Foreign companies especially from Europe, America and Australia wishing to draft a manufacturing agreement with a Chinese company need to figure out the kind of relationship they would like to form with the Chinese company. China lawyers won’t be able to draft a proper manufacturing agreement until they have a complete knowledge about what type of manufacturing relationship is intended.
Here we are highlighting different types of manufacturing arrangements used in China that foreign companies should watch out carefully.
Original Equipment Manufacturing (OEM) Agreement-
OEM in China referred to the Chinese company that originally build a given product and sell it to the foreign company. In its traditional definition, an original equipment manufacturer (OEM contract) is a company whose goods are used as components in the products of another company, which then sells the finished item to users. This firm is referred to as a value-added reseller (VAR).
After making the purchase, the overseas companies can make changes to the product according to their own logo and trademark. The term has become a label used to describe a variety of companies. To further customize the product, the foreign company can also make few cosmetic changes to the product/s such as- shape, color, adding new features and more according to their preference. The most critical part of an OEM agreement is to determine the IP in the changes to the product that involves customization for the buyer.
Contract Manufacturing (CM) Agreement-
In a CM agreement, a foreign company developed a product design in its home country and agreed on a deal with a Chinese manufacturing company to manufacture the new design. More specifically, contract manufacturing is an outsourcing of certain production activities that were previously performed by the manufacturer to a third-party. Nowadays, outsourcing companies have become specialists in a multitude of services for manufacturers including design, production, assembly, and distribution.
The unique thing about contract manufacturing agreement is the new design being manufactured for the first time in China. The American and the European businesses can save significant money on labor, materials and other expenses related to production. The foreign buyer owns all of the IP- the IP in the design and the IP in the brand. The factory owns nothing.
Original Design Manufacturing (ODM)-
An original design manufacturer (ODM) is a company which designs and manufactures a product which is specified and eventually branded by another firm. Such companies allow the brand to produce without having to engage in the organization or running of a factory.
Unlike CM agreement where manufacturers can make hundreds or even thousands of different products, ODMs often specialize in only a handful of categories. Since it is the foreign company that comes up with original concept and design, it owns the design related rights. But there are circumstances occurred in China where the Chinese factory claim the IP right by arguing that since the entire R&D and commercialization work has been conducted in China, the factory owns the IP in the product design. That’s why China lawyers suggest their clients to be extra cautious and vigilant at the time of singing Original Design Manufacturing Agreement in China.
Here are the basics in terms of what you should be discussing with your potential Chinese product supplier:
- Products (list of products; whether products will be off-the-shelf, custom-designed, or a combination; exclusivity of products)
- Payment Terms (amount due; date(s) due; method of payment)
- Pricing (per unit; volume discounts; whether prices are guaranteed for a certain period of time)
- Warranty Terms (length, extent of coverage)
Quality Control Procedures (including disposition of defective products)
- Shipment Terms
- Subcontractors (prohibited, allowed if approved in advance, etc.)
The best possible way to resolve any issue regarding an OEM, CM or ODM agreement is to confront it in advance with a detailed written agreement that sets out a resolution to these issues that is fair to both sides.