What is OEM Contract Manufacturing
The term "OEM" is a common acronym found in the manufacturing industry. The letters OEM stand for "Original Equipment Manufacturer". According to Wikipedia, an OEM is basically a company that produces parts or equipment that may be marketed by another company under the brand of the manufacturer or another brand name. In contract manufacturing, OEMs and the contract manufacturer often operate under a contractual agreement that provides for the contract manufacturer to produce a specific part or product according to specifications provided by the OEM. Essentially, the OEM provides the contract manufacturer the specifications for the product, and the contract manufacturer builds the product to the OEM’s design.
If the contract manufacturer did not operate under a contract with the OEM, then the contract manufacturer could simply create products for the open market, or for other companies. In the alternative, the OEM could establish its own manufacturing facility. In today’s global economy, utilizing a contract manufacturer rather than manufacturing a product in-house is often more efficient, and provides cost and scheduling advantages, than if the OEM manufactured the product itself.
From the contract manufacturer’s perspective, being an OEM contract manufacturer has certain advantages. An OEM contract manufacturer can use its existing resources and experience to manufacture parts and products for the OEM’s business . The result is an additional stream of revenue for the contract manufacturer, and the ability to diversify the products it offers in the marketplace. OEM contract manufacturers are typically able to offer competitive pricing since the contract manufacturer can build the products on a larger production scale.
From the OEM’s perspective, utilizing an OEM contract manufacturer can both save costs and provide another stream of revenue. Since the contract manufacturer can purchase the raw materials to manufacture the product in bulk, the cost of materials should be lower for the OEM. In addition, if the OEM contract manufacturer already has the necessary machinery to produce the product, it is less expensive than manufacturing the product from scratch. Finally, if the contract manufacturer sells the parts or products on the open market, the quality of the product can promote brand awareness and visibility.
In sum, an OEM contract manufacturing agreement is a very beneficial business arrangement for both parties, and an interesting example of how cutting-edge technology, manufacturing, sales and business are intertwined in the modern economy. Understanding the basics of OEM contract manufacturing agreements can provide a strong springboard to further research into a wide variety of interesting related topics.
Core Aspects of an OEM Agreement
There are many aspects of an OEM contract manufacturing agreement that can be very important for both parties. If an order must be filled in advance of the sale of goods, then the manufacturers must have a clause in the agreement outlining when the OEM buyer must place an order and the time frame for delivery; other important aspects of the agreement must include terms for ordering goods, pricing for the goods, and quality control.
While pricing is not always essential to an OEM contract manufacturing agreement, it is crucial for OEM buyers to make sure that there is a warranty agreement provision. In addition to the warranty provision, other important aspects of the OEM contract manufacturing agreement are the liability and indemnity provisions. While many manufacturers would rather disclaim liability as a risk management tool, it is an important element for the OEM buyer to have an indemnity provision in the agreement so that it will be protected should the end consumer sue them based on the product’s defects or shortage. Another important aspect to include in an OEM contract manufacturing agreement is a product description. If the product description is not clear, the OEM manufacturer will not be bound by the agreement and will not have to produce a specific number of products if they are not specifically described in the agreement. Finally, all OEM contract manufacturing agreement should clearly state which governing law will be used to resolve any disputes that may arise.
Advantages of OEM Contract Manufacturing
The decision to engage in an OEM contract manufacturing partnership can have significant long-term implications for both parties. However, despite the initial concerns that may be associated with entering into an agreement, the decision to move forward with a contract manufacturing arrangement can be advantageous for both the manufacturer and the OEM partner.
The first major benefit of OEM contract manufacturing is the cost savings this type of contract offers. By having a third-party manufacture their products, OEMs are able to reduce the costs of constant production, particularly those related to maintaining equipment and facilities. Furthermore, because the contractor is typically equipped with the latest production technology and design elements, OEMs are able to avoid the high costs of purchasing new equipment and integrating them into existing facilities.
OEM contract manufacturing also provides the benefit of allowing OEMs access to expertise and skillsets they may not possess in-house. This is particularly beneficial for those companies that specialize in one particular product or type of product, rather than producing a variety of items. With a dedicated contractor operating on-demand, an OEM can remain focused on the design and marketing of its products, spending less time and energy on the manufacturing process.
In addition to accessing the cost and expertise benefits of OEM contract manufacturing, companies that pursue this option also gain an advantage when it comes to meeting market demands. Because manufacturers tend to operate on short notice and can provide a large number of parts and products very quickly, OEMs that make use of contract manufacturers can increase their total output and respond more quickly to demands. Companies that take advantage of this benefit can in turn gain a significant edge over their competition, expanding their presence in the marketplace.
Clearly, these benefits have made OEM contract manufacturing a popular choice among many niche manufacturers. For many businesses, outsourcing their production needs and working with a contract manufacturer offers both a cost effective and efficient means of operation.
OEM Contract Manufacturing Risks and Challenges
Risks and Challenges in OEM Contract Manufacturing Agreements
Similar to any business agreement, OEM contracts carry their own share of specific risks and challenges.
Currently, few jurisdictions have comprehensive legislative protections, leaving OEMs vulnerable to exploitation of their intellectual property (IP).
OEMs face particular risks when they share or disclose confidential information or proprietary technology to a contracting party for the sole purpose of entering into a contract. For instance, if the parties do not reach an agreement, the supplier may continue to hold the OEM’s confidential information or employ its proprietary technology within its own operations. This exposes the OEM to potential exploitation or illicit use of its proprietary technology by a competitor.
Furthermore, some OEMs may be unable to sign nondisclosure or confidentiality agreements and/or may lack the means to pursue legal recourse.
Supply chain disruptions, which often occur as a result of changes in the industry, government regulations, or shifts in consumer demand, can also seriously impact OEMs. For example, a shortage in the supply of raw components such as metals, plastics, chemicals and other materials can prevent OEMs from delivering completed products to their customers.
Customers may also demand shorter product lifecycles. A reduced growth period may increase production costs, resulting in detrimental price adjustments end-users and/or suppliers or subcontractors.
Communication barriers are another common problem. OEMs have expressed frustrations over the difficulties that arise in sharing important product information with suppliers or subcontractors. Even when OEMs are proactive in the negotiation process, considering such matters up front is helpful, as contracts drafted under duress offer little to no protection.
Adding to the complexity of these agreements is the growing trend of localization, wherein OEMs outsource their production to local subcontractors. Localization may increase the number of contracts an OEM has to consider and further complicates communication. Either the original equipment manufacturer or its workers must be fluent speakers in many languages to communicate consistently and effectively with subcontractors throughout the world. In the OAuth economy, OEMs negotiating contracts are also responsible for the language of the software and other digital tools they employ to facilitate the contract manufacturing process.
If you have specific questions or concerns about the intricacies of OEM contract manufacturing agreements, we encourage you to consult a professional who specializes in this area.
Strategies for Effective OEM Contract Manufacturing
OEM arrangements can be a key strategy going forward and would help manufacturers deal with the increasing competition in many fields, including electronics. That said, however, these partnerships also present special concerns that manufacturers must think through and navigate from day one. There are various areas of concern manufacturers should consider before entering into or improving their current relationships with OEMs. From our experience, these include the following: OEM contract manufacturing arrangements involving more integrated services, including design, prototyping and product support, are becoming more common, as is global sourcing of the manufacturing function . Some of our clients have even used joint ventures as an OEM arrangement to tap manufacturing resources. Apart from a broad analysis of the options available to a client, a major step in planning a successful OEM agreement is to select a prospective OEM partner that will be able to work with the client to implement an ongoing program that achieves the client’s business objectives. We advise a diligent and thorough approach to selecting an OEM partner. When looking for the right OEM partner, we typically perform the following:
Critical Legal Issues in OEM Agreements
To do business with a Chinese manufacturer typically an OEM contract /Manufacturing agreement is set up and is a critical document that binds the parties to a set of expectations and deliverables. It specifies key aspects of the relationship as well as rights and obligations for both the supplier and the OEM customer. It is essential that all aspects of the OEM contract are discussed and agreed upon by both parties. There should be no terms hidden in a Contract Manufacturer’s template. Both parties should actively participate in the drafting and negotiation of the OEM contract so as to avoid any misunderstandings. A Contract Manufacturing Agreement typically covers areas such as:
The OEM Contract should be established clearly setting forth the relevant considerations for both supplier and OEM customer. The following elements should be considered:
Governing Law and Jurisdiction With respect to governing law, OEM customers would typically prefer their own country’s laws to apply, however as the Supplier will have no vested interest in the OEM customers’ country’s governing law, NIALL O’CONNELL & CO., recommends using the governing law of China as it is not only more sensible for the Supplier but Chinese Courts understand the local law better than foreign courts. In this way, the Supplier will be more likely to respect the decision of a Chinese Court.
Dispute Resolution The primary reason for including a dispute resolution clause in an OEM contract is to avoid litigation in a foreign country with an unknown legal system, if a dispute arises. Should a dispute arise, there is the possibility of bringing on mediation or arbitration. Consideration must be given to where, when, under what governing law and by whom the mediation or arbitration will take place and typically these matters are agreed to by both the OEM Customer and Supplier prior to its execution.
Liability When considering limitation of liability, it is important to consider who the manufacturers are that are involved in the product. If the OEM supplier has been involved in the design and manufacturing then they will want protection from all damages and claims arising out of the use of the product. However if the OEM customer has been involved in the design of the product but not the manufacturing, they may accept liability up to a certain amount or limit liability to parts and components supplied by them. A fundamental element in a good manufacturing relationship is that the liability of both parties be negotiated and that both parties sign the agreement with well drafted and clear language regarding liabilities.
Evolution of OEM Contract Manufacturing
As we look to the future, it is clear that OEM contract manufacturing will continue to evolve. For instance, we are starting to see more large-scale automation. New developments in robotics enable companies to create robotics systems that can be programmed with ease and be used across a variety of lines. In addition, customization of robots has progressed to the point where they can be used seamlessly in different environments. Of course, automation will continue to replace human labor, but with mass customization requirements , there may actually be increased demand for skilled labor to service and maintain both manufacturing facilities and automated systems used to implement lean principles and practices.
Another big trend is the move toward sustainable manufacturing. More OEMs are taking steps to make their manufacturing facilities environmentally friendly in terms of raw materials used, waste produced, and energy consumed for manufacturing. This is being driven by a growing demand for sustainable products. In addition, sustainability is becoming a part of the lean/agile manufacturing movement, where a more frequent, sustainable approach to manufacturing may be a solution for reducing costs and increasing profitability.