In my blog titled “ China Product Development: Focus on Manufacturing Rights,” I have explained how to resolve issues related to product manufacturing rights that arise during co-development projects in China. It was perhaps the most ideal resolution one can offer. I have explained on the blog about our experience of how challenging it is to convince the Chinese side to follow that ideal resolution option. Here I am furnishing the options you could go for when the Chinese side refuses to agree:
Option 1- License the Underlying Technology from the Chinese Side
When the Chinese side firmly tries to hold the rights to the underlying technology in your product, your next move should be to negotiate a license to that technology. All over the world this sort of license is quite common and can be found in many forms such as-
- Negotiate a standard license for the underlying technology for which you will pay a license fee. This fee can be paid as a per unit royalty or lump sum for each item manufactured in a separate facility. In some cases, the payment for a license depends on the buying a specific number of units at a premium price. When this fee is paid, the foreign company can have a license to manufacture elsewhere. In spite of being a common procedure all around the world, its use in China is quite rare. As Chinese manufacturers become more sophisticated about monetizing their technology, this type of agreement will become more common, and our China lawyers are already starting to see that happen.
- You can go for an agreement with your Chinese manufacturer side that gives you the permission to enjoy the liberty to manufacture the items in a different facility, but only in the condition when Chinese manufacturer is unable to meet the predetermined delivery date, quantity or price terms. Most of the time, this license allow manufacturing in a different facility only for amounts in excess of a predetermined minimum. For instance, a Chinese company can manufacture 100,000 units per year at a set price and the foreign party is allowed to use a different facility only to manufacture anything in excess of 100,000. The downside of this approach is, it assumes the Chinese side will be capable of manufacturing the first 100,000 units, both in terms of quality and quantity.
Option 2- Walk Away
It is quite surprising to me how many times foreign hardware entrepreneurs fail even to consider the basic option of refusing to work with a Chinese company that will not cooperate on key manufacturing rights issues.
It is hard to understand what exactly a Chinese side wants to portray when it says that under no circumstances it will release the manufacturing/IP rights in a co-developed product. Chinese side wants to mean is- We have the full ownership of the product, we will manufacture the product, we will give you the right to sell the product in a foreign market on our behalf. If you achieve success we will continue to work with you but if you fail we will stop taking future purchase orders from you. We will tie up with other companies to market the product or do it on our own. The “other company” signifies big and popular companies, not like a start-up company like yours.
The outcome will be a financial disaster for your company. In this case, the best option is to walk away when it is clear that the Chinese side is trying to put you in an untenable situation.
Option 3-Turn the Tables
Some foreign developers think they have no other option than working with the Chinese manufacturer. They simply can’t walk away from the agreement. Though this situation is dangerous, it can work so long as the foreign entrepreneur is willing to turn the tables and operate how a Chinese company would operate in the same situation.
The foreign developer usually “writes off” the co-developed product in the turn the tables scenario. Instead, the product is treated as the foundation for the start-up company, it is considered as a research project that will provide the foundation for an entirely new product. For this new product, the foreign product developer will work to achieve control over the technology and the manufacturing rights. It may take a long time and goes through different rounds of development. The main target of the foreign developer in this approach is to get total product control by utilizing Chinese manufacturer a testing hub for developing a new product or technology.
Many foreign product developers told me that they intentionally didn’t walk away because they are quite confident that they can pull off this reversal of roles successfully. My personal view is, it is challenging task to turn the tables on Chinese manufacturers because over the years they have become seasoned to deal with this sort of situation and developed strategies to protect themselves. However, if executed and planned properly, foreign companies can become successful in turning the tables.