What Is Contract Manufacturing? Types and Examples

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 small and large businesses create goods that keep their companies profitable and competitive.

All businesses that sell products manufacture their goods 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: The manufacturer creates only product components or parts used in the client’s final product. 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 them 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: Under a private label, the contract manufacturer will create a complete product that is then sold under the client’s brand. 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 similar 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 production costs down.

Further reading: The 6 Types of Manufacturing Processes

Industries

Many industries outsource manufacturing to focus on core competencies like sales and marketing. Some of these industries include:

• Consumer Packaged Goods
• Electronics
• Automotive
• Pharmaceuticals
• Medical Devices
• Cosmetics

Step-by-Step Example

The contract manufacturing process typically starts with a company designing a product with custom specifications, usually with some manufacturer input.

For example, a small cosmetics company wants to outsource lipstick production.

1. The cosmetic company’s chemists formulated the lipstick, and their marketing team designed the custom packaging. The company wants to hire a contract manufacturer to produce both the lipstick and packaging so its teams can focus on marketing and sales.
2. The company researches to find manufacturers with environmentally friendly formulations/packaging and high-quality sterile production facilities.
3. The company finds a manufacturer that fits these specifications and visits their facility to determine their suitability.
4. The facility exceeded expectations, so they agreed to produce the lipstick and packaging and ship it to the cosmetic company’s warehouse.
5. The manufacturer begins production.
6. The cosmetic company visits the facility to conduct audits of the production process.
7. The manufacturer completes production and ships the lipsticks (in their packaging) to the cosmetic company’s warehouse.
8. The cosmetic company lists the new product on its website and begins marketing it to consumers.
9. 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.

Pros and Cons of Contract Manufacturing

There are many reasons for producing goods through contract manufacturing 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.
• 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 provide unique sector knowledge/expertise.
• Advanced Facilities: 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 use components made by other companies, a product’s lead time and cycle time will eventually decrease.

Disadvantages

• Less Control: Even if you have a transparent relationship with your contract manufacturing company, you won’t be able to control every step of the process. Their methods and materials may also be limited by their capabilities and equipment.
• Quality Control: 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 also be data protection and confidentiality risks to consider.
• 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.
• 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 must pay for facilities and staff, 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 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 thoroughly research their facilities and business practices. First, learn about the company’s manufacturing industry reputation by seeking customer testimonials that attest to its 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.

A detailed arrangement helps both parties establish expectations and avoid 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 the contract manufacturer creates products of the expected quality.