Manufacturing overseas

Structuring the offshore arrangement

If you want to engage an offshore manufacturer to produce all or part of your business’ products, you have a number of options including:

• contract manufacturing
• entering into a joint venture with an overseas company
• buying into an existing, or setting up a new, manufacturing facility.

Contract manufacturing

Entering into an agreement with a local manufacturer is the simplest option as it offers the greatest flexibility and the lowest set up cost.

In this context contract manufacturing entails an overseas firm manufacturing all or part of your product under contract to your specifications.

If your products rely heavily on your design to be competitive you should be very wary about who you give access to this information. You may consider manufacturing only certain components overseas to protect your intellectual property (IP). It remains your responsibility to market and sell the product.

• Find out more about protecting your IP

Risks associated with offshore manufacturing

There are always risks involved when entering into an agreement with an offshore manufacturer. Some of the key risks to your business include:

• Losing some control over the manufacture of your products. It will be impossible for you to control certain aspects of the offshore manufacturer’s business, which can result in failure to meet business objectives. In addition, acts or omissions by the manufacturer can reflect badly on the brand and ethics of your business. Including governance provisions in the manufacturing agreement can help to reduce this risk.
• The relationship between your business and the offshore manufacturer may deteriorate to the point where your business wants to exit the relationship. Reduce this risk by including governance, dispute resolution and exit provisions in the manufacturing agreement.
• Unauthorised use of your business’ intellectual property (IP). This is particularly relevant if your business relies heavily on product design to remain competitive. Include a comprehensive IP clause in the manufacturing agreement.
• Unauthorised use or disclosure of your commercially sensitive or confidential information. This risk can be reduced by including a confidentiality clause in the manufacturing agreement or by requiring the manufacturer to enter into a separate confidentiality agreement.
• Changes in foreign currency exchange rates. You will need to decide how best to protect your business against foreign currency exchange rate fluctuations that may negatively affect your business. There are several options, including hedging (for example, by entering a “forward foreign exchange contract”) or transacting in New Zealand dollars (transferring the risk to the manufacturer). Consult a professional finance specialist to determine which option is best suited to your business.

Key elements of a manufacturing agreement

Once your business has selected its preferred offshore manufacturer, the next step is to enter into a written manufacturing agreement with the manufacturer. Before signing any agreement you should always seek legal advice to ensure that the agreement is tailored to meet your specific business requirements.

The manufacturing agreement sets out the terms and conditions on which the offshore manufacturer will produce your products.

Ensure that any agreement you enter into takes account of, and allocates responsibility for, the risks involved in offshore manufacturing. A manufacturing agreement should address the following issues:

• an accurate description of the products including product specifications, raw materials and packaging. This allows the manufacturer to meet your business’ requirements and expectations
• the ordering procedure, shipping terms and delivery arrangements. This includes the transfer of title in the manufactured products from the manufacturer to you, a local reseller, or directly to the end customer
• the price for the finished product and the payment terms
• whether or not the manufacturer has the right to sell the finished product to third parties
• warranties and contractual protections relating to the delivery and quality of the products in case the manufacturer does not deliver on quality requirements or time
• a requirement that the manufacturer develops and maintains suitable business continuity practices and capabilities. This ensures continued supply and minimises risks, which could lead to an interruption of supply
• a comprehensive IP clause that clearly identifies who owns the IP in the finished product and any materials developed in the course of production (it would be usual for the New Zealand customer to own the IP)
• a process for effective management of the relationship between the parties to enable open communication and speedy resolution of problems, including:
• allocation of responsibility for ongoing procurement and supply
• service management and quality management; and
• processes for the management of contract change and escalation
• an escape clause for your business. Normally a contract will not end until it has reached its expiry date or one of the parties breaches the terms of the agreement. However, if the relationship between the parties deteriorates significantly or the customer loses confidence in the manufacturer’s ability to meet its obligations, the customer may want to end the relationship sooner. This can be addressed by including a provision that allows the customer to terminate for convenience (that is, for any reason) by giving written notice to the manufacturer
• a dispute resolution procedure. This should set out the process each party will take if there is a dispute. This could include giving notice to the other party that sets out what the dispute is and when it will be escalated to mediation, expert witness etc.  A clear dispute resolution process helps ensure disputes are resolved quickly and amicably where possible. It also gives parties certainty about what to do if they can’t resolve a dispute; and
• the country’s laws that will govern the agreement. If a dispute arises relating to the manufacturing agreement, the resolution, including the interpretation of any tricky contract terms, will generally be conducted in accordance with the “governing law” specified in the agreement.

Setting up, buying or joint venture manufacturing facilities

Setting up or buying your own manufacturing facilities overseas can be extremely expensive. You will need to have significant volumes of business to realise a return on your investment.

Running an overseas factory as a joint venture with a local party can reduce the risk to your business in New Zealand and lets you take advantage of local knowledge.

• Find out more about setting up strategic alliances and joint ventures

Some countries put conditions on foreign owned businesses and may have laws relating to foreign investment. Make sure you get advice from your accountant and other business advisors before you invest in overseas production facilities.

Steps to finding a manufacturer

1. Learn the regulatory requirements of your target industry.
2. Research the market or industry to find out its structure – it can be very different to what you might expect.
3. Define your needs accurately.
4. Research potential manufacturers.
5. Short list the candidates and get quotations or references. If you do not have anyone in market to assist, ask potential manufacturers for New Zealand (or Australian) reference clients. Follow these up.
6. Do a proper legal background check on the final candidates to verify the information provided, including ownership, registrations and business scope.
7. Personally visit the top candidates with a trusted translator and experienced resident.
8. Use a proper legal translation from a law firm for final contracts. Make sure the company you hire for this has experience in structuring offshore manufacturing contracts and is familiar with the law in the country concerned.

How to manage quality

A big issue facing companies considering local manufacturing is quality control.

You can outsource quality inspections for your products or employ someone to be onsite to oversee quality. Independent inspection companies can visit your manufacturing partner's plant and do quality controls and production audits.

Make sure quality standards are specified in your service level agreement.

• Find out about managing risks associated with manufactured products

Getting help

It is important to get advice from experts and specialists who understand the options, know your company, and understand the market.

There are a number of options for finding experts and specialists to advise you:

Contact New Zealand companies and individuals who have ‘been there, done that’ and are willing to help newcomers.

• Find a business mentor with export experience

Hire a specialist or consultant. Take care in selecting a specialist, ask for references and follow these up.

This guide is provided subject to our terms of use:

Use of the information contained in this guide is at your own risk and we are not responsible for any adverse consequences arising out of such use.  This is a complex area and we recommend that you seek legal advice before taking any related action.