My firm virtually always uses flat fee billing for China OEM supply agreements. We have done so many of these that we pretty much know the range of time one of these will take, even allowing for the required customization and the normal back and forth negotiating that will go on between our client and the Chinese supplier. Our time estimates are nearly always dead on, except for those clients who want the “perfect” OEM agreement.

Those take us less time.

Let me explain.

I am always saying it is easy to write the “perfect” contract and it is. The perfect contract does everything possible to protect your client. At least in theory.

By way of example, the “perfect” OEM agreement would contain something along the lines of the following:

  1. The Chinese supplier cannot raise its prices during the three year term, but the Western buyer has no minimum purchase requirement.
  2. Deliveries more than 10 days late, for any reason, result in a $100,000 cost reduction penalty.
  3. Buyer does not pay for 30 days after goods have arrived, been inspected, and been approved. No time limits imposed on buyer to do the inspection. Buyer pays nothing for non-conforming goods and need not return them to supplier.
  4. Chinese supplier is penalized for a defect rate of more than 1%. 
  5. Arbitration shall occur in Topeka, Kansas (buyer’s hometown).
  6. Chinese supplier cannot sell similar product to anyone else. Buyer is free to buy from anyone else.

Okay, you get the picture. This is obviously a great/perfect contact for the buyer.  

Except there is only one problem. Nobody serious is ever going to agree to this and, in fact, in our experience, contracts like this are automatic deal killers. That is why we should charge less for them. Over the years, we have been asked maybe half a dozen times to write OEM agreements not all that dissimilar from that set forth above. Each time, we have counselled our clients against this sort of agreement, but a few times we have been instructed to go ahead. Once (or maybe even twice), the client remarked on how they bet Wal-Mart has this sort of contract. Our response was that we had seen a number of Wal-Mart’s contracts and though they do tend to be pretty favorable for Wal-Mart, they also typically contain massive minimum purchase guarantees that make the contracts worthwhile for the Chinese supplier.

Now usually when we write a normal (as opposed to “perfect”) OEM contract, we hear back from our client within a couple weeks, discussing potential changes to the contract suggested by the Chinese supplier. We then work for another few days to a week on modifying the agreement to suit both sides and then we are none.  

With the perfect contract, we get silence and then we eventually contact the client. Each time, the client has told us that they have been unable to find a Chinese supplier willing to do business “our way” and so they will be looking elsewhere for their supplies. We suggest they allow us to modify the OEM Agreement and they go back out there, but they say no, they do not want to do business under terms that will put them at risk.  We say okay and move on.

The funny thing about the companies seeking the perfect contract is that they almost always are of a particular type: old line, mid-sized (not small) businesses that have been in business for a very long time and have carved out a pretty good niche and strong brand name in their market. They are looking at China not so much because they have to, but because they believe it will allow them to cut costs and thereby increase their margins. 

In any event, the lack of subtlety in the initial OEM Agreement and the subsequent lack of negotiations and back and forth between the Western buyer and the Chinese supplier means these are the agreements that fall short of our estimated time range. So I guess the next time someone wants the “perfect” OEM Agreement from us, we will have to charge less than for one that will actually work.

What do you think?

For more on China OEM Agreements, check out the following: