OEM China – What to Expect and What to Look out For
OEM China can be a huge advantage for your business. This guide will get you up to speed and walk you through some of the ins and outs of OEM in China
May 18, 2021
What is OEM? Short for Original Equipment Manufacturer, it is an acronym you might be familiar with if you get your products manufactured by another company, possibly in another country such as China, for example. By its basic definition, an OEM is a manufacturer that specializes in making a particular product or part for another company that provides it with the design and specifications. An OEM part therefore is manufactured to order.
China is the world’s largest manufacturer by output, a position it has held on to for 11 years. It is also the world’s largest automotive manufacturer. It produces more vehicles in a year than the United States, Europe and Japan combined, accounting for 30% of global production. The success of China’s automotive industry rests largely on the performance of its OEMs. China’s auto parts industry is estimated to be worth $550 billion. This is just one example of how China is a specialist when it comes to OEM products.
In this piece, we take an in-depth look at OEMs, how they work and how you can do business with one, especially in China. Read on to know:
What is an OEM?
The benefits and challenges of working with an OEM
What to watch out for when working with OEM China
What is an OEM and how does it work?
To fully understand what an OEM is, we need to go beyond the simple definition provided above. An OEM manufactures goods not for retailers but for another company, which sells these goods under its own brand. This explains the origin of the term OEM, which is said to come from the Dutch phrase “onder eigen merk”, loosely translated as “under own brand”. The company that buys an OEM product is called a “value-added reseller” (VAR). Usually, it improves the product or component or adds more components to it, thereby adding value to it before selling it.
Traditionally, an OEM works on a business-to-business (B2B) model while a VAR sells directly to customers. However, recently, more and more OEMs are selling directly to niche groups of customers (for example, technology enthusiasts who customize and assemble their own computers).
An OEM works in one of the following two ways:
1. It manufactures specific components for the VAR, which uses these in its final product. For example, Microsoft sells its Windows operating system and Intel sells its chip to PC maker Dell. This makes Microsoft and Intel the OEMs and Dell the VAR.
2. It assembles and completes the product for the VAR to resell. Taiwan-based Foxconn, which assembles Apple iPhones, is one such OEM. Its largest factory – a 1.4-square-mile iPhone plant – located in the Longhua District of Shenzhen city, China. If you look at the back of any Apple product, you will find the printed statement “Designed by Apple in California Assembled in China”.
Working with an OEM – Benefits and Challenges
Outsourcing your manufacturing to an OEM can be lucrative for the following reasons:
Expertise: An OEM does not make hundreds of different types of products but specializes in just a few. It mass-produces these goods, which means it knows the most efficient and cost-effective way to manufacture them. Because it might make similar products for other clients, its knowledge of the engineering and development processes of such goods is the best in the business. An OEM product is almost always associated with quality and originality.
Inexpensive: It costs much less for an OEM to manufacture a product or part than for the reseller to do it themselves. Low cost is a huge benefit of mass production, especially in a low-cost manufacturing region like China. By outsourcing production to an OEM, the reseller is also saved the expense of setting up and operating their own manufacturing unit.
Fast: Being a specialist, an OEM can fulfil large orders in a short amount of time. This ensures your final product reaches the market that much faster.
Flexibility: By leaving the manufacturing to an OEM, you can focus on other areas of your business, especially research and development (R&D). Do not forget, an OEM is just the manufacturer. It only produces goods you have designed and conducted market research for. Hence, time spent on R&D is time well spent.
Warranty: A reputed OEM will back up its products with a manufacturer’s warranty. Insist on one when you outsource to a China OEM.
That said, buying an OEM product can be challenging if you are not careful. Here is what can go wrong:
Risk to intellectual property: When working with a China OEM, one of the risks you open yourself up to is compromising your intellectual property (IP), such as trademarks, design patents and copyrights. China is a first-to-file country, which means IP rights are awarded to those who register them first. So, your OEM product might bear a trademark you own in your country or in the country where you intend to export that product. But a domestic company might have registered the same trademark in China and might claim trademark infringement, leading to your product being detained by Chinese customs. There have been several high-profile trademark infringement cases involving OEMs in China. And with the Chinese courts interpreting the country’s laws in conflicting ways in these cases, it is advised that you follow steps to avoid a similar situation.
Lack of visibility: While you might know your OEM well, you might not know their suppliers down the supply chain. Chinese manufacturers are not known to freely give out information of any kind, including details about their suppliers. If the OEM changes suppliers somewhere down the line without your knowledge, the resultant change (for example, in the raw materials used) could seriously impact the quality of your goods.
Collaborator to competitor: An ambitious OEM might be tempted to compete with you. Having made your products for years and being privy to your designs and IP rights, it might use this knowledge to build its own brand and establish direct ties with customers, including your own. An OEM has the advantage of knowing how to manufacture the product in the most profitable way without making any investment in R&D. A famous example of a collaborator turning competitor comes to mind. Chinese tech major Lenovo started off assembling and distributing IBM equipment in China but bought the American company's PC business in 2005, allowing it to sell IBM PCs under its own logo.
3 must-dos when working with a China OEM
1. Protect your IP: China only acknowledges trademarks that are registered locally. This, coupled with its first-to-file system, makes it extremely important to register your trademark in that country if you intend to manufacture there. You can register your trademark either through the China Trademark Office or World Intellectual Property Organization (in the latter case, you must apply from the country where you trademark is currently registered). Manufacturing in China without a locally registered trademark leaves you open to:
Having your goods blocked by Chinese customs, which does not permit the export of goods that infringe upon IP registered by others.
Infringement lawsuits from companies holding the same trademark in China, even if they might be squatters and sellers of counterfeit goods.
Your Chinese OEM registering your trademark in their name and threatening you with a lawsuit if you attempt to switch to another OEM.
While registering your trademark in China, keep a few things in mind:
China’s unique sub-classification system – While the country accepts the International Classification of Goods and Services for the Purposes of Registration of Marks established by the 1957 Nice Agreement, it divides the classes into sub-classes based on the product’s features, including function, usage and raw materials. For example, Class 25 includes clothing, footwear and headwear. But under Class 25 in the Chinese system, boots, sandals and sports shoes come under different sub-classes. It is important to find the right sub-class to register your product under.
Registering your trademark in Chinese characters – If your register just the Roman characters that make up your trademark, you run the risk of another business registering the same trademark in Chinese. This might adversely impact your business and brand value. This is even more important if you plan to sell your product in China itself, because China requires Chinese names on products. But be careful when deciding on a Chinese version. Direct translations don’t always work. It is more important for the Chinese characters to signify what your product or brand stands for.
Registering your trademark in China can be a complicated process and can take a year or more to complete. But it is an important step to complete. A trademark attorney/agent can make the process easier.
2. Negotiate an airtight contract: Make it comprehensive, covering everything from product design, specifications, raw material and equipment choices, production deadlines, packaging, and quality control procedures to branding, pricing, the contract duration and everything in between. This will save you a lot of legal hassles down the road. Remember, just signing a purchase order is not good enough. Negotiate an airtight contract, paying special attention to the following aspects:
NNN agreement – Make your China OEM signs an NNN agreement, where NNN stands for “non-use”, “non-disclosure” and “non-circumvention”. This means the manufacturer agrees to, a) not use your product/design/concept in a way that makes them your competitor, b) not disclose information about your product/design to a third party, and c) not sell your product at a lower price. An NNN agreement helps protect your IP in a foreign country.
Termination terms – Clearly spell out the events that can lead to contract termination (unauthorized use of IP by the OEM, for example) as well as the consequences of termination (for example, what is to be done with products that have already been completed, steps for return of confidential information).
Exclusivity agreement – You need an exclusivity agreement if you plan to give your OEM exclusive rights to produce all or a part of your products, or if you want to ensure that you are the sole seller of a particular product in a particular market. The exclusivity terms must be spelled out clearly in the contract and must extend to the OEM’s sub-contractors, if there are any. Exclusivity agreements are a powerful protection when you have a unique product or one that is in high demand.
Non-compete terms – An OEM usually has more than one client. Given that it specializes in a particular product, your competitor might be among its clientele. Your contract should include a provision prohibiting the OEM and its affiliates from producing additional products that might be used by competitors.
Payment terms – Set a firm payment schedule. It is always more advisable to pay after the goods have been inspected rather than after shipping.
3. Ensure quality control: The entire point of working with an OEM is to get quality products. Hence, it is important you pick an OEM with an in-built quality control system. Some manufacturers might have their own quality control department. Some might use the services of third-party quality inspectors. What is important is that the OEM is transparent about the measures they take to uphold quality standards. Before signing a contract, make sure you ask the manufacturer about their processes and checks. If you can, visit their factory for a physical audit. Even if you are convinced, don’t just take their word for it. Insist on samples before finalizing the purchase order.
4. Get yourself a China sourcing agent: Outsourcing your manufacturing to a China OEM becomes a lot easier when you work with a China sourcing agent. From helping you verify and select an OEM to monitoring production, a sourcing agent increases your chances of receiving a quality product for the best price and on time. Advantages they have that you might not, such as:
A local presence in China, which means they can visit the OEM’s premises for verification and checks.
Fluency in local languages, which is useful when communicating with the manufacturer, drawing up contracts and filing paperwork in Chinese.
Years of experience working with Chinese manufacturers, which means they know the best deals and can also help you detect and avoid shady manufacturers.
In-depth knowledge of Chinese business culture, so they can help you build long-term ties with your OEM.
In conclusion, outsourcing to an OEM in China has many advantages – high quality products at low costs and the satisfaction of working with experts being just a few. However, do not forget to take the necessary precaution of protecting your trademarks in that country.
Sourcing Allies is a team of expert China sourcing agents that has helped western customers manufacture and source products from low-cost regions since 2006.