How to Stop Your Supplier from Becoming Your Competitor

Renaud Anjoran over at the Quality Inspection Tips blog recently wrote on How your Chinese suppliers might become your competitors. Renaud provides excellent suggestions for preventing your foreign product supplier from competing with you, based on his notes from a talk by Paul Melkebeke, Samsonite’s Vice President for Asia.

Melkebeke talked of how Samsonite protects its IP by all available means — patents, international trademarks, design registrations, copyrights, manufacturing agreements, NNN Agreements, etc., but also how companies should need to do more than just IP registrations and contracts.

I wrote similar things in an article many years ago for a now defunct International IP Magazine:

Though you should be sure to protect your IP with registrations and contracts, you also should do the following as well:

  • Do business with the right people. Companies with nothing to lose are far likely to take your IP than those with established businesses and reputations and incentives for not getting sued. Do your due diligence.
  • Think about what you have that needs protecting. What do you have that others want? What do you have that your competitors would love to get their hands on? Is it your technology? Your customers? Your brand?
  • Figure out how you (not your lawyer) can protect what needs protecting. Can you break into subparts what you want to protect so that nobody can get access to the full thing? Can you get away with sending an older version for sale or manufacture overseas? Can you lock your critical IP down in your building  or on one computer such that your employees cannot leave with it? Can you keep the key portions on a server in the United States or the EU? These sorts of protections are usually called structural protections and they can be absolutely critical.

Melkebeke noted how Samsonite helps its suppliers improve on efficiency and quality, knowing the supplier’s other customers (Samsonite’s competitors) will also benefit from these efforts. One way to handle this is to become the exclusive buyer from your supplier. But if you are not Walmart, the odds of you being able to achieve that are slim. We have had clients that purchased equipment for their foreign product suppliers with the written proviso that equipment can be used only to make our client’s products.

Melkebeke noted how “many suppliers compare their FOB price to Samsonite’s retail price and think it is all profit. Many of them start their own brand and push for distribution. But retail space is not cheap and these companies are not expert at this game, so they end up losing money. So far, none has been successful.”  This is something we often discuss with our manufacturing clients that outsource their product for manufacturing by others. When they claim “there is no chance our Chinese manufacturer will ever be able to compete with us.” I often give the following example:

We had an outdoor equipment manufacturer (“USA Company”) come to us after its Chinese manufacturer (“China Manufacturer”) stopped making outdoor equipment for USA Company. China Manufacturer had not only stopped making outdoor equipment for USA Company, but it had also (through a third party) registered USA Company’s brand name as a China trademark in over a dozen different categories/classes. China Manufacturer’s plans were to sell the outdoor equipment to the two large hardware store chains to whom USA Company had been making the overwhelming bulk of its sales.

But China Manufacturer completely struck out in its efforts to sell its own products to the two large hardware store chains. China Manufacturer went to those chains and offered to sell its product for about half the price of what USA Company had been charging, but both hardware chains basically threw it out because China Manufacturer had no plans and no ability to maintain constant stocking of the products and no plans and no ability to repair the products and no plans and no ability to handle returns and other customer service needs. China Manufacturer’s plans to sell directly into the US market were essentially a joke.

Nonetheless, China Manufacturer had done huge harm to USA Company’s business. USA Company had to scramble to find a new product supplier (it succeeded) and it also had to figure out how to get its products manufactured and shipped out of China without violating China Manufacturer’s trademarks (it did, by securing a trademark for small engines and then prominently plastering its name on the small engines of all its outdoor products).

The moral of the above story is that you cannot count on your Chinese manufacturer not trying to compete with you even if doing so makes no sense at all.

Melkebeke went on to note how the Internet has broken down selling barriers and OEM manufacturers can sell their products online, but only at “very low prices” and “this is not the way to build a brand.” China is Samsonite’s second largest market after the United States, and per Melkebeke, Chinese consumers are willing to pay a premium price for Samsonite products and are “as picky as Japanese consumers.” Because of this and despite helping its manufacturers improve, Samsonite is not really hurt by suppliers that try to compete with Samsonite because Samsonite prevails due to its quality and brand recognition. But, Melkebeke rightly notes that companies with a weak brand, and in certain categories (e.g., electronics, where components and specifications are easily compared) are at higher risk of losing business to a China supplier that seeks to compete with them. I agree.

Renaud then notes how Melkebeke advocated for employing legal methods to keep suppliers in their place. From the legal side, there is a lot that can be done to protect your company from your China supplier, even though, like anything else, these things will not work 100% of the time. And legal protections are more important for small and mid-sized companies than for a massive company like Apple!

More foreign buyers are entering into long-term purchase contracts with their suppliers (called OEM Agreements or Manufacturing Agreements, Product Supply Agreements, or Product Sourcing Agreements). There are several reasons for this trend. One is the drive for standardization. Chinese product is just one part of a worldwide supply chain. Major retailers have diverse sources of product. All product has to meet a basic standard to fit smoothly into the chain. Product delivered late or not to specifications fouls up the chain. Product subject to an intellectual property infringement challenge or that contains pirated, non-standard parts or a non-standard component that raises safety issues disrupts the supply chain.

In the early days of buying product from China, the price was so cheap that non-compliance issues and their resulting costs were simply absorbed by the foreign buyers at each stage of the purchase chain. In the current environment of tight supply chain management, disruption is costly and cannot be tolerated by retailers. As a result, retailers are imposing strict standards on their direct suppliers. The strictness of the controls and the magnitude of potential losses mean foreign buyers can no longer absorb the costs of non-conformance by the Chinese manufacturers.

Foreign buyers now have no choice but to impose the same standards on their Chinese suppliers. Thus foreign buyers must enter into written contracts for product purchases from their Chinese suppliers that mirror their own obligations to their major retailer customers. These contracts must be supplemented with detailed supplier manuals and codes of conduct to regulate the day-to-day business operations of the Chinese manufacturers.

The purpose of these agreements is to impose liability for non-performance on the Chinese manufacturer. That is, the foreign buyer is saying: “I no longer will simply absorb the costs caused by your lack of compliance with the conditions of sale. If you (Chinese manufacturer) do not perform, I will suffer a loss and I am going to pass that loss on to you.”

UPDATE: Just by way of one extreme example, a company that had promised a large retailer product delivery by March, called me in February after learning that its Chinese manufacturer would not produce its product until June. Because this company’s contract with its Chinese manufacturer that explicitly required production by March, there was nothing it could do. Sadly, this company ended up losing the large retailer as a customer and it soon went bankrupt because it had paid half upfront for the product and its Chinese supplier held onto the money. A good contract with its Chinese supplier that lined up with the good contract with its large retailer client would almost certainly have prevented these problems.

What are you seeing out there?