The New World of International Manufacturing Contracts

Navigating the New Era of International Manufacturing

The landscape of international manufacturing contracts has undergone significant shifts. If you’ve sensed this change, rest assured, you’re not alone.

Gone are the days when international procurement largely meant buying “off-the-shelf” products like t-shirts or computer bags — items that followed universal standards. The game began to change when overseas buyers desired minor tweaks to these standard products, and the real transformation occurred when they started providing entire product specifications to their factories.

However, many buyers haven’t updated their practices. They still rely on generic agreements or basic purchase orders. In today’s manufacturing world, such approaches are not just outdated, they’re risky.

In this article, we will delve into the evolution of manufacturing complexities and the key contractual considerations these changes warrant.

Understanding Product Categories

International product buyers typically navigate the following four product categories:

  • Open Source/Buyer Standard Product
  • Factory-Owned Standard Product
  • Customized Standard Product
  • Buyer Designed Product
  • Co-Designed Product

It’s important to differentiate between these product types due to their distinct contractual needs. However, many factories fail to categorize these products clearly, leading to potential confusion and complications.

1. Open Source/Buyer Standard Product

These are items such as t-shirts and medical gauze, where designs align with global standards. Their specifications, such as thread count or color, aren’t proprietary. These universally recognized products are crafted globally, predominantly in alignment with preset international specifications. The criteria for these products often derive from these global standards, and factories are expected to meet them. For instance, when considering fabric for t-shirts or underwear, one might reference the internationally recognized thread count or the Pantone color.

2. Factory-Owned Standard Product

This is another variant of the “off the shelf” product spectrum. In this context, the factory proclaims ownership of the design. Though there are instances where the manufacturing entity genuinely conceptualized and owns the design, there are also situations where the design has been “borrowed” or even blatantly copied. A common occurrence is with more complex products, like machinery, equipment, or electronic devices where the original patent has lapsed, allowing for replication without legal repercussions. However, there are times when a factory might secretly copy a design, which could lead to disputes if another party claims they own that design.

Though both these product types were once labeled “standard” or “off-the-shelf,” it’s essential to distinguish between products adhering to universal standards and those set by manufacturers.”

For off-the-shelf products, the specifications are typically set by the manufacturer instead of by universal industry standards. Furthermore, the warranty usually assures that the overseas factory will meet its own specifications. Additionally, there should be a guarantee that the manufacturer genuinely possesses the IP rights to the product.

Since this distinction is often overlooked, there hasn’t been a universally accepted term for the second type of “standard” product. As a result of this, buyers frequently mistakenly treat the second type of product as if it were the first, leading to potential complications. For clarity’s sake, we will refer to the first type as “off-the-shelf” product and call the second type of product “manufacturer proprietary product”.

3. Customized Standard Product

In this category, the factory typically owns the core technology, and the foreign buyer has rights to the external appearance or shell. We frequently see this with medical and electronic devices. Here, the factory possesses the rights to the technological components, but the foreign buyer holds the rights to the exterior design, including the casing that houses the technology. A prevalent stance among electronics factories (especially in Asia) is that the buyer can transfer the shell’s design to a different factory but cannot do the same with its internal technical components.

This delineation often leads to misconceptions among foreign buyers. Many enter negotiations assuming they have the right to shift the entire product – both its shell and its technical internals – to another factory for manufacturing. Based on the experiences of international manufacturing attorneys at my firm, foreign buyers often intend to relocate the entire product’s manufacturing to another factory, having based their entire business model on this premise. This often cannot happen if the factory is claiming to own some or all of the IP.

4. Buyer Designed Product

The product buyer has designed its own product and typically owns the IP to that product in its home country. This buyer is looking for the best overseas manufacturer to make its product and its key concerns are usually to get a good product on time and not to lose its IP to its overseas manufacturer or to anyone else.

5. Co-Designed Product

This product category encompasses the genuinely co-designed product. In this scenario, both the buyer and the factory collaboratively create the product. Such products necessitate a Product Ownership or Co-Development Agreement. Many foreign buyers, mistakenly assuming they have sole ownership of the design, remain oblivious to the intricate legal nuances and inadvertently end up relinquishing their IP rights. For insight into how companies inadvertently compromise their IP, check out China and The Internet of Things and How to Destroy Your Own Company.

Product Evolution Requires Increased Contractual Complexity

Driven by the rise of IoT products, autonomous driving technologies, advanced robotics, AI-powered devices, and other sophisticated products that integrate design, hardware, and software from a diverse array of sources—many beyond the oversight of both the buyer and the overseas product manufacturer—the landscape of complexity continues to expand.

All of this means that purchase orders or generic, all-encompassing purchase agreements rarely suffice. Yet many buyers remain anchored to outdated contractual methodologies. They err in assuming today’s processes are as straightforward as they once were when procuring standardized off-the-shelf products was more the norm.

The landscape of international manufacturing contracts has undergone significant shifts. If you want to thrive in today’s international manufacturing climate, you should adopt today’s more sophisticated contractual practices.