What Is Contract Manufacturing? Pros and Cons
Contract manufacturing is the practice of hiring a manufacturer to create product parts, components, or complete products usually within a specified time period. This manufacturing method helps both small and large businesses create goods that keep their companies profitable and competitive.
All businesses that sell products either manufacture in-house or outsource to a third party. Outsourcing is commonly used to save costs, improve quality, or speed up time to market.
Types of Contract Manufacturing
There are various types of contract manufacturing structures that contract manufacturers use:
Individual component manufacturing
In this agreement, the manufacturer only creates product components rather than finished products. By outsourcing the production of components that need specialized tooling, companies can speed up their production processes. Companies will either use the components in product assemblies or sell the components to consumers.
Labor or service subcontracting
Like individual component manufacturing, this agreement structure helps with one piece of the manufacturing process rather than the entire finished product. In this arrangement, a company will hire a subcontractor to support its in-house team in producing components that require additional resources.
Private label manufacturing
Private label manufacturers create finished products according to the hiring company's specifications. Then, the company will attach its branding and sell the products to consumers. This process should not be confused with white-label manufacturing, wherein the manufacturer produces generic goods. The manufacturer then sells the generic products to retailers who affix their branding and sell to customers.
End-to-end manufacturing
End-to-end manufacturing is a similar process to private label manufacturing. The difference here is that the manufacturer has more input on the product's design. This arrangement streamlines the production process to keep the production costs down.
Further reading: The 6 Types of Manufacturing Processes
How Contract Manufacturing Works
Typically, the contract manufacturing process starts with a company designing a product with custom specifications, usually with some manufacturer input.
For example, let's say a small cosmetics company wants to outsource the production of lipstick.
- The cosmetic company's chemists formulated the lipstick and their marketing team designed the custom packaging. The cosmetics company wants to hire a contract manufacturer that will produce both the lipstick and packaging so their teams can focus on marketing and sales.
- The company researches to find manufacturers with environmentally-friendly formulations/packaging and high-quality sterile production facilities.
- The company finds a manufacturer that fits these specifications and visits their facilities to determine their suitability.
- The facilities exceed expectations, so they create an agreement for the production of the lipstick/packaging and shipping to the cosmetic company's warehouse.
- The manufacturer begins production.
- The cosmetic company visits the facility to conduct audits of the production process.
- The manufacturer completes production and ships the lipsticks (in their packaging) to the cosmetic company's warehouse.
- The cosmetic company lists the new product on its website and begins marketing it to consumers.
- The production cycle is successful, resulting in sold-out inventory. As a result, the cosmetic company extends the contract for multiple production cycles to keep a steady lipstick stock.
Contract Manufacturing Examples
Many industries outsource their manufacturing to focus on core competencies like sales and marketing. Some of these industries include:
- Consumer Packaged Goods
- Electronics
- Automotive
- Pharmaceuticals
- Medical Devices
Pros and Cons of Contract Manufacturing
There are many advantages and disadvantages of producing goods through contract manufacturing:
Advantages
Save Costs
Hiring a contract manufacturer can save your company money on facilities, equipment, staff, and maintenance. Also, with economies of scale, manufacturers often save money on raw materials since they purchase them in bulk.
Instead of investing in manufacturing equipment and labor, companies with contract manufacturers have much less overhead. These cost savings reflect the cost per unit.
Additionally, outsource manufacturing allows companies to sell products in other countries while bypassing costly import taxes.
Specialized Skills
A contract manufacturer often has extensive experience successfully creating similar products. These specialized skills can be a unique competitive advantage, since they may have unique sector knowledge/expertise.
Advanced Facilities
For the best quality, search for companies with state-of-the-art facilities and specialized equipment to create your product.
Enhanced Quality Control
The best companies will have quality control measures in place to handle the scale of production you require.
Reduced Lead Times
For companies that manufacture their products but have components made by other companies, both the lead time and cycle time of a product will eventually decrease.
Great for Startups
When scaling a new high-growth startup, it's essential to focus your resources strategically. Hiring an outside company to create your new products will help you focus on sales, marketing, and other responsibilities.
During this time, you can also build capital and technical experience that can eventually help you build your own manufacturing facilities.
Disadvantages
Less Control
Even if you have a transparent relationship with your contract manufacturing company, you'll still be unable to control every step of the process. Their methods and materials may also be limited by their capabilities and equipment.
Quality Control
Ownership of your facilities means you also get to completely own your quality standards.
When you outsource your manufacturing, you can no longer analyze production or ensure timely completion with the required level of scrutiny. This could end up affecting whether product quality meets customer expectations.
Intellectual Property
When you manufacture a product outside your company, your intellectual property is always at risk. To protect your IP, secure patents whenever possible and hire reputable manufacturers that won't poach your products.
Foreign Outsourcing
Outsourcing to a foreign country presents several risks. First, a language barrier may hinder effective communication of your company's needs and product specifications. There may be data protection and confidentiality risks to consider, as well.
Third cultural differences in business conduct could result in offensive gestures from either side of the business arrangement. Lastly, when your manufacturing takes place thousands of miles away, long lead times are an obvious risk.
Capacity Limitations
Contract manufacturers manage many clients at once.Unfortunately, this means your order might be deprioritized in a supply chain disruption to accommodate the needs of bigger accounts.
Less Flexibility
When conducting your manufacturing in-house, you can respond quicker to market changes and supply chain disruptions. Contract manufacturers have multiple clients for whom they are fulfilling orders. Their obligation to other clients means you may be unable to increase supply production when demand increases.
Reduced Profit Margin
Although your company may initially save money because you're saving on manufacturing facility costs, the price per product can increase with outsourcing.
Contract manufacturers have to pay for facilities and staff them, so they pass along those costs to you. Their need to maintain their profit margin results in a higher price per product that you can either absorb or pass along to your end customer through a higher retail price.
Job Loss
When outsourcing your manufacturing outside your country, you risk removing valuable and well-paying jobs from the local economy.
Keys to Successful Contract Manufacturing
To maximize the benefits of outsourcing your manufacturing and make the best contract manufacturing decisions, follow these best practices:
Define Expectations
You'll need to set detailed parameters for the product, the completion timeline, and the number of production cycles. If you're creating products requiring special regulations (such as those from the FDA), hire a company certified to follow these guidelines.
Research Manufacturers
To establish trust with your contract manufacturer, you must conduct thorough research on their facilities and business practices. First, learn about their manufacturing industry reputation by seeking customer testimonials attesting to their quality and communication. The best manufacturers have ISO certification, establishing their dedication to quality management.
Next, ensure the facilities are clean and high-quality, especially concerning sensitive products that require sterile production. Lastly, learn about the manufacturer's market awareness and adaptability to potential supply chain disruptions.
Establish Detailed Contracts
Create a contract using the expectations you defined for your product and the manufacturer's capabilities. This contract should include details such as the product specifications and the completion timeline.
Having a detailed arrangement helps both parties establish expectations and avoid any confusion or disappointment.
Conduct Audits
Conduct regular on-site audits of materials, production facilities, and quality control of the finished product. These audits are critical to ensure that the contract manufacturer is creating products at the expected quality.
Further Reading
