Contract Manufacturing: Definition, Meaning, Advantages, Examples

Definition

Contract manufacturing is defined as the production of goods by a company for a brand or label of another company. This is an outsourcing process that is conducted by a contract manufacturer who offers such services for several firms.

The products that are manufactured are customized as per the specifications and design of the customer and sometimes even their own.

Meaning of contract manufacturing

Contract manufacturing is the organization that is creating or manufacturing the product for the other company. The concept is also used to refer to the companies that offer special services to several organizations about the manufacturing process.

The role of a manufacturing company can also act as a mutually beneficially liaison between two companies, one that wants a certain product and the second that can deliver that product.

In the international scenario, contract manufacturing is applicable when one firm asks another company located in a different country to manufacture its products. The contract manufacturing mentions a set of requirements concerning the quality, delivery dates, quantities, and certification.

It also mentions strict guidelines for testing and inspection of the goods, modifications to orders, compensation, and guarantees in case of breach of contract.

When you are hiring a contract manufacturing company look for these qualities

• The contract manufacturing firm is financially sound
• Has the ability to meet your specific demands
• Has a good and sound reputation in the market
• Has the ability to meet additional product demand
• Is flexible and can respond positively to market fluctuations
• Can transport the products directly
• Has a well-managed facility
• The manufacturing quality standard compliances with ISO-certified

Examples of contract mfg.

ABC Company is facing criticism for its quality which was considered top-notch at the beginning. It decides to enter into a deal with Peter & Company, which is a reputed contract manufacturing firm to outsource its products temporarily to see whether its customers are now satisfied with the products.

The company sees a dramatic shift as the customers appreciate the new products, and it results in an increase in sales figures as well as revenues. ABC Company decides to continue its contract deal with Peter & Company as it has proved beneficial.

An important real example of contract manufacturing is Starbucks that does not have any coffee farms of its own. It outsources all its main ingredients to serve its customers in different parts of the world.

Types of contract manufacturing

Contract manufacturing refers to the outsourcing of a few or all parts of a product to another firm or a subcontractor. Companies that are interested in outsourcing generally contract the subcontractor directly or through an agency for manufacturing its products.

The different types of contract mfg. are included in industries :

• Aerospace
• Electronics
• Automotive
• Packaging
• Personal care
• Food manufacturing
• Medical
• Energy
• Semiconductor
• Computer
• Defence
• Pharmaceutical
• Parts fabrication
• General fabrication

Some types of contract mfg. include

• Complex Assembly
• Grinding, Broaching, and Milling
• Die Casting
• Forging
• Sheet Metal Forming
• CNC Machining
• Machine Control Assembly

Forms of contract mfg.

As the nature of operations and business vary, it can result in several forms of contract manufacturing like-

#1. Manufacturing of entire product from one company to another

The hiring firm uses the contract manufacturing company for manufacturing most or all the parts of its product from it.

An example of a reputed contract manufacturing company is Foxconn Technology Group that supplies products to high-profile companies like Microsoft, Amazon, and Apple.

#2. The hiring of service and labour

If you lack the required manpower, you can contract a sub contractor or a contract manufacturing firm that deals with outsourcing of labor. A company can also outsource specialized services from contract manufacturing firms that deal with it.

An important example is Flex, a company recognized for offering services related to distribution, manufacturing, and designing.

#3. Manufacturing of a part of a product from one provider to another

Most of the electronic and tech companies use contract manufacturing firms to create components for their products. An example of a good contract manufacturing company is Deerfield Machine Parts that specializes in the fabrication of rubber, aluminium, and plastic tubing and supply it to reputed firms.

#4. Using facility and equipment

If a company does not have the necessary space or facility or equipment, it can deal with a contract manufacturing service and use their facility or equipment as per their requirement.

Advantages

1. Saves ample time especially the time needed to set up manufacturing units in another place
2. Contract has proved beneficial in a situation where a company does not have the knowledge about a certain place and instead has used a local company to meet its requirements
3. Firms can save on the cost of capital as they do not have to pay for equipment, labour, training, and place, etc. Most companies look at low-cost countries like China and India to get the benefit of low labour costs.
4. Hiring a contract firm results in an increase in productivity. It helps to send your products to market quickly.
5. The contact manufacturing process proves mutually beneficial for both the firms that are involved in it as one can have the products easily enough and the other gets a steady flow of business
6. The hiring firm takes advantage of outside skills that they do not possess but might be with another firm. There exist contract manufacturing companies that offer skilled labour or expert technicians on hire to other firms.
7. The contract manufacturing has its established network with suppliers or people with advanced skills to manufacture the products. He can share them with the hiring company if the deal seems beneficial to him.
8. Hiring company can put its onus on core competencies and what they do best when they can hand the manufacturing process to someone they trust
9. Contract manufacturing serve several customers and thus can purchase raw materials in bulk at reduced prices. They can benefit from the help of economies of scale.
10. There is an improved allocation of resources, and the company can put its onus on other important areas of its business
11. Increased innovation and ultimately improved brand reputation and recognition as the firm are dealing with quality products.

Here is a video by Marketing91 on Contract Manufacturing.

Risks of contract manufacturing

The risks attached to contract manufacturing are as follows-

1. The firm that places an order is dependent on the contract manufacturing meeting his demands promptly. There is also a lack of flexibility without direct control.
2. As the hiring firm is dependent on a contract manufacturing company for its parts, it might not be able to meet sudden demands in the market at the right time
3. It loses a certain part of the profit instead of offering contract manufacturing to another firm. The addition of a second profit margin has a direct impact on either higher sales price or reduced profit margins if the price of the products is not increased.
4. When a hiring company signs a contract with a contract manufacturing company, they lose a part of the control to the other firm. They can suggest strategies and offer guidelines, but it is actually up to the manufacturer to do as his deem correct.
5. It is vital to maintain a good relationship with your contract manufacturer. Remember the manufacturer has other customers and you cannot force him to manufacture your products before someone else’s products. Most hiring firms decrease the risk by working on a one-to-one basis with the contract manufacturing and offering him additional benefits for his extra efforts
6. While signing the contract, the hiring company must make sure that the quality standards of the contract manufacturing company are congruent with their own. There is always a risk that the manufacturer can make quality adjustments at your cost
7. When a company deals with a contract manufacturing firm, it has to divulge some of its trade secrets sp that the products can be made as per the required specifications. This causes a risk of intellectual property loss. Do not give a contract for your core competencies and make your contract full-proof to mitigate the risk as much as you can
8. Outsourcing has a risk of its own like lengthy lead times and cultural barriers that could result in difficult situations
9. There is always a risk whether the contract manufacturing have hired is up for the challenge or not. The hiring firm can mitigate the risk by giving him a short-term contract for the first time and keeping an eagle-eye on it for qualitative products
10. There are several countries where labour is cheap, and firms try to outsource the products from there to lower costs. The casualty in these circumstances is the existing labour force of that country that is unable to find appropriate work. This is an abuse of existing labour and resources as they remain unutilized.

The right time to use contract manufacturing

1. You have just started your business, and it is still on shaky grounds because the costs are too high, and you do not have enough working capital to create the product fully. It is at such times that the service of a contract manufacturing firm is wise.
2. If your business is facing financial difficulties, it is the right time to contract manufacturing company because it can help you in saving both time and money.
3. If a company is interested in improving the quality of its product, you can outsource it through a reputed contract manufacturing firm that will guarantee better components than the ones you have been producing
4. If the demand for your products is uneven or seasonal, you can take the help of a contract manufacturing company for the related period. You do not have to invest your own time, money, and effort for the whole year.

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