When contract manufacturing in China and elsewhere in Asia, an oftentimes overlooked but important step to consider is creating a contract. A contract is an agreement between supplier and customer that should outline assumptions and expectations from both sides. Done correctly, these contracts are important for creating structure and capturing critical details regarding timelines and workmanship.
In full disclosure, few companies at all will ever be able to legally enforce a contract and Chinese suppliers will not give a lot of weight to any legal document. The most significant reason to create this document is to begin a dialogue on the front end of a new partnership to (a) capture the most critical details for your product launch and ongoing supply chain needs so that (b) your business relationship starts afoot on a positive note.
Here are six tips for things to consider when structuring agreements between contract manufacturers in Asia:
“Quality” is a subjective term only brought into focus with technical details and measurements. Workmanship is often understood quite differently between a supplier and a customer. Clear agreements regarding quality ensure that finished goods are produced as expected and meet identified quality standards. Both parties should agree how quality will be measured, tested, and what level of quality is acceptable versus unacceptable. There may be varying standards for fit and finish, performance, and packaging that can be captured as categories such as “minor” or “critical.” Agreements will cover these as well as frequencies and conditions for permission to conduct factory audits and pre-shipment inspections or PSIs. With travel by company personnel nearly impossible, third-party sourcing and QC agents make good sense. Engaging a China sourcing agent is an effective tool for ensuring quality control during the pandemic.
Timing and Fulfillment
A contract manufacturing agreement should also include explicit terms detailing timing for production runs and fulfillment. If penalties for late delivery dates are included it should be explained that this is due to your brand being penalized by your customers. Production schedules are often loosely planned by manufacturers with priority given to high volume customers. Delays can become months rather than days at a time especially during busy seasons like Chinese New Year and before Black Friday.
Changes to Products
Changes from both sides are common especially on first production runs. Brands should be solely responsible for any modification in design and materials. As changes from original drawings are made, it can be unclear who then owns the intellectual property rights of the designs – the customer or the supplier. Pay particular attention to who pays for any new tooling or development work. A thorough written agreement outlines which party maintains IP rights given certain scenarios. This gives added protection to companies concerned with IP theft.
The actual cost of manufacturing is subject to fluctuation which means the factory may have grounds to increase costs even after negotiations have started. Factors such as currency fluctuations, material changes, and labor costs can have a significant impact on the final cost of manufacturing. While tariffs significantly impact landed costs they should be treated independently from manufacturing costs.
The rising costs of manufacturing are worldwide and not isolated to China. Contracts should include language that specifically details how and when the supplier can modify cost from the original quotation. In normal times it is not uncommon to ask for volume incentives or tiered pricing when possible that rewards quantity promises and targets. Without such an agreement, it would typically not be a breach of contract to escalate prices until an official purchase order has been placed and accepted.
Service levels are broad based aggregates and results of all of the above over periods of time. In Western vernacular these are measured typically as KPIs. Agreements should also articulate whether or not you plan on reviewing these, at what frequencies and any corrective actions or penalties to be put into place if the level of service does not meet the agreed upon standards. Conversely there should be some sort of reward or incentives for the supplier should KPIs meet or exceed established benchmarks.
Finalizing the Contract
When finalizing an agreement with a manufacturer, there are a few additional recommended actions before having both parties sign the dotted line. The contract should be written in both English and Chinese to avoid any misunderstandings due to language differences. When the contract is ready to be signed, the signee from the manufacturing party should be a factory owner or, at the very least, a general manager – not a salesperson or other factory employee. The contract should then be signed and receive the factory’s seal of approval, or “chops”, which is a customarily binding act in China.