Managing Supplier Responsibilities in a Manufacturing and Product Development Outsourcing Contracts

Editor’s Note: This is the first of a four-part series written by Thomas Keenan and Geofrey L. Master

Many brand marketing companies (“brand companies”) that source their products from China have, over the past few years, moved from simple third-party manufacturing to specifications-manufacturer relationships to a new model that has the manufacturer involved early in the production process to develop new products. This expanding role by manufacturers into product development (including even conception and design) has often come about as a natural progression in the relationship between customer (brand company) and provider (supplier or manufacturer), as manufacturers have grown in their capabilities and sought to expand their footprint into new value-add areas. These developments provide benefits to brand companies as well, including increased speed and efficiency in product development and savings through reduced capital investment and lower employee headcount.

In fact, in many cases this evolution in functions—the emerging product development outsourcing model—has developed so naturally, that brand companies have failed to fully grasp its significance. They have consequently failed to identify and address some of the risks that have come with the benefits. Both advantages and constraints in the evolving value chain should be fully recognized and addressed.

Brand companies that utilize their manufacturers for functions beyond manufacturing invariably face a new reliance on the supplier and may fail to clearly delineate responsibilities. Delineation of responsibilities was easier in the narrower, simpler sole-function manufacturer model. The increasing reliance of brand companies on their manufacturer has created new constraints; some are rather obvious and others less so, as customers find it more difficult to obtain the most competitive best “total cost” pricing when they are married to the same supplier for the manufacturing development and other deep supply chain functions.

The reality is that some of the most capable development suppliers do not offer the best manufacturing costs—in essence, because of their customer’s heavy reliance on their resources, have enabled them to move their pricing model from the traditional OEM “cost-plus” model to a “value-based” pricing model. Indeed, from a business model perspective, this is often precisely the objective of the manufacturer; while there is absolutely nothing wrong with this objective, the danger is that a brand company may find itself utilizing the model, but without the appropriate safeguards to maintain a proper level of control over its product destiny.

What is required by the responsible brand company is a clear cooperation framework that allows the company to benefit from the manufacturer’s value-added services, but not at the expense of important
customer protections. This article will explore key supplier responsibilities in a product development and manufacturing relationship and how advanced purchasing mechanisms incorporated into the sourcing agreements can help to mitigate and manage the inherent risks.

The first step for responsible supplier engagement is for the product company to perform appropriate pre-contracting due diligence into the potential manufacturer’s ownership, financial stability, quality and engineering systems, manufacturing and commercial abilities.

After establishing supplier capability and viability, next there are many supplier responsibilities that must be considered in a manufacturing and development services contract. As the role of manufacturers expands into what is, effectively, service provision, the classic issues faced in services outsourcings arise. Key among these issues are defined scope and deliverables, pricing and productivity, lead times and service levels (including quality) and product development. A brand company’s failure to properly manage any of these areas in the sourcing relationship can, and has, proved costly later in the engagement.

We will look at each of these key areas of responsibility in turn and discuss how companies should manage them through effective contracting. Brand companies can and should leverage heavily from the accumulated learning of services outsourcing over the past 20 years, as the business model for outsourcing has evolved to provide sophisticated customer protections through the contract, nuanced in some cases to account for the product environment in which these issues arise.

Geof Master
As a partner in Mayer Brown JSM’s Business & Technology Sourcing practice, Geof Master has broad experience in sourcing transactions, including the outsourcing and offshoring of information technology and services as well as of business processes. He can be reached at [email protected].

Tom Keenan
Tom Keenan is a Registered Foreign Lawyer (Victoria, Australia) of Mayer Brown JSM. He can be reached at [email protected].

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