In This Episode…
If you are developing a new product that is going to be manufactured in China or other Asian countries then there’s a good chance that you have product IP that needs to be protected unless the product is very basic and standard in nature. This is where product development agreements come in handy.
We’ll discuss how a development agreement covers a number of the actions you and your supplier need to take before your new product is ready for production
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Here’s the transcript of the episode if you’d prefer to read it:
Thanks for joining us for episode 56 of the pod.
The topic today is about product development agreements, so, what’s in them and why do you need one if you’re an importer and you’re working with suppliers in asia?
So let’s start off by explaining what a product development agreement is, basically it’s like a continuum when you’re going to work with a supplier in China, Vietnam, India, Taiwan, whatever, okay different countries. You’re going to work with a supplier and you’re going to purchase a product from them, there’s a continuum between you pick something like a light bulb and you say okay I want just this the same you change nothing you just send it to me you know and in that case, you’re really just distributing you’re going to resell their products so there’s no product development at all. Still, you might want to cover some of your risks, however, there’s no risk that they copy your product or anything like that, it’s more like you might copy their product so the supplier themselves might have some kind of distribution agreement or something so some special requirements, but anyway let’s see this is one extreme.
And then you know there are different shades of gray, you know you tell them ‘oh put my logo on it,’ or ‘the packaging should be like this’ and then you tell them ‘well you should also have this you know it should be that kind of maybe softer silicon rather than that abs or tpu’ or whatever they’re using. And then you can say maybe ‘oh it needs this extra feature you know’ and then all the way to you go to the manufacturer and you tell them ‘I have designed a product that’s completely new, it’s not like anything you have made before so I’m just looking at you as a company that can help me make it right and maybe also develop it and it’s totally new.’ and in this extreme I the buyer am doing all the design, I own all of the intellectual property right so this is quite different from I go and I pick a light bulb and I say just shoot me exactly that and nothing different.
Yes the opposite of if you brought something there in terms of your own design or maybe just ideas for extra functionality or just you know a visual design, maybe it’s a garment and you say okay here’s the print I just designed it and you know that’s your intellectual property and you want to protect it, so in that case what is the risk you want to cover?
The risk is that maybe the supplier will pretend that it’s their own product and will sell it to other customers or that maybe they will do some of the work and then they will not share it with you like maybe the source code or if there’s some electronics maybe the layout and the schematics and the PCB design and things like that. They might just say ‘well here’s the sample or prototype, but I’m not going to tell you what went into it and I’m also not going to tell you the component suppliers,’ because development is not just about the technical blueprints if you want it’s also about supply chain it’s also about knowing where this where the components come from.
So, a risk here, and we talked about that before in the podcast, is that the supplier says ‘okay, okay yeah we can help you do this part of the development maybe and source some of the suppliers’ and then it is really their intellectual property they don’t even charge the customer for that or maybe they charge the customer for it but since there’s no written agreement it’s not clear who owns the intellectual property. And by default in my understanding and I’m not a lawyer, make sure you call a lawyer to make sure you get that right. Usually, lawyers will be very happy to talk to you because making these kinds of agreements is a source of revenue for them. So what I was saying is if it’s not clear through a written agreement who owns the intellectual property if the supplier did some of the work they will probably take credit for it and say this is their intellectual property, and that means you cannot easily go to another manufacturer and that means you have little leverage on that supplier because they can cut you out and that that is covered by another agreement manufacturing agreement we will get to.
It’s not so easy for you the buyer to go see another supplier because a lot of the development has to be done again. That might be time-consuming and very expensive, so a development agreement is simply an agreement that covers these risks and it’s something that we always tell our clients that they need if they’re going to do development work with a manufacturer.
So the more unique the more customized your product is the more you’re going to need this sort of agreement?
Yes, because the risk is higher, there’s more at stake, there’s usually more investment in time and money and you want to protect that.
We have spoken on the podcast before about supplier choice and many times in written content as well and so when developing a unique product would you recommend trying to work with a contract manufacturer where possible?
Well, so it depends again where you are on that continuum from ‘I buy light bulbs or cables or screws and I want nothing changed, to this is this is my flying car and I designed it and found a way to make it work and now I need to manufacture it right!’
So if you go for screws and light bulbs and things like that you go to a manufacturer that has already made that, you know an ODM or OEM manufacturer that just specializes in that, more what they call ODM if you are somewhere in the middle.
Let’s say you want a tablet pc or a smartphone, we get a lot of requests for these, but it’s a little bit special so you have manufacturers, you know a lot of them in Shenzhen, Dongguan, Huizhou who’re specialists in smartphones and tablets and you can go to them and say ‘on the basis of this model of yours I want that different chip and I want maybe a different kind of screen and all the camera module I need to change that and the packaging and you put my logo on it.’ So, in that case, you really don’t want to work with a contract manufacturer because a CM will tell you ‘okay, but we’re not specialists of this kind of product so we’re gonna have to do quite a bit of R&D and research and everything to be able to put that together,’ however, that that OEM company would say ‘okay yeah sure based on our model we’ve already amortized you know most of the R&D and we’ve already upgraded to this current generation of chipsets so making these changes for you is fine and maybe we will charge you just for these changes but all the rest we’ve already amortized anyway.’
You don’t want to start the development from scratch if you make a product that is relatively simple or that is kind of unique in a way that you can really find very similar products already made somewhere in China then it does make sense to go with the Contract Manufacturer. Also, in case you are worried about going to one of these ODM or OEM manufacturers and giving them a lot of ideas and sometimes they do all the development with you, they get all your good feedback, and then they cut you off.
We’ve seen it where they’re happy to sell it to other customers and usually, that’s because the development agreement was not very strict or just non-existent or even if they supply it to you they will show it to other customers. One way to avoid this risk is to sign the right kind of agreement, that’s what we’re discussing today, sort of the legal tools, but also you need to think of the business fit in the long run and the risks that they do something wrong maybe with one of their sister companies or their cousin’s company and you can never prove that there is any link, and even though you have all the documents signed and chopped and confirmed that is still a risk. So if you want to avoid that risk, don’t work with a company that’s already making something similar, as they are already connected to a whole supply chain and a bunch of buyers that might be interested in your product, so it’s very easy for them to resell it to somebody else.
Could you talk us through the anatomy of this sort of agreement, please?
A key component really is to protect the buyers intellectual property I think I made that clear and that can be an extremely complex topic so again talk to a lawyer who is very clear about these topics and also about doing business in china or in whatever country where you want manufacturing and development to be done. We can send a link to some blog posts from the china law blog because they make it clear that there are cases that are really messy what they call when the intellectual property is blended (some of it comes from the buyers some of it from the manufacturer), so what exactly to do in this case.
So I want to break it down a little bit: it covers the intellectual property and should also cover the supply chain, namely the desired level of transparency of visibility that the buyer should have over the component suppliers and maybe the sub-suppliers. This is something that people tend to forget, but it’s not all about the technical aspect, it’s also about the supply chain aspects.
I also want to make a distinction. Lawyers usually talk about the development agreement which is something typically you sign before you start working with a supplier (or a design house by the way also it does apply) on product development and then they also talk about the manufacturing agreement which supposed to be signed before manufacturing starts. Some people have it signed all the way at the beginning together with the development agreement. Sometimes certain topics are still very unclear, typically the quality standard is not set, if it’s a very new kind of product the warranty terms that I expected and things like that are not all very clear and, in that case, you want to delay it a little bit. And then there’s something in the middle that lawyers tend not to really think of but really from my point of view is something in the middle, is industrialization.
Product development is getting all the design engineering and the supply chain setup and all done and confirmed with a prototype that looks alike works alike you know are pretty much what the buyer wants and the design the product design is frozen but then you can just go into production with that if it’s an electromechanical product if it’s for automotive aerospace and things like that you definitely cannot go directly into mass production. You also need to work on the development of the process and you need to maybe fabricate some tooling and validate it you need to confirm that this exact product design can be made with these manufacturing processes. I think we did a podcast episode on the new product introduction process (NPI) and really that’s what it’s about right.
Then there is manufacturing. Really when okay it’s just about purchasing the components you know checking them, putting them together, checking again, shipping, and some of this middle phase falls into the development agreement and some falls more into the manufacturing agreement and different lawyers will interpret that in different ways.
So these are really the three phases that tend to be boiled down into two separate agreements, so for example for the tooling, the main risk is usually about intellectual property and avoiding being hooked by the supplier so usually, it’s in the development agreement. Whereas setting up the manufacturing lines and maybe you know developing some testing jigs and things like that might be in the manufacturing agreement right, so it’s a little bit of an arbitrary distinction that doesn’t really make sense to me sometimes but I’ve read quite a few of these agreements and different templates coming from different lawyers will cover different things.
Now, having said that, basically, a development agreement’s key things that it says is you know what kind of products are going to be developed first, what is the scope of this agreement, confidentiality where often a non-disclosure non-use non-circumvention agreement has already been signed, but then it’s pretty much all the time also part of the development agreement, so making sure that the supplier is not allowed to leak the information, reuse the information in ways that are not allowed, and so on and so forth is a basic point.
Who is going to do what, because again it’s a continuum from the light bulb on the screws to the flying car designed by the buyer. So where do you fall in this continuum? Well, maybe if it’s really a new product the buyer themselves have an R&D team doing some of the engineering design and they also work with a design house doing maybe the electronic design and then they keep the mechanical design in-house and maybe they work with a couple of freelancers developing the firmware and an app and then they also start to work with with a supplier for a specific module. For example, if they need a camera module, well this guy’s a specialist for camera modules and they can help us get the exact kind of module we need so we don’t need to redevelop it from scratch. This is not uncommon for relatively complex products and then maybe that supplier for the camera module is just going to be just a supplier for that module, but then maybe the assembly together would be by yet another supplier, but that supplier will not be involved at that stage yet, so in that case, you want to make sure that the freelancers and the staff and the design house and that camera module supplier each sign an agreement about the development about what are they going to do what are their obligations who owns the intellectual property and so on and so forth and they might be different.
Right now in the case of a product let’s say relatively simple the buyer goes directly to a manufacturer in Shenzhen. In that case, is the manufacturer going to do all the development? Sometimes that’s the case so the manufacturer will say ‘okay we can do the mechanical side for ten thousand dollars and we can do the electronic side for three thousand dollars and then the testing for another two thousand and then the tooling we can make it and it’s gonna be six thousand dollars and you know all the packaging also then you know we can do it but you haven’t confirmed the design and everything yet okay so we’ll we’ll price that later.’
That’s quite typical right and as I said earlier we always suggest to our clients that they put this on the table as early as possible, saying something like: ‘Hey Mr supplier, yeah I have to sign an agreement with you about the development before I share any more information before you start any work you know. Sorry, my advisors/my boss/my investors/my customers, they insist they have to make sure that my company owns the intellectual property so we have to have a paper about that, is that okay?’ If you say that from the very beginning it’s going to be fine and there’s going to be no misunderstanding.
Now what I see is people who go to a manufacturer and they say: ‘well yeah I like this coffee machine, but I’d like it to be a little bit different and with this extra functionality and these two functionalities we don’t need so maybe just remove the buttons and you know what whatever make some changes,’ and then the supplier says ‘okay no problem we will do it,’ and then at one point the the the buyer starts to talk with some of their own customers and with potential investors and then they realize they have got to make sure that they own the intellectual property otherwise they really have nothing in their hands! So they go to the supplier and they say, ‘well, I already did some of the engineering work for free and it’s based on my product, so I don’t think you own any of the intellectual property here.’ You know what? They’re right! I back them up one hundred per cent if the customer did not ask how much is it going to cost me, how many hours of engineering you think you’re going to spend on this, what about sourcing for this extra piece of material that I mentioned, etc? You know as a customer if you just provided an idea and you had the manufacturer work for free, you are not going to own the deliverables of their free work right and, believe me, all Chinese suppliers think like that. if you don’t pay for it if you don’t have a clear agreement about that, it’s not yours.
Of course now if you’re in that situation you can still talk to a lawyer. They will have some suggestions if they’ve seen a lot of similar situations, maybe they will say ‘okay well they own the intellectual property and only they can manufacture it, but they cannot sell it to anybody else and they have to give you a bit of transparency on their pricing so that they cannot go crazy on their pricing to you. I mean so they cannot try to lock their price if possible with a simple formula. There are certain things you can do to protect yourself against some of the risks, but you’re not going to own the intellectual property, so as I mentioned it’s very important who will have what IP rights.
Now there’s a difference between having a paper that says I own all intellectual property rights and actually having also all the deliverables such as the 3d drawing in step format, the bill of materials with all the details including the contact information and name of the suppliers and price, MOQ and lead time, and so on. If you don’t have these deliverables do you really own your product? You know on paper it’s your intellectual property, but every time you’re gonna say ‘Hey I need to make a change here,’ the supplier is going to say ‘okay well you know here are the implications,’ and you have no clue and no way of knowing. Every time there’s a problem you say ‘well you know this finishing here is really not nice I’d like to send an engineer to the anodizing plant,’ the supplier is going to say ‘I can’t really tell you it’s like a business secret where this is happening,’ and in many cases, they also don’t know where it’s done themselves! Maybe they buy metal parts from a company that does die casting and surface finishing and the die-casting company doesn’t tell them where the surface treatment is done. That’s quite common so if you don’t have the deliverables in your hand basically you are really at the mercy of your supplier and, although if they do something wrong you can probably sue them if the contract is actually enforceable in their country where they have assets, but one of the primary purposes of the development agreement, as I mentioned before, is to to be able to go to another supplier and to reduce the over-reliance on one supplier. But if you don’t have all these deliverables well somebody’s going to have to pay to do this development again which is crazy and very frustrating, but it’s not uncommon at all!
Depending on the product and the situation and the arrangement with the supplier it might be much more complicated than that, deciding who’s going to develop the control plan and the testing plan and all of these things and who’s going to pay for that and will it be communicated to you the buyer? That’s more about the manufacturing process, but you know you you better also cover these bases just to avoid getting to the point where the product is developed, we’ve respected the agreement, now let’s go into manufacturing and then they don’t agree on some key terms and you’re back to facing the same risks all over again. This is why signing a product development agreement first and then signing the manufacturing agreement might be okay, but you need to make sure that if you don’t find common ground you really have the ability to switch to another manufacturer without wasting too much time.
If you do not have that ability then you should have them sign some kind of manufacturing agreement protecting you against the main risks and then of course you can always amend it you can always do an addendum you can always make another agreement that replaces and cancels it right but this is all related to proper project planning. if you don’t plan properly you’re going to miss some of these key topics and if you’re doing business with a company that is not aligned with you, that doesn’t really understand how you want to do business or a company that is just not a good company, you know, not honest, this might become a very big problem, so the product development agreement is excellent for reducing the risks and fundamentally keeping control over our project. It’s about setting the expectations, keeping some leverage, and transparency and control. These are legal tools that help you have transparency over your supply chain, transparency over what happens, and control so that you don’t have too many bad surprises and the ability to do a lot of monitoring if needed.
Related content where you can learn more about product development agreements…
- How To Protect Product IP When Working With Contractors & Factories In Different Locations? [6 tips]
- How Far Does An NNN Agreement Need To Go To Protect Your IP In China?
- How To Create A Valid Manufacturing Contract In China To Protect Your IP
- China Manufacturing and Product Type Chaos
- International Manufacturing Agreements and the Questions We Ask
- The NPI Process [Podcast]
- How and Why To Switch Chinese Manufacturers [eBook]
- Sofeast’s partners (includes a specialist law firm)
Here at Sofeast, we are not lawyers. What we wrote above is based only on our understanding of the legal requirements. We do not present this information as a basis for you to make decisions, and we do not accept any liability if you do so. Consider consulting a lawyer before making legal decisions.
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