EMS / OEM Contracts

Having read and negotiated hundreds of contracts, nothing seems as unpleasant as negotiating a purchasing agreement that has not been written for a build to spec relationship. In the largest % of EMS / OEM engagements, the EMS is bound to the OEMs bill of materials, quality requirements, performance specs, test procedures, tolerances, FAB design and literally every aspect of the end unit, except the details of the process to achieve the desires result of the final build.

Why is it that most OEM contracts an EMS receives and is asked to sign seem to be written around a different type of supplier that is selling their catalog product containing their own intellectual (IP) and not around the manufacturing and test service the EMS provides to the OEMs designed product?

Standard terms sheets and master purchasing agreements are important and should be taken very seriously. The EMS should not sign any agreement unless they can live-up to each and every element. The OEM needs to understand contracts not written around a "build to spec" relationship don't work for an EMS relationship. There are too many important clauses left off an IP contract and too many clauses that are just not applicable to a typical EMS relationship.

Let's run through some of the most non-applicable terms or situations I had been asked to accept when manufacturing and testing someone's products for them. I would suggest that you object to all of these as they could come back to bite your business or even cripple it:

1. Indemnifying the OEM from any patent infringement of their design.
2. Indemnifying the OEM that the product is "fit" for its intended use.
3. The OEM not accepting liability for any excess materials, either when it becomes necessary or as an upfront NTE NRE. I rarely saw any OEM contract with this even mentioned in their boilerplate. Excess material is an unavoidable aspect of the EMS business.
4. The EMS should only warranty a BOM component vendors pass-through warranty's and a workmanship warranty for some period of time, say 1 year from the date of manufacturer or shipment. There should be an obligation for the OEM to verify the shipped product is acceptable in a timely manner. OEMs that take say many months to inspect and uncover a quality issue can almost guarantee that other products shipped within that same window also contain a similar escape / quality issue. A warranty on anything effected by the OEMs (design) IP is not a good idea.
5. When there is no solid test plan and coverage, holding the EMS responsible for anything other than placing the correct part, on the correct pads, and applying the correct IPC solder joint should be acceptable. EMS companies want to send conforming product and if a solid test plan was supported, they would be required to correct any component or workmanship issues well before product left their plant. Now, to my EMS friends, please stop calling inspection - test. They are completely different fields and important aspects of building complex products, but are not the same. To our OEM friends, please stop telling your EMS partners "if their processes are controlled, there is no need for test", on complex PCBAs and box builds. By the way, be leery of a box build that doesn't have robust tests for the major subs and only has an end of process functional test. Be ready for extensive trouble shooting and rework when the red light fail notice appears on the screen. Then be ready to disassembly the box and figure out where the problem really exists if the FCT didn't indicate the failure mode.
6. Unreasonable payment terms (who out there has accepted the net 120 payment terms?) - I always felt a strong EMS can be a lot of things to their clients but should not be required to be their bank beyond reasonable payment windows. As the EMS is many times driving demand for long lead items to a forecast, money is committed long in advance of a recovery and payment should be within reasonable commercial norms. It's not just about the cost of money, it's about free working capital and retaining the ability to reinvest in your EMS from a capital equipment, human capital, systems and process aspect. If all your free cash is locked-up in slow to non-moving inventory and waiting for late payments, well this is when we see business asset sales in the M/A world of EMS.
7. Accepting egregious penalties for even the slightest /infrequent missed delivery commitments can be risky. Many times, a missed delivery window is due to a component source of supply the EMS must buy from (remember the EMS can't deviate from BOM without written approval) and a sole sourced component vendor enabling a late shipment can cost plenty. As the EMS is always chasing revenue and tend to control capacity scheduling through their plants very well, they will spend significant time and money to obtain the component parts within their needed window. These penalties are always sold as "getting the EMS to have skin in the game". In this low margin business, the EMS is like the pig at breakfast, not the chicken already. How about this, the EMS gets a premium for any delivery made on time if punitive penalties for a late delivery are a demand. If that's outrageous, then how is the inverse acceptable?
8. Please remove "Time is of the Essences" from your contracts. Now I know the OEM's attorneys want to retain this language. But this clause is just gray area legalize that could put years of perfect execution of any contract containing it in breech whenever the first late shipment crept into the deal, even if it is beyond a reasonable person's control to have foreseen or corrected it. If you must include some language along these lines, how about "Time is Important" as you'll always find way to sever a good relationship if that becomes your plan. With clients who insisted the EMS keep this clause as is, it usually seems to drive poor long-term EMS behaviors by being ultra conservative in all delivery commitments, pull-ins and such. Don't you want an EMS partner who is bold and takes risks to help you, not an EMS who feels like they are always walking through mine-fields with you.
9. Who has ever heard from an OEM that "Everyone signs our contracts as is, no negotiations"? When you finally get your first 20 page+ contract with numerous egregious issues and this is the OEM stance, set that paper on fire and block their phone numbers. Unless you are of equal size, cash reserves and legal staff; bad things happen when a contract is executed with no intention of living up to each and every clause. The best example of this was a huge medical client in the mid-west we had won. Our bid was accepted, the plant audit went well and we were negotiating the final contract. Flying to meet face to face with the new client I "negotiated" up through the first 2-3 levels of management and was told they never require their EMS to live up to each clause, just sign it. As I kept escalating, I finally got to the new VP of Materials and when asked about their company stance; was told "I can't wait for someone to violate a clause so we can take them to court".
10. Having to negotiate with an OEMs third party attorney who has no understanding or experience with the EMS world and the relationship that "build to spec" entails is maddening. They just don't know what they don't know and it either drags negotiations out much longer then needed or causes a good potential relationship to fail. They also tend to feel that "giving in" on a no-brainer clause like indemnifying the OEM 's design, means the EMS now has to give in on some other clause that is a shop stopper.
11. There has to be some level of firm shipment schedules and OEMs wanting unlimited schedule flexibility is not reasonable. Conversely, when an EMS receives a fully scheduled long-term order it makes a lot of sense to agree to a short term firm window that the EMS can count on to ship, a period of time where some % of the total PO can be moved out and after a longer period of time the schedule is 100% flexible. Of course, massive push outs can grossly impact material liability and cash flow, so be sure to button that down in the excess clause.
12. OEMs that are moving jobs firm one EMS to another, many times try to burden the new EMS with the complete inventory position, regardless of consumption or material status. An EMS must analyze true demand over a period of time and should be on the hook to buy that material. But excessive stock should be placed in a consigned area and as demand requires, then it can be both pulled, consumed and paid for. Expecting an EMS to buy all inventory regardless of consumption velocity is not reasonable.

In essence, an EMS becomes the OEM manufacturing floor. How the OEM's internal floor is treated is how the OEM's external floor should be handled. Excessive, 1-sided contracts tend to foster shorter term relationships and a self-fulfilling prophecy of a risky action of jumping to another EMS is more common than relationships managed under reasonable terms and conditions. There is much more to writing and negotiating a fair contract that works for an OEM and the EMS, these were just a few or the troubling areas that tend to bog relationship down.

We all can agree that the best contracts usually stay in the filing cabinet. If more OEM boilerplate agreements were written around the build to spec realities, it would be a better world for the OEM and the EMS partner. If you wouldn't sign a contract binding you in your personal life, then it's probably better to walk away from a similar one in your business life.