Manufacturing Contracts: What You Need to Know
Many businesses — including startups and large retail chains — work with contract manufacturers to manage some or all of their production lifecycle. Even original equipment manufacturers (OEMs) in the automotive and technology sectors, like Apple, Sony and Ford, enter into contract manufacturing agreements. According to a Market Study Report, the global contract manufacturing market value is forecast to grow at a compound annual growth rate of 5.5% between 2019 and 2028.
Some companies outsource production to reduce costs, while others do so to increase supply chain efficiency. For example, if a company has strategic access to raw materials. Your business may be introducing a new product or entering a new market. If you are evaluating contract manufacturer relationships for any of these reasons, it is critical to ensure you have your legal document processes in order.
How are Manufacturing Contracts Different?
A contract manufacturing agreement defines a relationship where a brand entrusts a contract manufacturer (CM) to meet the same quality, delivery, and workmanship standards they would if they made it themselves. A brand company, for example, Apple or Nike, may participate in some of the distribution or manufacturing processes. Yet they will own the product, related intellectual property related to design and engineering.
Contract manufacturing agreements help a brand focus on the marketing and sales of a product, and the responsibility for product quality is on the CM for fabrication at scale over a defined time frame. The manufacturing contract outlines the responsibilities of each party and protects the brand’s intellectual property ownership.
To be legally binding, a manufacturing contract must include the following:
- (A) non-disclosure agreement(s)
- Licensing agreements, such as when an apparel company fabricates clothing decorated with trademarked characters. Copyright ownership remains with the hiring firm.
- Quality standards for characteristics like purity, durability, or longevity
- Purchase orders to establish product shipment quantity, price, and delivery terms
- Mandatory process terms to ensure products are assembled, tested and packaged to brand specifications
- Supply chain agreements to ensure the manufacturer uses approved materials from approved suppliers
- Termination clauses to define when a contract needs to be renewed should all go well, or should one party (or both) not live up to their responsibilities such as quality, delivery time, or payment.
An AI-powered digital contract lifecycle management system can help to automate contract authoring and assembly and ensure terms meet a general contractor’s standards. It can keep track of each party’s obligations and alleviate strains on legal procurement and sales teams.
Benefits of Manufacturing Contracts
Many business and consumer goods manufacturers outsource to offset overhead such as assembly workers and capital costs for equipment, factories or assembly space. Many contract manufacturers in the United States, Canada, and Europe outsource their manufacturing to fabricators in countries like Mexico, China, and India.
Manufacturers in these countries often have lucrative relationships with suppliers of materials like metals, plastics, and other components. Labor is generally less costly in these countries, and contract manufacturers specialize in using equipment like robotics and high-volume fabrication machinery.
Focus on What They Do Best
Beyond owning high-capacity manufacturing equipment and having lucrative supplier relationships, CMs have skilled personnel, workplace efficiency best practices, and enormous talent pools in high population density zones. They have the economies of scale to serve multiple businesses (within competitive agreement parameters) from the same inventory of raw materials or components.
Contract manufacturers specialize in the production process and elements of the supply chain. They often have expertise in cultural differences and can address the language barriers with workers in low-cost countries where fabrication and assembly take place. Workers benefit from steady work. Hiring firms like Apple and Sony often specialize in product design, marketing, and multichannel sales to retailers and end-user customers.
Manufacturing contract negotiations enable each party and their lawyers to define their roles and responsibilities and be bound by the terms for a defined time period.
For a contract manufacturing relationship to thrive, the hiring firm needs to have clear oversight of production quality right from launch. Random and routine product sampling should be conducted to ensure the products being shipped to end users meet specifications. The hiring firm needs to provide clear feedback about product defects or non-conformance. Identify any flaws in the production lifecycle is important to minimize waste.
A test production run of products should be written into the business agreement to help the contractor train their people, set up their equipment, and define what top quality means for the general contractor and ultimate consumer. Clear feedback and regular communication is critical for defining the ideal quality, and maintaining that level of quality. CM should have the opportunity to rectify any issues, and follow a continuous improvement program. A lawyer, general counsel, or law firm can define the formal agreement terms for ongoing quality evaluation using contract management software.
Types of Manufacturing Contracts
A private label supply agreement is a relationship where a manufacturer such as Procter & Gamble produces a product for a reseller like Costco, and it is sold under the reseller’s brand name. Kirkland Signature is an example of a private label which many manufacturers produce products for. Kirkland has a strong following and good reputation for quality. Many manufacturers would rather co-brand with Costco to secure shelf space and sales in the wholesaler’s facility than be denied having their SKUs in Costco’s inventory mix.
If an original product is simply repackaged and sold as is, it is often referred to as white labeling. Small business startups often enter into a white-label relationship if they have a great product but lack brand name recognition. Some startups want to leverage a brand to gain traction in the marketplace, others are happy to deliver their products under a private label permanently.
Some private-label brands buy products wholesale from a manufacturer, enhance or modify them in some way, and then sell them under their brand name to consumers or businesses.
An agreement like this may include an NDA preventing original manufacturing companies from promoting their relationship with the product in the market.
Labor or service subcontracting is where a specialty manufacturer assembles or fabricates all or part of a product for a hiring firm. A primary general contractor may work with several specialty subcontractors with industry certifications to meet their clients’ delivery terms.
If a contract manufacturing company is involved in building vehicle seats but specializes in upholstery (not the springs or framing), they can sign an agreement to outsource the fabrication of those parts to individual component manufacturers.
This is a scenario where a hiring manufacturer manages all or part of the product design and materials sourcing for a product. Still, they contract out full-scale production to a third party.
For example, say a satellite services provider was awarded a government contract with the US Department of Defense and was required to deliver, install and manage military satellites as part of the contract. They may enter an end-to-end manufacturing agreement as a prime contractor with a satellite manufacturer and take full or partial responsibility for how the satellites perform relative to contract specifications.
ContractPodAi Can Help You Execute Manufacturing Contracts
Entering a manufacturing contract as a hiring firm or any of the outsourcing arrangements described above can’t be entered lightly. Putting your company’s reputation on the line by entrusting a domestic or overseas third-party demands considerable legal protection for all parties.
Assembling an NDA, license and copyright agreements, termination clauses, quality standards and service level terms into a cohesive, binding agreement can be very complex. For brands that enter into many agreements of this type, or even just a few, an innovative contract lifecycle management (CLM) platform can be invaluable. Authoring, reviewing, approvals, negotiations and sign-off on contract manufacturing agreements are all quite complex. Especially for those with minimal experience with agreements of this magnitude.
Contact ContractPodAi to discuss how we can streamline your contract manufacturing agreements and alleviate some of the stress and uncertainty from the process. We have the domain and manufacturing industry experience to support you through these lucrative times for your growing business.
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