6 Outcomes Of Signing A Strong Manufacturing Agreement With Your Supplier

As a buyer, you may be in a position of strength in front of a supplier. For example, your orders are quite attractive to them, and you can easily switch to another supplier. You may be tempted to work with a business lawyer to draft a manufacturing contract. That makes sense.

And that lawyer will probably prepare a relatively strong contract, too. That makes absolute sense from a lawyer’s point of view (their mission is to cover all risks, after all).

However, here are a few outcomes you can expect. (I am not providing legal advice here — just sharing a few lessons learned.)

1. Some suppliers won’t take it seriously and won’t even read it

The following situations come up quite often with local Chinese or Vietnamese suppliers.

It may come from their total lack of familiarity about the legal system in general (and it means they don’t hold their own suppliers to any enforceable agreement… not good).

It may come from their belief that it is a “corporate thing” they have to sign, but they will always find a way to settle issues with the buyer. You need to make sure they get your intention to have them comply.

The text may all be in English legalese and they might be unable to understand it. You will probably need to send them a Chinese/local language version.

(I am assuming here that the lawyer actually knows how to make a manufacturing contract enforceable in China or Vietnam. If that’s not the case, the supplier might see there are no “teeth” and might sign it quickly, but you will get no benefits out of that.)

2. Better respect for your business interests in general

If you want the ability to pull the tooling at any time, if you want your supplier to have proper confidentiality agreements with their own suppliers, if you want to set strict systems to prevent “products sold on parallel channels from a back door”, and more generally if you don’t want to be abused or held hostage by a supplier, a good manufacturing contract will help.

(Dan Harris wrote about this here, and it may give you ideas of the common terms involved.)

I should, however, add that a contract with a bad counterparty is not a good contract. If they really don’t want to respect the spirit of what they sign, they will find ways to cheat, sooner or later. Even the most water-tight agreement won’t cover all the risks for several reasons — if only because certain violations can’t be proven easily. Don’t do business with the wrong people.

3. Prices might become less attractive… but your total costs might drop

A properly drafted manufacturing agreement has the effect of having the supplier bear most/all the consequences of their mistakes.

In the typical OEM/ODM world, with buyers issuing POs and working outside of any frame agreement, who pays the price for quality issues? Most of the time, the buyer. Who pays the price of shipment delays? Both sides, in variable proportions.

Once a contract makes a supplier pay directly and in full for their mistakes, they will logically look back at their past mistakes, make a projection in the future, and add some “safety margin” in their prices.

Talking them out of this will probably be very hard, if not impossible. It is the same as telling them that an AQL of 2.5% is no longer acceptable, and you will expect them to pass an AQL of 0.65%. I have never seen such a tightening go without a price raise.

However, as they become more conservative and pay more attention to your orders, fewer issues may happen, and they will be more responsible. When looking at your total costs, it is probably a good deal for you.

4. You will need less policing… over the long term

If you can come back to the manufacturer after shipment and ask for compensation, do you still need to send inspectors to check their product quality?

I would say, yes, reduce your QA/QC budget, but do so gradually and based on evidence that the risks of something going wrong are lower.

If they haven’t made the necessary changes in their operations, they might still ship bad products to you unknowingly. (Or the owner doesn’t want it to happen, but his production manager makes the decision to get the goods onto a container anyway.)

Don’t underestimate the difficulty of improving those types of outcomes. (More about this in the next point.)

If you tighten your acceptance standards and “punish” a supplier harshly, they will not want to keep going and you may lose a good supplier. It is still your responsibility to choose a manufacturer wisely. Maybe they simply can’t reach your requirements, and it is your job to vet them properly in the first place.

5. They might work harder on improving their systems & processes… and that may slow things down

In the best case, factory management takes your orders more seriously and get to work on setting up better systems (both internally and with their own critical suppliers).

The most common approach is to add what Art Smalley calls ‘administrative controls’. For example, do more in-process inspection. It adds costs and may be skipped some of the time. Not the best approach.

Ideally, they’d drive process improvement. For example, create better fixtures for point welding in order to get rid of a recurring dimensional issue. If you really want them to do this but they don’t have the ‘hard skills’ to get it done, consider sending a consultant to their factory and paying half the bill.

They might also beef up their approval processes, and this may slow things down quite noticeably. For example, if you need them to develop new products, or simply new colors/finishings of an existing product, there are many ways to mess things up.

Faced with expensive chargebacks outlined in your manufacturing contract, they might implement a stringent new product introduction process. Set multiple review & approval points and add extra steps. If this is well done, it will bring risks much lower… but it will also slow things down and add costs (e.g. reliability testing to confirm the design is sufficiently robust).

Do you want them to “just go ahead and make adjustments in production” rather than sending you one more set of samples to approve? They might refuse since it puts them at much greater risk.

6. The supplier will become more reliable but less flexible

This point is closely linked to the previous one.

The supplier will make more realistic commitments and will try harder to do a good job. But, on the other hand, they will probably become more bureaucratic, especially after they got hit with a few harsh penalties they thought were not fair.

If you ask for a favor (e.g. delivering earlier than they committed to, to please one of your customers), they will be less inclined to say yes, for fear that quality will be compromised and that they might be charged back for it.

Conclusion

To sum up, a good manufacturing contract will reduce your risks and will shape your supplier’s behavior. It will depend on the clauses they accept and how strongly these clauses can impact their bottom line.

A good lawyer will tell you what you can realistically expect. A bad lawyer (in my opinion, anyway) will not understand the business implications and will push for the most extreme agreement (most in your favor, I mean) and this can have two negative effects:

1. The best suppliers will be offended and may turn it down without attempting to bridge the gap from extreme to reasonable.
2. Some suppliers might get ‘punished’ so much they will have to stop doing business with you.

What do you think? Have you had such experiences before? Any tips to share on how a solid manufacturing contract should look and work?

P.S.

You will also enjoy this podcast episode about the role of manufacturing contracts in protecting your IP and business: Are You Using A China Manufacturing Contract To Protect Yourself? [Podcast]

Editor’s note: This blog post was originally published on QualityInspection.org here and has been republished for Agilian readers.

Disclaimer…

We are not lawyers. What we wrote above is based only on our understanding of the regulatory requirements. Agilian Technology does not present this information as a basis for you to make decisions, and we do not accept any liability if you do so. Please consult a lawyer before taking action.

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