With the recent onslaught of tariffs, our manufacturing lawyers are increasingly drafting manufacturing contracts for Asian countries beyond China. In the last few weeks alone, we’ve drafted manufacturing contracts for Vietnam, Malaysia, Indonesia, Taiwan, and India.
This recent increase in manufacturing contracts for countries beyond China has only reinforced how the core legal and business issues tied up with such contracts spans the globe. With so many companies (and clients!) looking to move some or all of their manufacturing to countries other than China, we will over the next few months be writing often about the basic concepts underlying good manufacturing contracts, no matter the country.
One of the issues our manufacturing lawyers perpetually face is pricing. How much will the factory charge for the widget and, more importantly, how much will the factory charge for the widgets a month and a year from now. Oh, and what about currency fluctuations?
Many of our clients (especially those recently stung by trade tariffs) are seeking to lock in pricing. This is a tough one. If you are maybe going to buy 1000 widgets at $34 from time to time with no minimum requirements, no legitimate factory anywhere will lock in its prices for any extended period, if at all. They simply have no incentive to take a risk for an occasional buyer. On the other hand, if you contractually commit to buy five million such widgets, the factory will be a lot more willing to give you a price lock.
The same holds true for currency fluctuations/risk — which really just translates to price in the end. If you are an occasional buyer of 1000 widgets, you likely will not find a factory that will sell you its widgets for $34 for the next five years, no matter how much the Dong/Rupee/Ringgit/Bhat/Rupiah/Riel/RMB changes against the dollar. If you are buying five million widgets, sharing in currency risks very well might be doable.
Yet many foreign companies believe it possible to get a price lock when it really isn’t. Even worse, many foreign companies believe they have a price lock when they really don’t. Most factories throughout Asia are well-versed in how to convince their Western buyers that there is a price lock when there really isn’t. These factories lure buyers with a fake price lock and then when that price lock really matters, they easily and legally back out.
How do these factories accomplish this feat? Simply by refusing to accept a purchase they are under no obligation to accept. The below email from one of my firm’s lawyers regarding negotiations with a Vietnam factory nicely illustrates this sort of legerdemain:
The discussion on price adjustment is meaningless. If the Vietnamese factory is not required to accept all purchase orders with the locked price, it can simply change its price by refusing to accept your PO. It is standard practice in Vietnam (and pretty much everywhere else in Asia and around the world) for the Vietnamese factory to agree to a low price and in return get certain minimum order commitments from you the foreign buyer. Then when its costs rise (or less common, its currency rises) the Vietnamese factory will refuse to accept your purchase orders until you agree to pay a higher price. A price lock is only meaningful if the factory is required to accept your purchase orders with the locked price. In this case, your factory has rejected that approach, which means you will have no price protection. Your factory fully understands this and this is why they revised the contract as it did.
You must now decide whether you want to move forward with this factory without price protection or see if you can get price protection elsewhere. Or you might even want to see whether your agreeing to commit to buying more from this factory will get you a real price lock or not.
Please stay tuned for our next post in this series.