If two years ago, someone had asked me to describe my law firm’s typical China manufacturing client, I would talked about a company that was either doing contracting out its manufacturing to China or doing its manufacturing in China itself, all of this strictly for export from China.
It just struck me today that our typical China manufacturing client has changed. It is now an American company that is manufacturing in China to sell its products in China. And they are all going about this in very different ways. The following are good (and very recent) examples (with a bit of merging of companies and fudging of facts so there will be no identifiers) of what we are seeing out there:
- US company that had been making about 50% of its products in China for shipment back to the US for sale primarily to one very large American company. It now has a WFOE (wholly foreign owned entity) in China where it makes about 90% of its product for sale to that same very large American company, which now takes delivery of the product in China.
- US company that was making its product in the US and was using a Chinese company in China to assemble it in China and sell it there. US company and Chinese company had been working together for years and when it came time for the owner of the Chinese company to retire, the US company purchased it and stepped up its manufacturing in China.
- Chinese company is told by its two largest Chinese buyers that it must bring its product standards up to Western standards or the two Chinese buyers will switch to Western suppliers. Chinese company contacts my client who, in turn, licenses the right to the Chinese company to manufacture the US product. My client very closely monitors for quality and even has the right to reject product for sale. The interesting thing here is that all parties related to this product want it to be that way.
The two Chinese buyers who had demanded US quality product appreciate that nothing will get shipped to them unless my client deems it worthy of its name. The Chinese manufacturer/licensee likes this arrangement because without it, it would not have this business any more. My client likes it because it is making money on China sales that it otherwise would never have made and it is able to do so without having to build its own manufacturing facility and without compromising the quality of its products and its name.
Western companies licensing the manufacturing of their products to Chinese companies is the next big thing. What I find interesting is that the American companies usually start out very wary about these licensing arrangements. They oftentimes want to set something up where the Chinese company manufactures the product for the American company and then the American company buys the product from the Chinese company and then re-sells it on the Chinese market. They want this arrangement because they believe it gives them more control. This sort of arrangement is possible, but it seldom makes sense because it requires additional taxable transactions and it requires the US company to form a Wholly Foreign Owned Entity (WFOE) and it requires the US company to figure out how to market and sell its product in China. In the end, licensing is going to be easier and, if handled properly, can provide virtually the same safeguards.
Our clients are concerned about the Chinese manufacturer selling its US branded product out the side door or using the knowledge it has gained of the US company’s product technology and manufacturing processes to start making its own competitive product. These concerns are completely valid but they can be addressed virtually the same way in the licensing agreement as they would be under an arrangement where the Chinese company sells the product to our client for eventual resale.
We have a client that makes a component part that is so critical for the final product that we have been able to draft licensing agreements for the final product that are not much more detailed than “licensee shall pay $10 for each final product it manufactures and the amount of final product for which licensee shall be required to pay this $10 shall be determined by (and equal to) the number of critical component parts it purchases from the American company.” On the flip side, we represented an Asian manufacturer in a licensing deal with one of America’s largest and best known consumer product companies that involved a 160 page licensing agreement (not counting the hundreds of pages of technical attachments) that essentially made clear that the American company would monitor, control and determine pretty much everything our client did in relation to the American product, including the content of its advertising and to whom the product could be sold.
In addition to the licensing agreement, the US or other foreign manufacturer must not forget to register its intellectual property (IP), such as trademarks, copyrights and patents, in China under its own name. The licensing agreement can protect the foreign company’s intellectual property (IP) from its Chinese manufacturers, but it will not do anything to protect the foreign company from third party’s in China using its IP. For that, registration is required.
What are you seeing out there?