By Mike Bellamy
QUESTION: I have two patented products that need to be manufactured and would like to know how I can get in contact with a Chinese manufacturer to produce the product and distribute worldwide under a licensing agreement where I receive royalty payments and the manufacture handles production, distribution and invoicing. Any assistance or advice you can offer me would be appreciated. One of the products is for the automotive market and the other is outdoor recreational area.
Thanks for your question. The method you describe is possible, but you are sailing in some very dangerous waters.
This type of partnership does not have a good track record
I don’t have enough fingers to count the number of times in past few years that I have heard of the sales partner/ licensee/distributor doing the heavy lifting to create a product, only for the factory to cut that person out of the loop once the market has been opened. So, here are some tools to protect yourself:
Set up an exclusivity arrangement with the supplier. Have wording that protects against gray market imports and also covers anything that factory or its subsidiaries produce. For example, if you get exclusivity/licensing on only a brand, the supplier can always make a new brand on the same product and cut you out, so be sure to have true protection in your exclusivity arrangement.
It’s nice to have an exclusivity agreement in place with your Chinese manufacturer, but the protection under a document alone is far from sufficient. To further protect your interests I suggest the following:
- Find a supplier you feel comfortable with. If you sense they are not trustworthy during your initial discussions, then move on to another supplier before you get too far down the road towards production. Review carefully how they have partnered with other licensees.
- Do your due diligence. Get some references. If they are not active in your country, speak to their sales partners/ licensees in other countries to get a feel for what it is like to work with this factory.
- Rather than being a licensee, consider being the exclusive distributor in your country. A distributor takes title to the goods, marks up as they see fit, and most importantly controls the contact with the buyers. An effective distributor is much harder for the supplier to remove from the supply chain than a simple agent. The down side is you have some finance and product liability risks when you are the distributor, but often the mark ups are higher, so the reward may be worth the risk. There are pros and cons, so my point is not to say distributor is always better than licensing, but you should certainly explore your options.
Keep in mind that should things go wrong…
An exclusivity agreement for you to promote the product in your target markets signed in the jurisdiction of those markets while have more leverage than signing a licensing agreement with your Chinese manufacturer in China because it is pretty easy for a Chinese manufacturer to skirt around your licensing agreement.
Rubble in the jungle
When Muhammad Ali took George Foreman to the ropes in the 1974 classic boxing fight he called it the “rope-a-dope”. In situations other than boxing, like China Sourcing, I use a “rope-a-dope” to describe strategies in which one party purposely puts itself in what appears to be a losing position or even so called win-win position, but in the long run they have a hidden agenda and are attempting to become the eventual victor. In the case of licensing, the buyer may feel they are in a position of strength but then bammmmm…..rope-a-dope. For example: you sign with Chinese manufacturer A, but company A outsources to Chinese manufacturer B down the road which is owned by company A’s cousin and company B exports the product around the world. You have no agreement with Chinese manufacturer B, so they don’t pay you royalties. Rope- a-Dope! Down goes Foreman. There goes your paycheck.
The solution is to have (in addition to your licensing or exclusivity agreement) clear ownership (under your name!) of the Intellectual Property (IP) in the markets where you feel the goods may be sold.
What fs there is not a lot of IP?
If there is not a lot of IP that can be put under your name, then consider being the brand owner. Even if you are the sales agent, licensee or distributor you can work with the factory to develop a local brand for your market. If you own that brand as a trademark and the end buyers value the brand, then should the factory try to cut you out of the mix at a later point, they can’t do it using the original brand. So you have a better chance of retaining your buyers’ loyalty. Plus, if you own the brand, you can move production to another factory if needed. So you, rather than the factory, are in the driver’s seat.
Trust (a little) but verify (a lot)
Have a plan in place to keep an eye on back door shipments from your supplier. For example, if you set up exclusivity/ licensing for your market and the official order is 10,000 units. Perhaps the factory makes 20,000 units and sells the difference to a China based broker, who then sells to an international broker who then imports the product into your market. The factory can claim they are respecting your market exclusivity by not selling direct to your market, yet your market position is being cannibalized none the less. A good exclusivity arrangement should make it clear, that such a scenario is not acceptable, but like everything else in China, you need to verify that the agreement is being respected.
One way to verify is to visit the factory on a regular basis to keep an eye on what product is shipping where. Hire an agent to represent you if you don’t get to China often.
Another way is to try to be the big customer of a smaller factory. If you are the lifeblood of a factory, they are less likely to try to cut you out. If you are a minnow and they have whales for customers, you won’t get respected.
I highly suggest you first focus on picking your specific product. Second, start looking for Chinese manufacturers you feel are honest and with a good reputation. Third, even if they appear honest, you still need to get a good contract in place after doing your due diligence. Finally, always keep a close eye on what is happening. Pray for the best, plan for the worst!
Wishing you successful China Sourcing!
Due Diligence experts at www.CBIconsulting.com.cn helped the author by providing insight into how to keep an eye on factories.
Contact the author if you would like to be put in touch with an English speaking lawyer in China to review your contacts or register your IP. Legal support is outside the author’s area of focus, but author will be happy to make an introduction to somebody that can help you.
The post is originally written by Mike Bellamy of PassageMaker Solutions. It is featured here as part of Smart China Sourcing’s promotion of China Sourcing Academy’s courses. Check out their courses here.