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What is a manufacturing agreement and why should you care?

What is a manufacturing agreement and why should you care?

Originally posted on JJS Manufacturing Blog

A manufacturing agreement establishes crucial obligations and includes key clauses such as warranty provisions, technology requirements, and turnaround times. It should be signed by the electronics manufacturing services (EMS) provider and their original equipment manufacturing (OEM) partner. The agreement ensures both parties enter into a relationship knowing they can trust each other.

Most OEMs want to manufacture their product as quickly as possible, but…

When you have spent a long time designing a product, understandably you want to see that product come to life as quickly as possible. But jumping too quickly into a partnership is ill-advised.

Yes, it might take you a little longer to get all the fine details of the contract agreed but a little extra effort in the short term is well worth it.

Although some EMS providers will be willing to go straight to production, the best and most enduring relationships are forged as both sides know and understand each other.

Preempting potential problems

  • What do you get for your money?
  • How should you pay?
  • Who is in charge of delivery?
  • What should the forecast period be?
  • How do you manage excess stock, and who pays for it?
  • Who is in charge of quality assurance and product inspection?
  • What should the product warranty include?
  • Who is responsible for tooling and testing?
  • What governing law should be applied to the contract?

How would you answer these questions? They can all reasonably be answered in many different ways based on diverse perspectives. No one way is ‘better’ than the other; however, you do not want to wait until there is a problem to find out that your perspective is vastly different from your EMS provider.

Why you should work on a manufacturing agreement together

When you sign a manufacturing agreement, you know exactly what to expect from your partner. The document should be the result of an OEM-EMS partnership that begins with negotiation—working out how to resolve potential issues before they become problems. Every relationship has small problems along the way, but a strong relationship will be able to weather these. If you can work with your EMS partner on a contract at the very beginning of the relationship, you will begin to build up a level of mutual trust and respect, and it is likely that your relationship will last in the long term.

How does an OEM benefit from a manufacturing agreement?

OEMs are protected legally and economically

The manufacturing agreement sets out key legal obligations for the manufacturer and the OEM. It also establishes the invoicing process and payment terms. Most significantly, the document states which legal system will interpret the contract. For example, an OEM based in the UK will not want to wait until there is a problem and find out that they are subject to Chinese law.

IP is protected

Protection of a product’s intellectual property (IP) is essential for an OEM that has decided to outsource manufacturing. The contract should stipulate that the EMS provider can use this IP for a specific purpose. However, throughout the manufacturing process, the EMS provider may make improvements to the product. In this case, the IP is likely to belong to the manufacturer—unless agreed otherwise.

This should be discussed before production so that clear terms are added to the manufacturing agreement. Alternatively, future improvements and the relationship may be jeopardised.

Product testing is agreed upon

EMS providers do not test every final product they build—unless discussed during the manufacturing agreement negotiation process. Testing products takes additional time and skill and is generally more expensive. Testing can also require the OEM to provide detailed data and in some cases, specialist equipment. Therefore, it is preferable to agree upon the required level of product testing from the start to avoid frustration and expense.

Product quality is guaranteed

There have previously been conflicts between OEMs and their EMS partner resulting from misunderstandings about product quality and possible regulatory implications. However, manufacturing agreements ensure that the selection of raw materials, components, manufacturing process and controls, testing, release, quality, and documentation adhere to the expected product quality.

The product specification is known

A bill of materials is essential for product development as well as for product commercialisation. During the design phase, it’s not uncommon for the BoM to change, and it is essential to make a record of past and present revisions to see what has changed. When it comes to manufacturing, the BoM should show all components and subassemblies and how they fit together. Agreeing on the BoM when negotiating the manufacturing agreement will ensure that both parties understand and have agreed upon the necessary components.

If the product changes, both parties are clear about what will happen

Product designs can change. And not at the most convenient times. Manufacturers understand that this is a reality for product developers, but this still has the potential to be a frustrating time. Both parties clarifying how they will handle Engineering Change Notes (ECNs) is crucial to effectively resolving them and continuing to manufacture the product successfully.

The mechanisms for buying materials will be clear

Both parties have responsibilities for buying materials. The OEM should be clear about the materials’ costs and their respective mark-up; they should also specify the amount of inventory required. The EMS provider should specify that they will make the purchases from approved vendors at the best price possible. It is also typical for the EMS provider to purchase sufficient materials to protect lead-time requirements and to get possible volume discounts.

Conclusion

There are three possibilities for an OEM looking to manufacture a product. They could contract an EMS provider and hope for the best. They could send a purchase order and ask the EMS provider to build a certain number of units. (This would at least mean they are aware of the terms and conditions, but it will not contain extensive operational requirements.) Or they could work on a comprehensive manufacturing agreement with their chosen partner.

This will take time as legal negotiations are never simple. But it means that both parties will enter into a relationship trusting their partner. A solid manufacturing agreement will lead to a better product, fewer problems, and more profitable commercialisation.

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