Using a ‘manufacturing NDA’ to protect your IP when developing and manufacturing your products in China is often seen as key. Here I’ll break down what documents you can use in China to provide a degree of protection, but I’ll also show you a much better way to prevent trouble.
What’s in an NDA for China manufacturers?
Most everyone has heard of IP theft from China. Just recently in a CNBC poll, 1 in 5 US companies said that they’d been a victim of Chinese IP theft.
How to protect your IP? Well, a traditional NDA (Non-Disclosure Agreement) that you may use in the West, is not enforceable in China, let’s get that straight immediately.
A China manufacturing NDA doesn’t really exist as a single document. The China Law Blog has written some useful recommendations on how to protect your IP (Intellectual Property) and other rights when developing electronic products in China, the legal way.
According to them, when producing goods in China you should consider having NNN agreements (basically NDA++), Product Development Agreements (PDA), and Manufacturing Agreements (MA) with your Chinese suppliers.
Let’s look at each agreement:
The acronym stands for ‘Non-Use, Non-disclosure, and Non-circumvention.’ (NNN). You are preventing your supplier from using your IP, cannot make your information public or share it with a ‘friend,’ and cannot sell your product to your customers at a lower price to undercut you.
The following are the basic things you should know to draft an effective NNN Agreement for China:
1. NDA Agreements are inadequate for China.
2. Choose Chinese law as the governing law.
3. Choose Chinese as the official language.
4. Do not choose two official languages.
5. Choose China courts as your jurisdiction (usually).
6. Do not choose arbitration (usually).
7. Choose the right Chinese court as your venue.
8. Make sure you are protected against subcontractors.
Product Development Agreement
Your Product Development Agreement (PDA) protects you during the important developmental stage of your product. By now you will have sourced a supplier and perhaps have agreed on an NNN with them, however, the NNN doesn’t cover development.
Who is developing your product? Who bears the cost? Is there an agreed and reasonable timeline for it to occur that fits in with your target Time To Market? You need to able to agree on these points in an enforceable agreement, otherwise, the Chinese supplier working on development for or with you might take ownership of your IP after ‘covering the costs’ of it.
On the other hand, in the absence of an agreed timeframe, the supplier might not develop the product on time or budget which leaves you too late to market or scrambling to put out a product which isn’t up to the required standard.
A good product development agreement generally includes provisions addressing the following:
1. The product to be developed.
2. The technology the foreign company and the Chinese manufacturer will contribute.
3. Who will provide the product specifications and in what form.
4. Who will own the IP rights to the resulting product.
5. Who will pay for product development costs?
6. Who will pay for the molds and tooling?
7. Setting of milestones.
Your Manufacturing Agreement (MA) sets out your expectations precisely for the supplier. This should preferably be in both English and Chinese and leave no room for interpretation. It should outline exactly what you require in minute detail and the penalties you will exact on them so that if the supplier does not reach expectations you will have a case for them to answer.
For instance, this will reduce the likelihood of a supplier cutting corners on quality to increase their margins because you didn’t make it explicitly clear that a certain grade of the material was meant to be used for the product.
This post on China OEM Agreements also shows much of what should be included in more detail.
Why negotiate these agreements with your Chinese supplier?
There is a lot of value in negotiating these as it will teach you about the cooperativeness and intentions of your prospective partner.
A factory which negotiates on the clauses may actually be better than the one who just blindly signs, as it says something about their attention to detail and how seriously they take their obligations.
Most importantly, getting everything out in the open ahead of time will make you realize how little of ‘your’ product design you own if you do not pay a reasonable development budget. No money, no honey.
Be Warned. Do not think that you can actually enforce these agreements
Now it’s time for my counter-argument against such a manufacturing NDA’s usefulness.
Cooperation between supplier and customer goes well as long as both sides are winning. If that balance gets lost you need to find the least painful way to get out of the relationship.
Trying to sue a factory in China as a foreign entity is unlikely to bring you anything. Even with the most professional legal counsel, the courts in China are not in your favor. Even with a watertight Manufacturing Agreement as suggested above by Dan Harris in his blog, it could take years to get a result, and only then if the case is big enough. Meanwhile, the offending factory will simply continue to produce on in a different location under a different name.
People new to the industry often underestimate that changing to a different factory means changing to a whole different supply chain, which takes time. It took a company like Flex more than a year to move a product from one of its US factories to a Mexican one, and those were both fully owned. If relations are antagonistic it may prove difficult to transfer those molds you paid for. A lot of animosity starts when a bad factory exploits the grip it has on its customers, and, in ‘boil-a-frog style,’ slowly starts to lower quality and/or raises prices.
How to prepare your escape plan to move from a ‘bad supplier’
Some in the industry say that most China factories get complacent after 2 or 3 years, and there is nothing for it but to replace them.
To be safe it’s always a good idea to keep detailed documentation on your product:
- Assembly SOP (Standard Operating Procedure)
- Injection machine setting
- Testing jigs, testing software
As soon as you sense things starting to go sour with a Chinese supplier, you need to make sure you have lined up a solid alternative well ahead of ending the relationship. It’s better to endure one or two more bad or expensive shipments than to have no product at all. Plus when your current supplier understands that you now have a second source, with approved samples fully ready to go, he may suddenly become much more agreeable and you may be able to salvage the relationship, get things back on an even keel, and save yourself a lot of trouble.
A better approach: Keep the factory relationship healthy
To keep the relationship healthy you need fairness and balance: both sides need to benefit, and a balance of power helps to ensure this.
Things change over time, specifications are updated, quality requirements clarified, and labor and material costs rise. A harmonious relationship will only last if it continues to be worthwhile for both sides, so, in my opinion, a strong negotiating position is far more important than a static document.
A good factory relationship in China gets a lot better over time.
Once your supplier really understands your products and priorities, they can be a great help in sourcing components and recommending suppliers. They will give you really valuable input on how to improve or design a second generation. So a good relationship is worth investing in, if they know you will shop your design around 10 factories they are highly unlikely to put a lot of effort in preventing what may well be other people’s problems. If however they know that you will buy from them, at a price you will hold them to (unless specs really change), they will make triple sure to go over every detail.
Best is, of course, to prevent all this sort of unpleasantness by being very careful in selecting the most suitable, right-sized factory, for whom you are important enough not to piss off, from the start. I will get into this another time, meanwhile, my good friend @Howell Wang (http://www.insightsolutionsglobal.com) has been doing factory audits for a long time and can be of great help negotiating a sensible deal.
As for fairness, most of the business people I decided to work with in China are very reasonable and honest men. But if you promise to buy a steady 10,000 pcs a month in exchange for them developing a product for free, and you then only order a one-time 500 pcs, do not be surprised if the factory looks for other sales channels to recoup their investment.
At the moment when you have 5 factories bid for your project you clearly have the upper hand, and you could cherry pick their BOM’s and see if one of them is willing to accept a really low price. I would not drive too hard a bargain, as it may well come back to bite you: once you have started the relationship and are locked in, the factory has the upper hand and can come up with plenty of excuses to restore what they feel is a fair margin.
In fact, there is a pretty good chance that the factory with the lowest bid has such a strategy in mind: so, if the price seems too good to be true, it probably is!
Conclusion: Build a great relation with one right-sized factory
Using legal documents to make up an enforceable ‘China manufacturing NDA’ goes some ways to protect your IP in China. But for a foreign company operating in China, any legal wrangling tends to be very difficult to get adequately resolved. Fostering a good, mutually beneficial long-term relationship with your Chinese supplier is a much more effective way to go. You are much more likely to achieve a “balance of power” if the factory is not bigger than needed. If your orders are important to them they will work hard to keep you as a client.
What do you think? Have you had success with manufacturing NDAs in China? How about making the effort to build great relationships with your suppliers? In these cases, did they still misbehave? Please leave a comment to share your thoughts and experiences.
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