China Manufacturing ContractsIn yesterday’s post, On SMEs Trusting China Manufacturers. Don’t. Just Don’t., we wrote about product outsourcing mistakes often made by small companies (SMEs). The same day we wrote that post, The Quality Inspection Blog did a post, 9 Things Only a Large Company Can Obtain in China/Vietnam, comparing what large companies are able to achieve when outsourcing their product manufacturing that small companies cannot.Before I discuss Quality Inspection Blog’s post (by analyzing the nine things it cites) I want to note how true it is. Small companies sometimes read how they should do X with their product manufacturing and then insist on doing X even though virtually no product manufacturer in China or Vietnam or Thailand or Mexico or Cambodia or the Philipines or wherever would ever go along with X unless HUGE product quantities are ordered. Put simply, Walmart can require certain things of its product suppliers around the world that your company cannot.

The first thing that springs to mind is product exclusivity. Our manufacturing lawyers usually ask our clients that are looking to have a product made overseas whether they are concerned with their foreign manufacturer making the same product for others. When we ask the question using the word “same,” and our client responds “yes,” we then ask what for them constitutes the same product. Sometimes they will respond with something broad like “I don’t want them making IoT devices for anyone else” When I get this sort of response, my thought is that this is never go to happen unless our client is prepared to purchase billions of dollars a year in IoT devices from this one manufacturer. I say this because most contract manufacturers that make products for small companies make their products for from 3 to 300 foreign companies. No manufacturer that makes IoT devices for 100 companies will stop making IoT products for all 100 companies just to secure your $800,000 in yearly business. The economics of that are just not there.

In this sort of situation, our manufacturing lawyers will usually provide the following sort of explanation as to why what our client seeks is both impossible and unnecessary:

Wait a second. This company you wish to use to make your IoT product. It makes all sorts of IoT products for all sorts of other companies around the world, right? And your IoT product is a health device you plan to sell to health clubs in Canada and the United States, correct? So why do you even care that this company makes and sells IoT devices for olive growers in Spain, Israel and Greece? You don’t care about that do you? I am asking these questions because there is no way this manufacturer is going to stop making IoT devices for olive growers in Spain, Israel, and Greece just to get your start-up order for 10,000 health club IoT devices and I am not aware of any reason why this should matter to you. So how about we just try to get this manufacturer to agree (with China-enforceable NNN provisions) not to make or sell health club IoT devices?

Quality Inspection Blog starts its post by discussing how there is much good advice on “Linkedin and elsewhere, aimed at importers sourcing products from China, Vietnam, or other low-cost Asian countries” but much of this advice is NOT applicable to companies buying under 20 million USD a year — and, sometimes, not under 1 billion USD a year.” It then lists out the following nine things large importers can get from their suppliers but small companies usually cannot. Note that my summary below of the Quality Inspection Blog is in regular font and my own comments/opinions are in italics.

1. Negotiate with large contract manufacturers in many countries. Apple has been looking at producing iPhones in Vietnam and/or in India. Apple knows “large contract manufacturers (e.g. Foxconn) are willing to set up a plant wherever Apple wants.” But if you are a company looking to buy 5,000 mobile phones in Vietnam or India, you very well may not be able to find anyone to make them for you in such a small quantity. This is so true. Our law firm has been working a lot lately with clients looking to source electronic products from Vietnam and Thailand and the Philipines and unless they are willing to buy in fairly large quantities, they are not having much luck in finding suppliers. But much depends on the product and the country. For instance, many of our toy and houseware product clients were able to relatively easily shift their contract manufacturing manufacturing to Vietnam and Thailand. 

2. Reserve production capacity for the mid- or even the long-term. Quality Inspection Blog mentions having heard how VF Corporation was able to reserve the capacity of several buildings in Chittagong, Bangladesh. Large companies with mature planning and distribution systems have a good idea about their needs five years into the future and they can often find contract manufacturing companies that will reserve them the capacity to realize those plans. So true, but for a small company this is just virtually never going to happen. 

3. Negotiate directly with large sub-suppliers. Li & Fung can reserve greige fabric and dyeing capacity before it knows for certain the colors its massive list of clients will choose. Li & Fung can do this because it has massive buying power and because it is able to talk directly with large sub-suppliers. In many cases, contract manufacturers will refuse even to reveal from where it gets its materials and components to its small company buyers.

4. Open-book visibility about the manufacturing facility. Large buyers are often able to get deep-dive costing information from their contract manufacturers. Things like the “what their supplier pays for rent, per employee, for each line on the bill of materials, and so on. For large buyers such as General Motors or Airbus, this is a given. Any part supplier not willing to share this level of detail is discarded.” Small companies generally should not even bother asking for such information. 

5. Force the factory to use your own ERP system. Many tier-one auto suppliers have to use an SAP implementation that perfectly integrates with the SAP implementation used by their buyers. “So, if 50% of a plant’s activity is for GM, 40% is for Chrysler, and the rest is for smaller customers, the plant will need to use 3 different ERP instances.” Small companies often work with suppliers that don’t use ERP at all.

6. ‘Open account’ payment terms. This is much more common for large companies. I am always impressed by small companies that are able to pay 50% or less upfront. For more on manufacturing payment terms, check out China Manufacturing Payment Terms.

7. Product warranty & liability from the supplier. Large companies can get their manufacturer to sign legally-enforceable contracts that make it liable for product warranty and liability obligations and that require the manufacturer to carry liability insurance. “This is pretty much unheard of for an importer buying ‘only’ 500,000 USD a year from a given factory.” I disagree with this statement as we are nearly always able to get overseas factories to sign for good warranties. However, this whole area of warranties and liability insurance is a minefield. How valuable is a warranty if you are working with a manufacturer that has only $100,000 a year in profits? See China Manufacturing WarrantiesHow valuable is it to get your manufacturer to buy a crappy insurance policy written in Vietnamese? Also, if you require your manufacturer to spend 30 cents per widget for insurance, it likely will just flip around and charge you 30 cents more per widget to cover this cost. Might you not not be better off just buying your own insurance in your own country for 30 cents per widget? See The China Price and Product Liability Insurance: Never the Twain Shall Meet

8. Shaping the supply chain PHYSICALLY. “You set up a mammoth plant and you don’t want your high-value component suppliers to be more than 1 hour away from you, for just-in-time inventory replenishment? They can be requested to set up a new manufacturing facility next to you.” Small company? No way.

9. Have their own teams on site all the time. “When you develop new products, can you afford to have your own engineers at the main factory, and going around component factories as well? Probably not with the same intensity as, say Apple (who dispatch not only engineers but also supply chain security staff and so on and so forth). In the end, that makes a very large difference in quality & time-to-market performance.” True, but there are a number of very good quality inspection companies, including the company — Sofeast —behind the Quality Inspection Blog. Not quite the same thing as having ten of your own people live in the factory, but a thousand times better than no monitoring at all. 

I am going to add a tenth item: price stability. Large companies are often able to get their suppliers to commit to long-term pricing, whereas this is just not possible for most small companies.

So what can small companies that use overseas contract manufacturers do to protect themselves? Go with the basics, as described (at least in part) in our post yesterday.

What are you seeing out there?

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Dan Harris

I am a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

I mostly represent companies doing business in emerging market countries. It has taken me many years to build my network and it takes constant communication and travel to maintain it. My work has been as varied as securing the release of two improperly held helicopters in Papua New Guinea, setting up a legal framework to move slag from Canada to Poland’s interior, overseeing hundreds of litigation and arbitration matters in Korea, helping someone avoid terrorism charges in Japan, and seizing fish product in China to collect on a debt.

I was named as one of only three Washington State Amazing Lawyers in International Law, I am AV rated by Martindale-Hubbell Law Directory (its highest rating), I am rated 10.0 by AVVO.com (its highest rating), and I am a SuperLawyer.

I am a frequent writer and public speaker on doing business in Asia and I constantly travel between the United States and Asia. I most commonly speak on China law issues and I am the lead writer of the award winning China Law Blog (www.chinalawblog.com). Forbes Magazine, Fortune Magazine, the Wall Street Journal, Investors Business Daily, Business Week, The National Law Journal, The Washington Post, The ABA Journal, The Economist, Newsweek, NPR, The New York Times and Inside Counsel have all interviewed me regarding various aspects of my international law practice.

I am licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at my firm, I focus on setting up/registering companies overseas (via WFOEs, Rep Offices or Joint Ventures), drafting international contracts (NDAs, OEM Agreements, licensing, distribution, etc.), protecting IP (trademarks, trade secrets, copyrights and patents), and overseeing M&A transactions.