My law firm has probably written more product distribution agreements in the last year than in the three years proceeding. There are two main reasons for this. First, China’s increasing wealth (despite the slowdown) directly translates to increasing demand for quality foreign product. Second, we are dealing with a “second wave” of foreign companies, not the first wave which went into China years ago as Wholly Foreign Owned Entities (WFOEs).
So what is involved in successfully having product distributed in China? There are essentially two keys. One, a good distributor. And two, a good contract with your distributor. In other words, pretty much the same as what it takes to succeed in having your product distributed in Peoria.
What does it take to secure a good China-based distributor for your products? It is like just about everything else in China: due diligence, due diligence, due diligence.
In an article entitled, “Pre-Screening Overseas Distributors: 50 Questions to Ask,” Laurel Delaney, who writes the Import & Export column for About.com, asserts that the best way to find a good overseas distributor is to gauge the answers you receive to 50 very specific questions. I really like Ms. Delaney’s question list, though I would probably reduce it at least somewhat, but I would be sure to leave the following ten:
- How long have you been in business?
- Can you share a few success stories about similar, yet non-competing products you have sold?
- Have you represented other foreign companies? Explain what you did.
- How long has your relationship lasted with the top three companies you represent?
- How will our line fit in or complement your existing portfolio of products?
- What’s your game plan for building our brand in your country?
- Do you have good market coverage, including a trained and educated sales force?
- What specific territory are you interested in covering?
- Can you deliver on pre-agreed sales targets?
- Where do you see our brand in 3, 5 or 10 years?
If you take only one thing away from Ms. Delaney’s article, take away that you will be establishing a long-term and important relationship with your Chinese distributor and that means you absolutely should find out whatever you can about them before you do the deal. In other words, you need to conduct thorough due diligence.
As for the deal itself and the contract you will use to reflect that deal, the issues are really quite similar to what you would face in the United States or in Europe, but with additional legal issues relating to the legality of your product and the duties that will need to be paid to bring it into China.
The typical issues we see in Chinese distribution contracts are the following:
- Will your Chinese distributor be your agent? Do you want to structure your deal so that your Chinese distributor essentially becomes your agent in China and you pay it by commissions, with the actual sales transactions being between you and the end user (as opposed to between the end user and your distributor)? We virtually always suggest that the deal be done with you simply selling your product to your Chinese distribute and your Chinese distributor, in turn, selling your product on to the end users. This distribution method usually makes sense for a whole slew of reasons.
- Will your distribution arrangement constitute a franchise arrangement? Generally, you want to be be careful not to inadvertently create a franchise arrangement because franchise arrangements in China (just as in the United States) must comply with a whole host of regulations. Speaking very generally, the more your distribution agreement mandates that your China distributor follow your marketing plan or business system and spotlight your brand/trademark, the greater the likelihood that you are tipping into a franchise arrangement.
- Will you grant your Chinese distributor an exclusive? Will your Chinese distributor have an exclusive territory, customer type or product range? If so, for how long? Generally, if you grant an exclusive, you should be sure to set sales quotas/performance targets that will allow you to terminate the contract if not met. My law firm has been contacted by far too many American companies that granted their Chinese distributors long term exclusive distributorships only to have the Chinese company do absolutely nothing to try to sell the American companies’ products in China. Beware the Chinese company that wants exclusive distribution rights to your product not to sell it, but to mothball your products so they do not compete with their own products or with the products of other companies for whom it is a distributor. Setting adequately high minimum sales quotas will protect you from getting stuck with an under-performing or non-performing distributor. Clearly defining the sales quotas/performance targets is essential. The typical provision mandates a certain minimum dollar value of sales or a minimum number of units sold. Your Chinese distributor’s failure to meet the minimum for a certain period might result in termination or, alternatively, it might just lead to it losing exclusivity.
- Who is responsible for what on sales and marketing? The key here is clarity. Chinese distributors oftentimes expect their foreign product supplier to engage and pay for at least some of the China sales and marketing costs. There is no right way to handle this other than being sure that both sides of the distribution deal understand who is responsible for what.
- What about your trademark(s)? If you are going to sell your product into China (whether through a distributor or otherwise), you absolutely must register your trademark in China before doing so and you absolutely must register that trademark in your name, not that of your distributor. To be sure that your trademark remains yours in China, your distribution agreement should license the limited use of your trademark to your China distributor. Your distribution agreement should make clear that the use of your trademark is subject to compliance with the contract by your distributor and compliance with the limitations on the use of your trademark.
- What happens if the relationship terminates? A good distribution contract makes clear what happens upon termination because doing so greatly improves your chances of smoothly transitioning to a new distributor. Is your distributor allowed to sell down its remaining inventory of your product or must it cease sales immediately? Are you required to buy back the inventory and, if so, at what price? You want to put in your contract that the distributor must inform you of any pending and future sales. Where will your disputes with your distributor be resolved, and by whom?