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What is contract manufacturing?

01 Jun, 2022 | Manufacturing

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As a businessperson, there are times when you have too much on your plate, and trying to do everything on your own can be counterproductive. Have you thought about outsourcing work to people with relevant experience and skill sets?

Successful businesses take advantage of delegation and outsourcing to distribute their workload. In fact, the global outsourcing market was estimated to be $92.5 billion before the pandemic. These days, it is hard to spot a business function that can’t be outsourced. From IT to manufacturing, you can outsource it all.

Third-party manufacturers – which are also known as contract manufacturers – can be a boon for businesses that don’t have the resources to do their own manufacturing. However, it can also be a bane for businesses that want to have full control over production. This article will explain contract manufacturing in detail, along with its pros and cons. This will help you decide whether contract manufacturing is right for your business or not. Let’s dive right in!


What is contract manufacturing?

Contract manufacturing is the manufacturing of products for third parties on a contractual basis. For example, let’s say Tom wants to open an apparel store, but he doesn’t want to actually produce clothing on his own. Tom can hire John to manufacture clothes for his business. In this scenario, John is the contracted manufacturer.

Contract manufacturing goes back to 1961, when Olin King founded SpaceCraft. SpaceCraft was a contract manufacturer that produced satellites and communications equipment for NASA and other US government agencies. Today, you can find contract manufacturers across many industries, including:

  • Aerospace
  • Electronics
  • Automotive
  • Packaging
  • General fabrication
  • Personal care
  • Food and Beverage
  • Medical
  • Energy
  • Semiconductor
  • Defense
  • Pharmaceutical

Businesses usually approach contract manufacturers when they need to mass-produce a product. Foxconn, for example, manufactures products for Apple. Not only does their experience result in higher quality products — they also often also make fewer errors in production.


The benefits of contract manufacturing

Contract manufacturing is adopted by various industries because it helps businesses source products at a cheaper rate. Companies like Apple, HP, and Microsoft leverage contract manufacturers to create their products in mass quantities and higher rates of efficiency.

On the other hand, contract manufacturing helps small-scale businesses that can’t afford to set up their own production facilities with the latest tech and equipment. Instead, they channel their limited funds into research and product design. No matter what size your business is, you can benefit from working with contract manufacturers. Here are four benefits.


Benefit #1: Leveraging economies of scale

When you increase production quantity, the cost of manufacturing each unit decreases. This inverse correlation between production quantity and the unit cost is called economies of scale. There are several reasons to justify this phenomenon; for instance, as you produce more units, you get better at producing them. This minimizes waste and reduces cost.

When you produce in bulk, you need to purchase raw materials in larger quantities. This provides you with greater bargaining power, and it allows you to get those materials at a cheaper rate. As you get materials at a lower cost, your overall production cost is lowered.

Since contract manufacturers are skilled in manufacturing, their production systems are optimized for maximum efficiency. On top of that, contract manufacturers are usually set up for mass production. Thus, they’re able to source raw materials for less money.

Benefit #2: Saving time

As you outsource production to contract manufacturers, you don’t need to manage the production process as much. Instead, you’re able to focus on other important functional areas  such as research, development, and sales.

Benefit #3: Conservation of resources

You need to have deep pockets for in-house production. Land, machinery, raw materials, and labor are all costly. Plus, you need to constantly upgrade technology and train your employees. All these costs can be avoided by working with a contract manufacturer. Plus, as a new manufacturer, you might be both inefficient and mistake-prone. Over time and with more experience, you would probably be able to streamline your process. However, these challenges can be mitigated by outsourcing your manufacturing.

Benefit #4: Access to global markets

When you expand to global markets, you have to consider the compliance rules of each region. Unfortunately, many countries have trade barriers restricting foreigners from setting up their manufacturing units on their land. Outsourcing to contract manufacturing in those countries grants you access to those restricted markets.


The challenges of contract manufacturing

Challenge #1: Quality issues

In pursuing mass production at a lower cost, you should make sure that quality doesn’t suffer. When outsourcing production to a third party, you need to constantly inspect whether production adheres to your standards or not. You should work in tandem with manufacturers to clearly explain what you need from them, and how to best achieve it.

Challenge #2: Less control

When you work with a contract manufacturer, you’re at their mercy for production. When and if there are delays, your business suffers. You might also lose the flexibility to respond to market trends. For example, if there’s a surge in demand for a product, you might want to increase production. That simply might not be possible with contract manufacturers. This kind of control and reliability can be difficult to find with third parties.

Challenge #3: Intellectual property (IP)

When working with a contractual manufacturer, you will inevitably share sensitive information, including product design and intellectual property secrets. There’s always a chance that your manufacturer steals your intellectual property and uses it to either launch their own brand, or sells this sensitive information to a close competitor. Because of this, it’s absolutely crucial to take certain precautionary measures for avoiding such scenarios.


Always sign a contract manufacturing agreement

A contract manufacturing agreement is a legal document that binds the contract manufacturer and business. If either party breaches the contract, one party can sue the other party in a court of law. This agreement safeguards both parties. Make sure the agreement includes the resolution for any type of dispute or disagreement. Each party’s responsibilities during a dispute should also be included.

Your customers don’t care whether products are manufactured in-house or through a contract manufacturer. They are only concerned with the end product’s quality. If you outsource production to a contract manufacturer, you need to make sure those products meet your standards.

If the contract manufacturer creates faulty products that customers don’t like, it will tarnish your reputation — not that of the contract manufacturer. This means you need to establish guidelines to define the scope of work, roles, and responsibilities of the manufacturer. You should also include specific numbers of products to be produced, delivery timeframes, and the manufacturer’s responsibility to handle design and other aspects of production. This should all be clearly defined in the contract manufacturing agreement.

To get the best results from contact manufacturing, you should always collaborate as much as possible with your manufacturer. Try your best to perform regular on-site visits to audit production quality. Share information and resources that could help the manufacturer make the best possible product and match your expectations.

However, when sharing such sensitive information, it is crucial to get a non-disclosure agreement (NDA) signed by your contract manufacturer. This helps assure that your manufacturing partner doesn’t give away precious data and work processes to any other players in your market.


Working with contract manufacturers

What services do contract manufacturers commonly offer? They include the following:

  • Designing products for manufacturing
  • Preparing product models that can aid with production
  • Manufacturing products manually with labor, or automatically with machinery like 3D printers
  • Assembling components to make finished products
  • Packaging goods
  • Shipping finished products to warehouses

There are usually two approaches to working with a contract manufacturer. Let’s explore both options.


Option #1: Build to print

In this method, the client has a lot of control over the manufacturing process. When two parties agree to work on a build to print basis, the client provides several resources to the contract manufacturer. The resources can be human resources, R&D documents, and more.

For example, the client company can send their engineers to explain product design and go over other development documents. After understanding these requirements, the contract manufacturer will come up with a prototype. Once the client is satisfied with the prototype, they start manufacturing.


Approach #2: Build to specs

Contrary to the build to print approach, the build to specs method provides greater flexibility and control to your contract manufacturer. The client does not share any design or resources with the manufacturer for reference. Instead, the manufacturer needs to come up with the design by themselves. The manufacturer will share their designs with the client for review. Once the client agrees on a design, the manufacturer can proceed with the production. Even though the manufacturer is involved in the ideation process, the client holds all intellectual property (IP) rights to the product.

In the build to spec method, the contract manufacturer works on both concept and design. Many contract manufacturers usually operate on the “cost-plus” model. In this case, the manufacturer calculates the overall cost of manufacturing — including materials, labor and a profit margin.

For instance, if the production cost is $1,000 and the manufacturer wants to earn a 10% margin ($100), he would quote a price of $1,100 to the client. If the client agrees to the quoted price, they can proceed.


Improve your contract manufacturing with DEAR Systems

As a contract manufacturer, you need to deal with large quantities of goods and a lot of complex processes to successfully create your product. As you scale, you’ll start working with multiple clients — and that’s when challenges start to compound.

DEAR Systems can help solve these complex problems. Our cloud-based solution is designed for manufacturers who want to create a bill of materials and start planning for production. You’ll find that during production, your materials will need to be replenished constantly. DEAR Systems can also help automate reordering processes and account for lost or damaged goods — which are absolutely essential functions.

DEAR Systems is great for those looking to streamline their manufacturing workflow. If you are interested to see how DEAR Systems can help, book a call with our experts today!

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