Young technological companies, and particularly start-ups, often run into difficulties in their attempt to break into the relevant markets, whether local or foreign. It happens mainly because the process of marketing and selling a product or service requires a significant expense that most young companies struggle to fund.
Furthermore, where a company is young and unfamiliar, many big distributors would not take the risk of introducing its new product or service to the market, and the company itself does not have the experience and connections required to do so on its own. Alternately, the company must raise a lot of capital in order to establish a brand new, large-scale network of marketing and sales abroad.
One of the best and most effective ways to break through this barrier is by entering into OEM (Original Equipment Manufacturer) agreements. Manufacturing companies who have trouble marketing their products independently enter into such agreement with larger and more established companies, who seek to sell the product or service of the smaller company under their brand name.
The small company can then distribute its products through a renowned company with experience in the relevant market and thus gain reputation itself, without bearing the high marketing costs. The larger manufacturing company, by distributing the product of the smaller company under its brand name, enjoys the opportunity to “upgrade” the product and/or bundle of products or services offered to its clients.
This article overviews the main aspects and terms a company must take into account when considering signing OEM agreements. We will also discuss the advantages and disadvantages of entering into such agreements.
Important terms and aspects of OEM agreements
As in every contractual engagement, the parties may reach commercial understandings between them based on given interests and circumstances. However, there are several sections that typically appear in such agreements, which are important to be familiar of:
The first issue is exclusivity. This clause is essential to OEM agreements where the interests of the two parties are conflicting (which is usually the case). The smaller company seeks to restrict the exclusivity granted to the larger company and use as many distributors as possible to market its products, and thus increase the chances of its products to break into the relevant market. The large manufacturing company, on its part, is bound to distribute the product under its brand name, and would not want to face multiple competitors and see its marketing and distribution investment go in vain. The parties can resolve this issue by establishing the nature of the exclusivity (whether limited to a certain territory, clients with specific features or a certain period of time) or by determining that the exclusivity is contingent upon fulfillment of certain sales objectives.
The second issue is intellectual property ownership. It is very important for the contracting parties (especially the smaller company) to protect the intellectual property rights relating to the product to be distributed by the larger and more experienced company. In such circumstances, the smaller manufacturing company must make sure it will remain the owner of all intellectual property rights, so that the distributing company will not be permitted to copy the product distributed under its brand name or claim any ownership of that product.
Another issue that must be taken into consideration is product technical support. There must be a clear understanding between the parties regarding the technical support responsibilities between them, entering into the OEM agreement. Such understanding should prevent disputes between the parties and assure that the end customer will eventually enjoy the best service possible (which will naturally improve the reputation of the product and the manufacturing company). Therefore, the agreement must specify the types of technical support to be provided by the smaller company and the ones for which the larger company will be responsible. One way to resolve this issue is by determining a very specific definition for each type of possible failures. Thus, the contracting parties may, for instance, agree that the distributing company is to deal with relatively simple failures/technical issues while the smaller company (the manufacture of the product) will tackle the more significant ones.
The description above certainly does not cover all the important issues relating to OEM agreements – a company must also consider the method of payment for the product, the responsibility for its installation, the deposit of the product file in the hands of a trustee throughout the agreement term, taxation matters etc.
Advantages and disadvantages of OEM agreements
The advantages of such agreements are clear: the product of the smaller manufacturing company is distributed in the relevant markets while the company itself bears an insignificant marketing expense, as marketing is conducted by the larger manufacturing company. Hence, an OEM agreement diminishes the risk and marketing expense for young companies.
Moreover, an OEM agreement somewhat legitimizes the smaller manufacturing company and its product in the eyes of end customers and potential investors, who are exposed to the product and the company thanks to their ties with the larger manufacturing company – who typically enjoys a stable reputation in the market. From the standpoint of those customers and investors, the fact that such agreement was signed between the two companies indicates the potential of the manufacturing company and its product and signifies that they should be noticed.
On the other hand, there are some disadvantages to OEM agreements, mostly for the smaller manufacturer who seeks to break into the market with its product. In many cases, even though the product is sold (sometimes even successfully) by the distributing company, the smaller company remains unknown, as the product is associated to a greater extent with the renowned distributing company. Therefore, such agreement might not contribute to (and perhaps even harm) the potential growth and success of the smaller manufacturing company.
Furthermore, in general, the profits gained by a small manufacturing company whose products are marketed by a larger manufacturer are not particularly high. Thus, while the company reduces the expenses on marketing, its profits decrease accordingly.
As described above, many factors must be taken into account before an OEM agreement is signed, especially from the point of view of the smaller manufacturing company. Nonetheless, often that company does not have many other ways to break into the market and distribute its product, given its limited financial and human resources.
Hence, when a company chooses to enter into such agreement, it must be aware of everything the agreement includes and offers in order to optimally protect its rights and interests.