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Think about day to day activity and plan for the worst
1. Clear definitions
Always use the same terms to refer to same things (parties, products, specific contract terms).
2. Correct identification of the parties
A good contract starts with knowing who you are working with. This is not always straightforward as agents may parade as factories, and actively try to hide it. Always do a background check on your counterparties, or mitigate your risk by ensuring that no money changes hands too early in the transaction.
Do you accept subcontracting? Perhaps not beyond a certain extent. Or perhaps it is essential for you to have subcontracting. In any case, think about it and include the scope you want to avoid surprises.
3. Product definition
Define the product as accurately as possible. You can also refer to samples if they have been issued in multiples and both parties have signed on all. If the product is still in development, identify the development process in an appendix in order to assign checkpoints.
Most products must comply with norms in the country of sale. Insert compliance to these very norms as a supplier obligation.
Consign critical technology or design parts to ensure control over supplier production. You can also consign parts on which you have a strong cost advantage. Suppliers may consign products to your warehouse to improve your cash flow.
Products may change from time to time. What will acceptable notice be for changes to be implemented in production? How do you want to control the change and approval process? Also, very important, stipulate that products cannot be changed without your prior agreement. Clandestine cost down drives by suppliers are a major source of quality problems in Asia, block this risk in the contract and specify remedies if it were to happen.
If you source a ready-made product, make the supplier hold you harmless in case of alleged patent, copyright or trademark, trade name, service name or other infringement allegation by a third party.
4. Product packaging definition
Packaging and labelling is part of the product. Specify packaging in the contract: not only retail packaging, but also shipping materials.
Include the right to check not only ready to ship fully packed goods but also at any time during production, within a very short time notice (or without notice). Keep your quality check options open.
If your goods are imported on pallets, do not forget that some jurisdictions require fumigation certificates for wooden pallets. Specify that these are to be provided at no cost, or specify metal / plastic pallets but these are usually a bit more expensive.
5. Quantity and price definition
Product quantities are usually set by minimum order quantities, order multiples and price breakdowns at certain quantity steps.
- Place big schedule orders on which you draw quantities
Think of specifying multiple deliveries for a single order if it drops the price sufficiently, or provide forecasts and negotiate prices accordingly.
Add a most favoured customer clause that gives you same rights as the factory's most favoured customer for similar goods. It is not very useful day to day but gives you recourse if you accidentally find that you have been fleeced all these years.
6. Goods inspection provision
These will be your products so as mentioned previously you want the right to inspect any production facility at an hour's notice, or less. You will also want the right to inspect lots before they ship.
In case products fail their QC, they will have to be reworked. You will incur additional costs for rework QC. Specify that all additional costs because of failed QC will be borne by the supplier. This also gives them an incentive to perform well.
In case of stress at the supplier, specify that you will want to witness the sealing of containers, to avoid receiving scrap metal or other rubbish in part of the shipment.
- Define an escalation process
When the quantity shipping is not too large we suggest that customers plan for 100% inspection of the goods if the sampling inspection fails. This ensures that bad products are isolated quickly and will be reworked quickly. The escalation process should of course be entirely paid for by the factory.
7. Product warranty provision
As the importer you will be legally responsible for the quality of goods. That does not stop you from arranging terms with your contractor. What do you want from them? Verifiability of your claims will be in the seller's mind. How do you convince them?
Repairs are cumbersome as they involve moving parts and / or people. Demand financial compensation, or extra units to be delivered to you upfront at no cost. If the supplier is small plan for the risk that they may not be around by the time a product problem is reported.
- Plan a product failure storm
Plan for supplier obligations in normal failure rate conditions and add exceptional provisions in case of a very high failure rate. Define these rates.
8. Payment terms
Method and time of payment must be specified. Be sure not to make critical payments until you have confidence your order is safe. Letters of Credit remain the safest means to exchange money and goods between not well known far away third parties.
Make payment conditional on QC checks
Reserve a right to claims within a short period of final goods receipt (perhaps 2 weeks). This is sometimes accepted by factories, even in China or India.
If the supplier is established and you source many product lines from them, reserve the right in writing to offset payment against other work. This seems obvious, but in fact if the factory is part of a large group they may stop all work for you until a single dispute is resolved.
9. Delivery date, place provision
Date and place of delivery must be specified.
Include penalties for delays and make them progressively tighter. Also think about transportation.
10. Transportation and Incoterm
Define a preferred transportation method, who pays for what and when risk is transferred. In other words, define your INCOTERM.
If you usually ship by sea and can ship by air in case of delays, specify that the supplier should pay the extra cost. This also works when upgrading from air cargo to express courier.
Note: not related to contracts and more of a simple tip, finding out in advance what the dates of major public and religious holidays are in the country of production can spare you some surprises in shipping, from difficulties in booking transport to choke points at ports to unanswered calls or emails.
- Don't deal with far away administration
Avoid local complications by requiring Incoterm FOB at least (see our newsletter #3 2009). The supplier will clear customs out of their country so you don't have to get involved in it.
11. Plan for closure
Specify the terms for contract termination and cancellation. What happens to open orders, materials in process, warranties? If you want to cancel you may want to get out quickly. But what if the supplier does? Require a long enough notice period. Plan for warranties survival.
12. Confidentiality, Intellectual Property and publicity
You may (or may not) wish to keep your contract with the factory confidential. In such case forbid publicity of any kind.
If you are concerned about publicity of your relationship with the factory, then it is worth mentioning that your products cannot be displayed in the factory showroom or shown by sales people, or at trade shows. This does not prevent it from happening but gives you recourse when you find out.
- Suppliers can be too enterprising
More enterprising suppliers may be tempted to sell your products to others without your knowledge. The easiest to make a like-original fake product is after all to use the original (see our newsletter #3 2010). If you own the designs, it is worth writing down that the factory is not allowed to copy them, sell them to 3rd parties, or sell parts and / or finished products to third parties. Specify penalties.
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