson for the supermarket chain said it couldn't comment on matters before the courts. "All I can tell is we're vigorously defending the claim," said Doug Brummer, VP of marketing for A&P Canada.

However, in court filings, the company denies it breached his contract. Furthermore, it says it has voluntarily advanced up to $65 million to struggling franchisees to help them survive.

If the plaintiff's lawsuit succeeds, A&P says, it wants that money back. It further notes that a majority of its 66 franchise operators don't support the lawsuit.

The dispute, which goes to trial in October, provides a rare glimpse of the highly secretive world of supplier rebates, a widespread food industry practise that determines everything from how much consumers pay for groceries to which products get on store shelves.

In fact, supplier rebates are considered so commercially sensitive, everyone involved in the lawsuit has had to sign confidentiality agreements. The plaintiffs don't even know how much money they're allegedly owed. That's one of the things they hope the courts will force A&P to divulge.

The franchisees say they believe A&P has been withholding their fair share of the supplier rebates. A&P denies it is in breach of its contract.

Rebates work like this:

  • Supermarket suppliers of everything from milk to laundry soap give the big grocery store operators rebates, or discounts, on prices for a variety of reasons.
  • Sometimes, it's a straight volume discount. The more the supermarket chain buys, the less it pays per item. Other times, the supplier gives price breaks in exchange for exclusivity deals. The store will buy all its milk from only one dairy, for example.
  • Suppliers use rebates to induce stores to try new products or promote existing ones.

In an industry where stiff price competition keeps profit margins on sales razor thin, the grocery industry relies heavily on supplier rebates for survival.

There is no single accepted rebate for any item. Everything is up for negotiation. The retailer who can drive the hardest bargain can usually realize the biggest gains.

When A&P first created the Food Basics business, it estimated the value of those rebates at 4 per cent of total retail sales and committed to passing those rebates on to its franchisee. And for the first year it did.

But then A&P changed its accounting practises. Rebates are no longer shown as separate items on franchisees' invoices, though A&P says it continues to honour the terms of the agreement.

Around the same time, the franchisees say their profits started dwindling. Sales were still rising. It didn't add up.

"The franchisees are getting squeezed like a lemon at a county fair," said David Stern, of Sotos Associates, the law firm handling the franchisees' case. "They're selling to the public at rock bottom prices. But they're not necessarily getting the products at rock bottom prices."

A&P blames increased competition from low-cost operators like Wal-Mart Canada Corp. In fact, A&P says it's done more than its fair share to prop up struggling franchisees by giving them breaks on things like rent, realty taxes and, in mall locations, common area maintenance fees shared by all tenants.

"A&P had no interest in establishing unprofitable Food Basics stores," the company says in its counter claim.

But the franchisees point to A&P Canada's growing profits and wonder if that's where their rebates went.

The year before A&P created Food Basics, the company was struggling. Canada's food distribution business was changing. Major competitors, such as Loblaw Cos. Ltd. and The Oshawa Group, which later became part of Sobeys Inc., had launched discount chains, No Frills and Price Chopper.

The concept — rock bottom prices, bare bones stores — was a hit with consumers. The discount segment now accounts for 30 per cent of all supermarket sales in Canada.

A&P, which was still operating full-price conventional stores, under the A&P and Dominion banners, was under pressure.

In 1995, the company plunged into the discount market with its own version, called Food Basics. The stores were located in formerly under-performing A&P or Dominion stores.

The first franchisees were mostly seasoned A&P employees, people like Petterson, who began stocking A&P store shelves while in high school, went on to manage a corporate A&P store, then leaped at the chance to launch his own store.

The entry fee was modest, $25,000, plus a loan from A&P to cover the initial cost of inventory and equipment. A&P provided everything, from products, advertising to accounting.

A&P estimated supplier rebates would amount to 4 per cent of goods sold, and also charged franchisees other fees for things like advertising, administration and other services.

The new chain was wildly successful, exceeding even A&P's internal forecasts for sales. Sales at some stores more than doubled. Franchisees' profits soared past the company's $100,000 a year target.

The main point in dispute is A&P's decision to stop showing the rebates as a separate line item on franchisees' invoices. Instead, A&P folded the rebates into the "net" cost of the goods. The company also changed the fees it charged for other services, as was its right under its franchise agreements.

The franchisees say that's when they began to notice profits shrinking.

A&P denies the claim and blames increased competitive pressure in the marketplace. Price competition was heating up. As well, suppliers also changed their billing practises. They stopped publishing volume rebates, instead incorporating them directly into the cost of the product.

Not satisfied with A&P's response, the franchisees took their fight to court.

Last December, they succeeded in being certified as a class, which means they can pursue their case as a group under Canada's relatively new class action law. A&P appealed the certification, saying the three plaintiffs didn't fairly represent all the franchisees.

Petterson, Bernie Marchant and Norm Orr all earn above average profits from their stores, and don't owe A&P any money, the head of A&P's franchise operations, John Peardon, noted in his affidavit.

In comparison, 68 per cent of the franchisees are still paying off their inventory loans, 54 per cent receive periodic subsidies, and 21 per cent are in arrears on their weekly billings, Peardon's affidavit reveals.

The average store profit for all 66 franchisees was $72,333 in 2002, Peardon added.

But Mr. Justice Warren Winkler agreed with the franchisees that the issue in dispute — supplier rebates — is common to all franchisees regardless of whether they've accepted additional aid from the company. A&P appealed the certification but lost in a higher court last month. It's now seeking leave to appeal to a higher court.

Winker also rapped A&P's knuckles for its conduct since the franchisees launched the suit. Among other things, Winkler noted:

  • A&P arbitrarily deducted rent increases from franchisees who refused to sign a release of any claim they might have against A&P.
  • Another franchisee received $1.5 million in store renovations after signing the release form.
  • Peardon personally delivered to each franchisee a release form, which stated the company feared a successful lawsuit would make the current franchise agreements "commercially unacceptable" to A&P.

"The evidence shows that A&P has engaged in a course of conduct that is intimidating, threatening and coercive," Winkler said in his decision.

Winkler barred the company from communicating any further with its franchisees about the lawsuit.

Within the A&P, Food Basics is regarded as a success story. The chain has grown to 66 stores, most of them in Ontario, including 24 in Toronto. They account for a third of all A&P sales and half its profits, according to financial statements its parent company publishes in the U.S.

In the discount supermarket segment, Food Basics ranks second in market share behind Loblaw's No Frills, according to Peardon's affidavit.

The model is seen as so successful, its U.S. parent company, The Great Atlantic & Pacific Tea Co. Ltd., is now experimenting with it south of the border under the direction of former A&P Canada president Brian Piwek.

Even if the franchisees win their case, A&P says it's doubtful it could meet their demands. It doesn't keep records of supplier rebates beyond six months.

Meanwhile, Petterson's dream of expanding into the vacant retail space next door is on hold. "There's no incentive if every day you're going backward."

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