Four steps to better OEM-EMS contract term sheets – in less time
In this article I expound upon the term sheet as the vehicle for expediting the usual contract negotiation process of the supply agreement on those points most often debated, and the subject for prolonged negotiation, for those same business terms.
Using those terms laid out and presented in advance of an agreement or letter of understanding, PO for NRE… streamlines those negotiations hugely.
The normal process for OEMs to process ODM / EMS provider selection; notification and award, followed by efforts to negotiate the supply agreement can typically take months for the standard, prolonged negotiation. And this includes teams of legal eagles. By following suggestions in this article, you can cut the time involved in this process, significantly,
while still being effective.
When searching for your ODM or EMS provider, I strongly recommend requiring a simple but thorough statement of contractual business T&C’s be included in the RFQ package, and agreed to, at the beginning stages before either party signs anything – while everyone is still keenly motivated. (See, also: 9 key points help OEMs negotiate better contract service agreements with EMS providers)
Following are several key business terms when engaging ODM / EMS providers:
Request to know the provider’s pricing formula and activity or service rates with current your product. This should be extended to cover any new products. This should also state any volume considerations or volume price breaks in a simple matrix.
Many providers quote business today and then raise prices later for new products and models after the competing stage with alternate EMS providers is done. This is not always the case but its more prevalent than we want to believe so set your baseline here.
Out of scope charges
Define what is payable as scope fees and charges. State clearly that anything not listed is denied. Items such as ECO charges for admin fees, calibration for items such as test or tools, rework, delays, reschedule fees, conversion costs, employee over time (to deliver on time or from expedites…) are all examples of items you either will or won’t cover.
Cost reductions and expectations
State your expectation in percent (%) levels expected for materials and transformation rates. There should be at least a stated target level accepted if you cannot get a hard commitment.
How are orders to be placed? Purchase order or by forecast? Also, be sure and state the liability where necessary.
Changes / reschedules
Outline upside thresholds or limits, capacity reservation, push outs, cancellations…
In relation to the above, how is material liability accounted for? Who is responsible for what? This means common parts, unique parts, NRE, broken reels, MOQ’s…
I suggest providers be required to present a list of all ‘special’ parts and he discloses those parts that subject to any carrying charges or special consideration in the event of a push out beyond what you state is reasonable or, that you owe the supplier in event of cancellation.
Not listing or disclosing common industry known material liability issues leaves you open to the standard full liability conversation that isn’t valid. Defining in advance what you and the supplier expect is a much better approach.
Warranty, service terms
Outline what is covered and what is not covered for the duration of contract warranty, charges for service as well as where (geography) services will be performed, plus the rates. Shipping repairs back to China may not be everyone’s idea of service.
Choice of law for international agreements
As simple as it sounds, choice of law for international agreements is more thought provoking than it appears. The common convention is to insure neither party is put at a disadvantage in the event the contract and or business terms have to be settled by a court.
This aside, laws and contracts are interpreted differently in different countries. Also consider arbitration and what conventions govern arbitration.
IP protection and non-competes
Intellectual property and non-compete clauses are especially important with ODM agreements. These insure your product is not competing with a similar product in the market and also there is a common ground on which party owns portions or all of the IP.
On time delivery
Suppliers should be held accountable for commercially reasonable investment in overtime and premiums associated with expediting to meet scheduled deliveries and to expedite those materials to meet those deliveries. Insist on ‘commercially reasonable’ efforts by the supplier to meet delivery dates state and state an on-time delivery expectation rate for the month or quarter by part number or metric that makes sense for you.
Again, it would seem logical that providers would want to drive for perfect factory yields as it makes them more efficient and reduces cost. With little resources to spare, most of the time you get what you ask for. State exactly what yield and corrective action data is to be reported, and when.
State trigger points and expected repercussions to drive resolution of field failures on levels for both a single item as well as on an assortment of items. Rates given should cover a quarter and possibly one year, as well. Aim for ‘industry reasonable’ or best efforts.
If you are transitioning products between EMS providers, state the material assumptions and transfer processes. Suggest the provider purchases all parts within reason that demonstrate current demand.
Insist he also counts components and parts at the exiting providers’ location(s) to help eliminate any part transfer disputes and, that he loads into their ERP system as ‘on hand’ inventory before more parts are purchased.
To some, this might seem like a lot but you can accomplish all of this in four steps.
Step 1: Develop your highly focused term sheet stated in lay terms and cover all of the usual hard fought negotiation points. This sheet should accompany your RFQ along with the forecast of volume and minimally cover key OEM-EMS / ODM business points. (See, also: Ways OEMs can use RFQs to manage EMS providers and material costs)
Step 2: Respondents are to agree to or provide terms they will agree to accept with the RFQ response.
Step 3: Before you issue your PO, or select the supplier to work with, compare those terms and responses to help you create your supplier ‘short list’. You will have probably already accomplished a win even at this stage.
Step 4: Negotiate the term sheet with your preferred supplier and get them agreed to by both parties.
With planning and some thinking ahead, and you will be amazed at how much leverage you can actually achieve. Then, provided you negotiate in true win-win style, you can get to an agreement in as little time as a few days or as long as a couple of weeks which is much shorter than a duration of months cited at the beginning of this article.
Legal team support is important and has a purpose, but not for the actual business term sheet itself because no one understands the supply chain better than the supply chain professional who has to make the supplier agreement work.
– Steve Linahan
Degrees of supplier motivation
We inherently know that by reducing the number of points of discussion in advance of awarding an OEM program to EMS providers we can place ourselves in a position to anticipate a noticeable improvement in the process leading up to establishing the formal OEM-EMS engagement. But, my experience tells me most parties one either side don’t do this.
In using the term ‘inherently’, my reasoning is supported by an industry understanding that not awarding business until supplier agreements are reached, and fully vetted, intensifies the sense of urgency and the flexibility for both parties. I’m sure most readers can agree.
Knowing this, there are clearly some unique situational caveats: Your leverage is better before the award v. after; but we have to assume there is a strong desire by the EMS provider to win your business.
So there are degrees of supplier motivation. However, the base principle should be, and has proven to be, directionally correct from my experience.