Product Manufacturing Deals are Far More Complex Than Ever.

Traditional supply and manufacturing arrangements focused on arm’s length transactions between product customers and their manufacturers. These arrangements were typically driven on straight-forward manufacture of labour intensive products and components to complement customers’ own manufacturing footprints. Such manufacturing, aimed at the lower cost of labour, usually involved clear ‘hand-offs’ between customer and manufacturer and the risk points were relatively easy to identify. In the last twenty years, however, manufacturing in Asia has moved beyond mere manufacture to become broader virtual extensions of customers’ product value chain. Manufacturers’ services now include activities such as product development, mold financing and management and inventory and logistics management. This manufacturer integration into broader aspects of supply chains has brought significant advantages and opportunities, but also raises new issues and risks. In order for brand companies and other product customers to protect their businesses and maximise their manufacturer relationships, their contracts and broader engagement framework must be properly structured to bring out the best in the relationship while properly managing the risks.

Initiation and Expansion of Manufacturing

When customers engage manufacturers in Asia they often embark on long term evolving partnerships. Initial engagements may involve purchasing a commodity product that the manufacturer already makes or has ready capacity to manufacture. Next, may come the transfer of manufacture of the customer’s labour intensive products or components, to existing customer specifications (same mess for less). Even this first follow-on step carries risks, as often the transfers are coupled with the closure or reduced capacity of the customer’s manufacturing facilities that are difficult to reverse. This shift further involves introduction of risks outside of the customer’s direct control, including the manufacturer’s environmental, social compliance issues as well as the challenges of volatile commodity markets, rapidly rising labour costs and currency fluctuations — which have sometimes exceeded individual manufacturers’ coping capabilities. Additionally, quality assurance issues become more complicated with the extension of the supply chain, with new parties and functions half way around the world.  

Expansion of Value Chain Role

As their experience and capabilities have grown, Chinese manufacturers they have been eager to take on broader responsibilities within their customers’ value chains — and many customers have been receptive. Manufacturers are getting involved earlier than ever in the product life cycle — including in development processes often involving sophisticated engineering and design. This expanded manufacturer role has helped customers shorten lead times to manufacture, further reduce high cost headcount and provide for a more seamless handover to manufacturing. But this development has also given rise to some significant customer constraints, including difficulty in maintaining best (competitive) manufacturing cost. Longer supply chains, quality issues and an ever increasing-reliance on the manufacturer have come to color many aspects of the customer-manufacturer relationship. Overly reliant manufacturer relationships can be extremely difficult to unravel without significant adverse impact on the customer’s supply chain.  

Product outsourcing

In short, product manufacturing is growing into supply chain outsourcing and bringing the same risks traditionally found in other service outsourcings, including those related to increased manufacturer dependency and loss of leverage. It is important to address outsourced product development and the corresponding customer risks through comprehensive contractual arrangements. Failing to address important components of the supply chain — such as allowing ambiguity in the ownership of the designs or other work created by the manufacturer or through collaboration — ambiguity that only becomes more difficult to resolve later. For example, when manufacturers provide specific manufacturing equipment (tooling) without properly structured agreements, it is sometimes impossible to move the tooling to another manufacturer. Problems can further arise in a number of recurring contexts, such as premature project terminations.  

Regardless of the level of manufacturer integration in the customer’s supply chain, the customer needs to maintain adequate control of critical production factors such as ownership of critical intellectual property and means to ensure best cost manufacturing and product quality.  

No two manufacturer-customer relationships are entirely the same and each manufacturing framework needs to capture the risks in fact associated with the arrangement. Sophisticated manufacturing agreements not only manage risks and protect customer interests, they facilitate the creation of value in the overall relationship, such as by cutting costs , lead times and necessary inventory levels, effective utilisation of management tools, and improved costs and quality through waste elimination and product productivity mechanisms.