Minimising risk when changing suppliers in the automotive industry

Changing suppliers is a fact of life in the automotive industry. There are many reasons why this occurs, but often it is driven by competitive pressures and a need to source parts at a greater scale, higher quality, or at a lower cost point. It may also be part of a strategy to diversify risk by having multiple suppliers.

When making these changes managing obligations to your existing supplier should be front of mind. Also, if you are not in the position of the original equipment manufacturer (OEM), and have another customer in the supply chain, you need to manage the change process with your customer as well.

If these issues are properly planned for then the transition can effectively deliver the outcomes you are looking for. However, if not properly managed, the consequences can be disastrous. Here we explore some of the potential risks in that process and how to minimise them.

Contractual Risks

It’s crucial that you look at your contracts with your current supplier to understand your obligations. Some of the issues to check for are:

• Are there any clauses that bind you to a particular purchasing level with your existing supplier (such as minimum volume requirements, or “take-or-pay” clauses)?
• Do you need to formally terminate the contract, or can you simply cease placing orders?
• If you need to terminate the contract, what are the notice requirements?
• Have you provided forecasts of expected quantities, and what are your obligations with respect to these forecasts?
• What is the situation regarding IP? (more on this below)
• Are there any express restrictions on the use of information or materials given by the supplier that go beyond regular IP rights (such as agreements not to reverse engineer supplied products)?

Intellectual property risks

Since changes in supply are driven by commercial factors, it may be tempting to have a new supplier simply replicate the existing supplier’s product. This might be done by providing samples of the product, or even drawings and technical specifications for the product in order to minimise development time and cost.

While this approach might be acceptable in some circumstances, it will create massive problems in others. You should never assume that a new supplier can simply take and replicate the existing part, nor should you assume that you can provide any technical information from your existing supplier to a new supplier.

This is the case even for seemingly simple products. Even the simplest of product can be the subject of intellectual property (IP) protection that you might miss if you are not careful.

As a starting point, check who owns the IP. It is common in the automotive industry for customers to own the IP in supplied parts. But don’t just assume this is the case. There can be a range of commercial reasons why the supplier may retain the IP rights, and replicating their product can open up major IP infringement risks. Some of these include:

• Copyright – Copyright is a particularly complicated and risky area, and it is often overlooked in these situations. Depending on jurisdiction, some copyright protection in the overall design of a product may be lost when the product is mass-marketed, and this can lead to a false sense of security about copying automotive parts. But copyright can still exist in aspects of the product, and associated documents. For example, copyright can still exist in:
  • design and production drawings;
  • instruction manuals;
  • packaging and labelling;
  • markings or text on the product, or on internal components – in one case we’ve handled, a court found copyright infringement based on copying of the printed markings of an electronic circuit board.
• Patents – Although the automotive sector has not historically been patent-heavy, we are increasingly seeing suppliers use patent protection as a means of locking in their position. If a supplier holds a patent relating to a product, you still have options. You might be able to source a slightly modified product that does not infringe the patent. You might also be able to challenge the validity of the patent. However this will depend on the scope of the patent in question. If you suspect there are patents relating to the product in question, you should seek professional assistance in locating relevant patents, and get advice about your infringement risk and possible re-design to avoid infringement.
• Registered designs – These offer limited protection for the visual appearance of a product only. While the protection they offer is limited, you need to be aware of them, as an identical looking product is at risk of infringing a registered design.
• Confidential information – If the existing supplier has provided information regarding their product on a confidential basis, it cannot be provided to the new supplier to assist them in developing the new product. This sort of information could include detailed technical specifications (containing information that might not be apparent from examining the product itself), manufacturing information (such as processes used and required tolerances) or commercially sensitive information (such as suppliers of sub components and costing information).

Customer Approval Risks

ISO/TS 16949 is a major quality management standard applicable to the automotive industry. That standard sets out the requirement to conform to product and process approval procedure recognized by the customer. These approval procedures typically require a supplier to notify a customer of proposed changes to a product, including changes to component supplier.

In the case where a Tier 1 supplier changes its Tier 2 supplier of a component, this is likely to trigger a requirement to notify the OEM of the change in supplier.

Failure to properly notify the OEM of the change of Tier 2 supplier may mean that the OEM is misled into believing that a part is still being supplied with components from the original Tier 2 supplier. This is because the OEM expects to be notified, according to its approval process, of any change in Tier 2 supplier.

This could expose the Tier 1 supplier to liability under trade practices or consumer protection law. This is not just a theoretical possibility. We have been involved in a case where a supplier in Australia was found liable for significant damages resulting from this type of conduct.

How to minimise your risk

So how can you minimise the risks and avoid making potentially costly mistakes? Here are some steps you should be looking at:

• Review supply contracts closely – know your obligations to your existing supplier and any contractual restrictions on changing suppliers.
• Don’t assume that you own the IP in the product and that another supplier can simply replicate it. Check your contracts and be sure about what IP you own.
• Unless you are certain that you are entitled to do so – do not give a prospective supplier any documents prepared by your existing supplier (which might contain copyright materials or confidential information) from your existing supplier.
• Get IP searches done to identify any registered rights (e.g. patents or registered designs) that the existing supplier has over the product, and seek advice about the scope of protection they offer.
• Be very careful about having a new supplier develop the product based on the existing product - even though there might not be protection over the entire product, aspects of it might attract protection.
• If you are not the OEM, be sure to follow all approval processes imposed by the OEM or by your customer, including those required under ISO/TS 16949 - failure to do so could mean you are misleading your customer.

If you have any questions on managing automotive supply chains or intellectual property issues, please reach out to Rob McMaster.