Manufacturing Contract: Definition, Key Terms, Benefits

What Is a Manufacturing Contract?

As an entrepreneur, you don't have to deal with manufacturing a product you develop. Instead, you can create a contract with another company to manufacture your product so that you can start selling it on the market. This process is typically referred to as contract manufacturing. A manufacturing contract sets the terms for this kind of agreement, while also outlining the responsibilities and obligations of each party.

A contract manufacturer is a company that produces goods for another business. The contract manufacturer is responsible for sourcing the raw materials needed for production. They also provide manufacturing processes to meet certain requirements, such as:

• Delivery dates
• Quality
• Quantity

By signing an agreement with an outside firm, you can get the assistance you need to produce and sell your products. This allows you to create a product without investing in equipment, machinery, or specialized product knowledge. For example, you can use a manufacturing contract to arrange for a local or overseas manufacturer to make all or a part of the product your company produces and then sells.

The hiring company typically provides the formula or design for a contract manufacturer to replicate or even improve upon. Then, the hiring firm deals with the marketing and selling of the product.

Key Elements of a Manufacturing Contract

Manufacturing contracts can have considerable variation. You might sign a contract for one specific product line, or you could sign a few different agreements with various providers in a specific region. No matter your specific needs, you will want to create a manufacturing contract that outlines the exact terms of the relationship between your company and one or more other organizations.

Any agreement should include aspects such as:

• Intellectual property ( here is some further reading on this topic)
• Project costs
• Responsibilities of all parties
• Liabilities of all parties
• Turnaround time

In regards to intellectual property, manufacturing contracts will typically contain strong language assigning all rights to any products, marks, copyright, patents, inventions, and other intellectual property assets, to the business, and further that the manufacturer shall not retain, copy, make use of, or otherwise disclose such information to any party for any purpose.

Manufacturing contracts must also cover certain elements to make the agreement legally binding. Make sure your contract includes these elements so that all parties are protected in case of a disagreement or a failure to deliver on promises. Important legal elements include:

• An offer of work
• Acceptance by all parties
• Intent to create a legal relationship
• Consideration, which is the transaction of currency and/or goods

Additionally, most manufacturing contracts will include some or all of the following components, depending on the company's specific situation and the products they want to create:

• Essential processes: Your manufacturing contract should define terms for key processes. Outlining this in the contract will help ensure that all parties are on the same page and satisfied with the end result. Key processes can include:
  • Delivery
  • Invoicing
  • Lead times
  • Payment
• Licensing agreements: This aspect of an agreement is essential if an organization expects its contract manufacturer to use trademarked intellectual property. A third party cannot legally manufacture a product without this, so they need this agreement to avoid lawsuits for trademark infringement.
• Non-disclosure agreements: A nondisclosure agreement, or NDA, is important if you are dealing with proprietary services or products. This is particularly common in the technology sector. For instance, Apple would include an NDA in any contract with a third-party manufacturer to ensure they can surprise consumers when they reveal their latest products.
• Purchase orders: These documents establish the terms of a transaction between an organization and its contract manufacturers.
• Quality standards: If you are contracting out your organization's manufacturing, you need to make sure you receive high-quality services and products. As a result, most manufacturing contracts have various stipulations that detail quality standards. In the long run, this not only saves you effort and time, but it will also cut down on the possibility that the customer receives a sub-par product.
• Supply chain agreements: Your organization's products are probably not beginning and ending in the same place. To improve efficiency and communication throughout the entire production process, you can establish a product's supply chain in a manufacturing contract. For example, you may need to involve skills and services from various business partners in order to design, market, package, and produce your products.
• Termination clauses: The manufacturing contract will end at some point. The initial contract should address what happens to things such as intellectual property and patents to ensure that the relationship between your business and its manufacturers does not come to a contentious end. Often, a manufacturing contract will include specific clauses assigning any and all rights to inventions, patents, copyrights, trademarks, and any other intellectual property assets, to the business and to the exclusion of the manufacturer, with additional language barring the manufacturer from retaining, copying, making use of, or otherwise disclosing the confidential trade secrets and intellectual property of the business during and in perpetuity after the existence of the contract. It's also useful to outline the circumstances in which the contract can be terminated, such as insolvency or a breach of the contract.

Image via Unsplash by clayton_cardinalli

Benefits of Using a Manufacturing Contract

Companies may choose to create a manufacturing contract for a few main reasons. In general, these contracts make it less expensive, more efficient, and simply easier to bring new products into a market and then achieve broad distribution. The main benefits of using a manufacturing contract include:

• Cost savings: Your company can save a lot of money if you contract with a manufacturer that has already invested in the right equipment and knows the manufacturing process. You might do this with a manufacturer that produces similar but noncompeting products. Depending on the manufacturer's location, you could also enjoy savings in terms of:
  • Energy costs
  • Labor costs
  • Overhead
  • Raw materials
  • Taxation benefits
• Distribution: Contract manufacturers can sometimes drop-ship a product to customers in a specified geographic area, or they may even ship your product to all of your customers. Some manufacturers handle individual customer shipments. Others may deliver the product to a central warehouse, and then you will need to take care of shipments as the hiring company.
• Easier market entry: It may be difficult to enter the market where you produce your goods, but you can still make them at low prices and export them to nearby countries that would be harder to reach if you manufactured your products elsewhere.
• Focus on core competencies: By using a manufacturing contract, you can free up people at your own company so that they can focus on their true strengths, such as marketing or selling. Otherwise, your firm may not have the capability to make your product in a country or factory setup that saves you money.

Risks of Using a Manufacturing Contract

Manufacturing contracts can come with some risks as well. For example:

• Cultural differences, such as language barriers, can create complications for contract manufacturing. It is always a good idea to define terms clearly. Furthermore, if necessary, consider drafting a contract in multiple languages and have each contract reviewed by local representation familiar with the region to ensure each version is legally consistent with one another to avoid any misunderstandings.
• You will not have complete control over the quality of the product produced.
• You likely will not be the only company working with the manufacturer you choose, which may raise questions about delivery timelines and the potential to share proprietary information.
• You will give your product ideas to someone else to make, so you might feel like you are giving your best ideas to a possible future competitor. Some unethical manufactures do give away product ideas from one client to another.

This is why it's so important to get a legal contract in place if you plan to work with a contract manufacturer. A legal contract will protect you against any fraudulent behavior. Without a good contract, the manufacturer could simply tweak your product and sell it if they see the demand your product has in the market. A contract details your legal rights as well as recourse if the manufacturer breaches the contract. You will want to make sure that you know which country governs your contract if you negotiate with overseas manufacturers.

Having a solid contract in place will help protect you and your business from these potential problems, so you should work with an experienced lawyer when creating your manufacturing contract.