OPERATIONS

Too Close for Comfort

How to keep your foreign distributor from becoming your competitor.
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Your competitors are undoubtedly an honorable bunch. Just the same, though, would you want to depend on any of them to distribute your product -- the one with the proprietary technology? Of course not. But that's exactly the situation you can find yourself in when you start trying to sell your products overseas.

In such large, complex markets as Japan, China, and Europe -- the last especially after it unifies in 1992 -- it's wisest to sign on with a local distributor who understands how business is done and can customize your product. But in Japan, for example, many distributors are primarily manufacturers who became distributors to provide service to their customers. That means they could easily become your competitors. As a result, "you need to be trusting, but you also need to protect yourself," says James Logan, president of MicroTouch Systems Inc. "You don't want your distributor coming back to haunt you as a competitor."

Logan, whose company sold $7.5 million worth of touch-sensitive computer screens and other input devices last year, spent more than a year negotiating a simple but unusual contract with Nissha Printing Co., its Japanese distributor. The contract contains about a half-dozen provisions designed to discourage Nissha from taking any steps toward walking away with MicroTouch's market or technology.

Like many small companies, MicroTouch stumbled upon its foreign opportunities. In 1986 Logan discovered through an inquiry to Dun & Bradstreet that of the 80 companies that had asked about MicroTouch in the past year, 30 were Japanese. "It was an interesting tidbit that I stored in the back of my mind," he says.

It moved to front and center that spring when he got a letter from Nissha, a giant Japanese printer. As the letter explained, the company was shipping a piece of printing machinery with a touch-screen component to the United States. Does this machinery infringe on your patents? Nissha asked. No doubt the Japanese company was concerned about the legal issues, but there were probably other motives behind the missive. Perhaps Nissha, which already made simpler touch screens, was investigating what U.S. patents already existed, just as Canon once scrutinized Xerox's patents on copiers. Or the letter may simply have been a pretext for contacting MicroTouch. That was fine with Logan, who used the opportunity to ask Nissha about its touch screen and to send off some literature.

During 1986 Nissha bought about a half-dozen screens from MicroTouch and began doing some informal market research with its customers. In December, impressed with what it was finding, Nissha sent three representatives to meet with Logan at company headquarters outside Boston. They wanted to strike a distribution deal.

The Nissha executives -- much to Logan's surprise -- came bearing cameras and rattling off detailed questions. Nervous, Logan asked that they not take pictures inside the factory. "We didn't get into real technical conversations about how the product works," he says.

But they did start talking about a distribution agreement. In March 1987 Nissha and MicroTouch signed a one-year deal, essentially a trial run. Logan knew that Nissha wanted more -- a longer-term contract and exclusive distribution rights covering the whole Far East, not just Japan. He started a more thorough investigation of his new partner.

Sound backward? It should. Logan should have investigated Nissha before reaching any agreement. A contract with a Japanese company is serious business, no matter what the terms. If, for any reason, Logan had wanted to sever his ties with Nissha, he'd have had a rough time finding a new distributor. Japanese companies place a high value on loyalty, so other distributors would likely have shunned MicroTouch.

Fortunately, Logan didn't find any evidence that Nissha was in the habit of appropriating technology. "But," he adds, "we wanted to think of long-term safeguards."

After visiting Nissha in May 1988, Logan spent the next several months hammering out the mechanics of the deal. To help tear down the language barrier, he hired Jack Plimpton, who is fluent in Japanese, as director of marketing. In December 1988, some seven months after Logan's visit, they sat down to sign the contract.

During those months, Logan and his advisers came up with a few ingenious ideas to, as he puts it, "tie Nissha down in as many ways as possible." First off, Nissha would become a stockholder. Logan felt that if Nissha invested $500,000 in return for a small percentage of equity, it would be likely to devote more attention to Micro-Touch. He settled on $500,000 because he felt it was enough money so that Nissha would feel it, but not enough equity to dilute existing shareholders. Nissha didn't raise any objections since such investments have become commonplace. "The Japanese favor them," says Plimpton. "They view them as a healthy mingling of blood."

The Japanese partners were a little surprised, though, at a twist that MicroTouch added to the standard equity agreement. It worked like this: Nissha would pay $500,000 for its shares, but if MicroTouch deemed the contract broken, it could buy them out for one penny per share. Isn't that rather low? the Japanese asked Logan after he proposed it. When they recognized it for what it was -- not an investment, but a sign of commitment -- they were more than willing to agree. To Trevor Nagel, the attorney representing MicroTouch, the buyback agreement was crucial since the Japanese government does not have a reputation for enforcing noncompete clauses very vigorously. "If Nissha started competing with us in Japan," says Nagel, "we couldn't rely on the courts to make remedies."

Logan also required Nissha to provide marketing information, keeping MicroTouch informed of who its major customers were, the different applications, and where the competition was heading. "If we don't understand anything about the market, we become subservient subcontractors to them," says Logan. Though not all that uncommon, this could have been a sensitive negotiating point for Nissha. What was to prevent MicroTouch, after all, from learning as much as it could about its Japanese customers and then cutting Nissha out of the deal?

The MicroTouch team also added a provision making the contract enforceable under Massachusetts law. That was more than just parochialism on its part. The Japanese court system is notoriously sluggish, and Massachusetts boasts well-developed high-technology law. "Precedents help everyone," says Nagel. "You want to be in the most sophisticated system you can."

Perhaps most important -- and, as it would turn out, the biggest sticking point -- was the contract's noncompete clause. It was the same standard clause you might find in any distribution agreement, lasting for five years, two years beyond the life of the contract itself. But to broaden it, Logan added a nondevelopment clause, which addressed his worst fears. "I worried they'd terminate the contract and, the next day, unveil their new touch screen," he says.

The Nissha executives appeared to agree with these provisions, though they hesitated over each new clause, claiming they had to check with the appropriate government agency. That's often the case with Japanese executives; they act a bit like car salesmen running back to check with the sales manager about offering you that special low price. Logan occasionally used his board of directors as a foil, but he made most decisions right on the spot. By Christmas 1988 they had reached an agreement to everyone's liking.

Or so Logan thought, as he planned the ritual for signing the contract. By now, Logan knew enough about Japanese custom to make a ceremony out of it. The Nissha executives were to appear at a downtown Boston skyscraper, in the office where MicroTouch would hold its board meeting later that day. While the board watched -- along with the venture capitalists who had funded Logan -- they would pick up the special fountain pens and, with a flourish, sign the 12-page contract. The Nissha executives arrived, but they declined to sit down. We're sorry, one of them announced, but we have reason to believe that if we sign this contract we could face criminal prosecution and fines of $25,000. Logan's face reddened. "I was getting sick of the whole thing at this point," he says.

Plimpton tried to get at the root problem. The Japanese fair-trade commission, they told him, did not look favorably upon the noncompete clause. Never mind enforcing it, the government wouldn't even allow it. "The government seemed unhappy that the document had no language about future intentions or any long-term relationship," Plimpton recalls. "They felt we might take advantage of Nissha."

Well, the MicroTouch group reasoned, if the government wants something more, why not sign a letter of intent to enter a joint venture? Logan had previously rejected the idea, feeling that the market probably wasn't big enough to justify such an expense. But a letter of intent, he points out, "would not legally bind us to a joint venture -- only to investigating one." Plimpton floated the idea; it seemed like it might just fly. It did, though Nagel admits, "I'm not sure why." The contract was finally signed last January. There was no ceremony. "I was tired of spending money on lawyers," Logan says.

So far, Logan believes his money and time were well spent. The contract is holding up. It could become a model, he says, for the kind of agreements that U.S. manufacturers might strike with European distributors after 1992. Then there will be competitive and financial advantages to forming closer relationships with distributors: the market will be harder to infiltrate and customers will demand more. "This kind of contract could be just the right thing," Logan says.

Assuming, that is, that MicroTouch and Nissha continue to work well together. Logan, trained as an economist, doesn't discount any possibility. "I'm not saying this is a 100% sure thing," he says. "It's not foolproof. Even if no one of these barriers is expensive enough to prevent them from ripping us off, the sum total probably will be. That's the law of probability. But I guess we won't really know for a few years."


LINES OF DEFENSE

What to include in your distribution contract

James Logan, president of MicroTouch Systems Inc., approached his negotiations with a Japanese distributor well aware of the risk of his technology being copied. So he carefully worked out a 12-page contract to protect himself. Here are the main lines of defense upon which it rests:

* Patents and trademarks. While U.S. patents are hard to enforce in Japan, they do provide some deterrence to copycats.

* Noncompete/nondevelopment clause. The Japanese government will not usually enforce such clauses beyond the duration of exclusive agreements, regarding them as stifling competition. Nonetheless, MicroTouch included a noncompete in the contract and got away with it by also signing a nonbinding letter of intent to enter a joint venture. Another option: open a wholly owned subsidiary in Japan, or a branch office. The government is much less likely to scrutinize contracts between two companies in Japan.

* Access to marketing information. You can specify that you want the distributor to send you the names of customers, applications, and information about competitors. You can also be explicit about visiting customer sites; Logan wasn't, and he regrets it. But he has a backup. Jack Plimpton, Logan's former marketing director and now an independent consultant, visits Japan every six weeks and can keep an eye on things.

* Local enforcement. You don't want to go to court in Japan -- or any country outside the United States -- if you can help it. But if your partner won't agree to interpret the contract according to U.S. law, suggest arbitration in a third country such as Hong Kong or England, where American arbitration processes are recognized.

Last updated: Jan 1, 1990




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