It’s always a good idea to sign an agreement before entering a complex business relationship. On the surface, contracts might sound dull and be seen as unnecessary or time-consuming. But they are a bit like seat belts—they protect you at all times—and you wouldn’t drive off without belting up first. So, by the same logic, entering a new partnership without signing a manufacturing agreement is not a good idea.
What is a manufacturing agreement?
A manufacturing agreement establishes the EMS (electronics manufacturing services) provider and the OEM’s (original equipment manufacturer) contractual and service obligations. It addresses key terms and conditions, including warranty provisions, technology requirements, and turnaround times. The most common type of manufacturing agreement is a non-exclusive contract manufacturing agreement, which facilitates EMS providers and OEMs working together on long-term projects.
There is no one-size-fits-all manufacturing agreement; they differ depending on the EMS provider, their customer, and the project. There are, however, ten key clauses we believe should be in every agreement. A solid contract will ensure both parties know what to expect during the relationship—and hopefully ensure its longevity.
1. Product and price
This section should describe the product the EMS will be expected to build, test and deliver and will typically reference full technical specifications in a separate appendix. Unit pricing based on standard material lead times and agreed forecast/demand patterns should be referenced here too. It may also be helpful to explain what mechanisms exist if accelerated deliveries are requested by the customer or if forecast/demand patterns vary significantly. Any uplifts in material costs or unit pricing should be clear and transparent, the same should apply to any cost reduction initiatives.
2. Delivery expectations, invoicing, and payment terms
When and where the product will be delivered, who is responsible for transportation and costs and where any potential liability or risk may fall should all be covered here.
How and when the OEM will pay the manufacturer for the final product should also be detailed as well as when invoices will be sent and agreed credit terms. It is also a good idea to discuss how any invoice disputes would be dealt with.
Payment terms may include subsections addressing the following issues:
- The inclusion/ exclusion of taxes
- The inclusion/ exclusion of raw materials
- The cost of late payments
- Anything that is offset
3. Material ordering and planning
Manufacturers must use demand forecasting provided by their customers to establish raw material requirements for production and predict future resource requirements.
It's common for EMS providers to request rolling 12-month forecasts which should be reviewed monthly. Depending on the details of the agreement, a proportion of these forecasts (3-6 months) will then be used by the EMS provider to secure materials and plan internal resources around and are effectively taken as fixed/firm.
Components with extended lead times or minimum order quantities are usually covered in a separate appendix. This allows the EMS to purchase devices that fall outside of forecasted quantities but are known to be critical to maintaining supply. Close collaboration is required when discussing this clause to ensure enough products can be manufactured to meet the market’s expectations whilst also balancing risk and liability on both sides.
4. Managing excess stock
The EMS provider should only purchase enough material for live projects; however, there may be occasions when material suppliers impose minimum order quantities —and the manufacturer is forced to purchase more than is strictly necessary. Alternatively, a component may reach the end of its life, leading to the EMS provider needing to buy and store excess stock in order to extend the lifetime of the customer's product.
Financing and storing excess stock is an overhead for the manufacturer; therefore, there may be occasions when the customer will need to bear this cost. To avoid misinterpretations about what constitutes excess stock, the manufacturer and their OEM partner should discuss the issue before products are manufactured.
Managing excess stock fairly requires both parties to communicate effectively and honestly from the beginning—and communication must be kept open throughout the relationship. For example, there may be times when the OEM needs to change a part, leading to excess inventory in the manufacturer’s facilities. It may be possible for the EMS provider to help move these parts, either by selling them or using them in a different project, but if not, the customer will have to cover the costs. If both parties keep an open dialogue, successfully resolving potential challenges will be much easier.
5. Technical requirements
The OEM should be confident that the technical requirements of the product are clear and transparent and that they will not be changed in any way by the EMS provider without prior consent. For this reason, it is important to detail the technical requirements in the manufacturing agreement, which will typically include elements such as:-
- Bill of Material (BOM)
- Approved Vendors List
- Printed circuit board (PCB) specification and Gerber data
- Mechanical drawings
- Product markings and label requirements
- Test specifications for in-circuit tests and/or functional test
- Traceability requirements
- Packaging specifications
- Shipping instructions
In addition, clearly defined mechanisms and processes for managing engineering changes throughout the project should be agreed here too.
6. Quality assurance, inspection and test
Both parties should understand what actions are taken and what actions are not taken (as standard) to ensure quality. For example, it is a common misconception that EMS providers test all final products they build. Unless a test is requested by the customer, the data and equipment are made available and, crucially, this function was costed as part of the quotation, the EMS will (as standard) typically only inspect their workmanship to a recognised quality standard i.e. IPC-A-610E Class 2 or 3.
If the customer requires more in-depth inspection or testing or a detailed breakdown of what was tested, how it was tested, and the results, this must be communicated and stipulated in the manufacturing agreement. And this is also the time for the EMS provider and its OEM partner to negotiate any potential extra costs involved.
It is much easier for both parties to understand what they expect from each other and the exact price before production begins to avoid any misunderstanding further down the line.
7. Product warranty
The OEM remains the design authority and is responsible for specifying the parts needed to assemble the product. The EMS provider is then responsible for ordering these parts from reputable supply chain partners and ensuring they are fitted in the right place using the build information provided by the customer. In some cases, the EMS provider will also test the product using equipment and instructions given by the customer.
As such, the EMS provider can only offer a warranty against the service they provide i.e. workmanship. They cannot provide a warrant against the materials listed in the BOM or AVL or whether the product performs as expected in the marketplace.
Of course, if there is a problem with the product due to workmanship, the manufacturer would be responsible for resolving the issue. This needs to be clear from the outset of the EMS-OEM relationship. If a product goes to market that was incorrectly designed or designed with an incorrect component, the OEM will be responsible for reimbursing the end customer for a faulty product and also any costs associated with repairs.
8. Tooling and testing
Primarily, both parties should agree on who is responsible for tooling and test equipment required to manufacture and deliver the product. Typically tooling and test equipment will remain the property of the OEM. As such, the customer is usually responsible for upgrades and repairs whilst the EMS provider is responsible for ensuring the equipment is stored correctly, used only by trained staff during production and maintained (to an agreed level) effectively.
9. Terms and termination
The parties should be clear about the length of the agreement and its start date. If the agreement is renewable, it would be beneficial to establish the renewal term, including if it is extended automatically or if any written notice is required.
After the term has ended, if the customer wants to terminate the contract, the manufacturing agreement should specify the notice period; it is not uncommon for the notice period to be 12 months. The parties should also discuss the critical effects of termination, including ongoing payments, intellectual property rights, and licences.
10. Governing law
The parties must set the governing law for the manufacturing agreement. Establishing the governing law allows the parties to choose the legal system that will interpret the contract in the event of a dispute.
Conclusion
Entering into any relationship can be complicated as each party begins with different expectations. For this reason, negotiating the right manufacturing agreement will ensure the EMS provider and their OEM partner share core values and understand what is expected from each other.
Quickly starting production and leaving aside legal formalities would be a short-term win. But taking the time to negotiate a manufacturing agreement will almost certainly lead to a mutually beneficial, long-term relationship as both parties know where they stand and can trust each other. And trust is the foundation of any strong partnership.
