Protecting your product and supply chain
A Spanish company contacted us to ask for advice regarding selling their product in Asia. They were looking at the business structure only from a sales point of view without considering the risks on the Chinese perspective. This company currently uses a manufacturer in Spain to produce it and wants to sell it in China. It has an innovative but easily copyable element, which means if it becomes “hot”, the local factories will start making it by themselves. How to protect your product and supply chain?
First of all, before diving into the business model, some questions should be considered:
- Who owns the patent and where? And the molds?
- Is the trademark registered and where?
- Will it be manufactured in China in the future?
- Are the clients in China or other Asian countries?
- Do they have a solid NNN agreement with these factories?
Even if you own the patent in Spain, or Latin America, and you registered a trademark too, you should do it in China as well BEFORE bringing it to this market. We have seen products in trade fairs that were later copied and sold. If your product has an advanced cutting edge technology, difficult to replicate, and you keep the Intellectual Property in the country of origin, then it is a different case. However, if the element is easily replicated and has high chances of being copied by Chinese manufacturers, then you should consider registering it in the PRC and sign NNN agreements with each one of the factories BEFORE you disclose key information.
Manufacturing in Spain might be the solution for now, eventually, for cost reasons, logistics, taxes, tariffs, licenses or others, the client might consider choosing a Chinese or South East Asian factory. If that is the case, then the business model should be discussed to make the most of the structure.
Another question was whether their company should be based in Mainland China, Hong Kong or Singapore. Based on the source of income, the location of the main clients, the importance of geography, the distribution structure and other costs associated with human resources, warehouses and taxes, these 3 locations will offer different benefits. There is no one perfect answer, but definitely a more appropriate choice for their specific business model.
Unlike in Western countries, in China you need a tailor made NNN agreement so the suppliers comply with Non-disclosure, Non-use and Non-Circumvention. They should be written in a way that makes it highly unattractive for the factories to breach the contract. For example, being totally in Chinese as the official language, enforceable in Chinese jurisdictions and with Chinese law being the governing law, together with severe damages provision in case of conflict. Usually, one third will just read it and sign, another third would require changes, and another third would negotiation most of the clauses. Make sure you receive it signed before disclosing confidential information, even if it is only for a quotation. Other important clauses to keep in mind when negotiating with suppliers are: who owns the molds if the relation is terminated, conditions of the purchase contract, how to deal with inspections, how to deal with quality problems and the penalties, how to set the disputes and so on. Mistakes at this stage will cost the company a fortune or even losing the business in this market.
The risks of not doing the homework appropriately and going straight into selling without proper due diligence might lead to consequences such as: not being able to sell it in China anymore due to patent disputes, registration of trademarks in bad faith and delay of sales, factories manufacturing without permission, counterfeit products, disclosure of information by suppliers and subcontractors, and a dozen more.
On one side, some manufacturing industries will start moving out to South East Asian countries with lower costs. This might have been delayed due to COVID but it will happen eventually. Still, China is a great choice for manufacturing due to its mature infrastructure, industrial parks, tax incentives, skillful and varied workforce, labor cost, communication, service providers, efforts from the government to attract foreign investment and so on.
On the other side, more and more companies trying to sell to the attractive Chinese middle class are moving in and get their piece of cake. Especially the SMEs that were traditionally selling only in their home countries, now are looking at Chinese consumers for obvious reasons. Those will little experience doing business here are the ones who should do the homework appropriately before diving into the market.
Conclusion for this specific type of companies:
- Do the homework: industry, legality, location, partner, feasibility, etc
- Discuss the different alternatives of an appropriate business model
- Get a lawyer to write your NNN agreement and negotiate on your behalf
- Get IP experts to advise you on how to protect your specific product
- Talk to experts who can provide you a holistic picture from the Tax, Accounting and Legal approach
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