Contract manufacturing guide
Contract manufacturing guide
Table of contents
This guide provides a brief introduction to some of the most important topics when considering outsourcing or planning to outsource part of your production to a contract manufacturer.
In contract manufacturing, one company (the hiring company) outsources part or all of its manufacturing operations to another company – the contract manufacturer (CM). The services provided by a CM can be limited to the actual production processes, but may include engineering, logistics and technical advice related to the design of the product being manufactured. Some CMs function as development and manufacturing houses integrating product development and manufacturing – these are sometimes referred to as Original Design Manufacturers (ODM). Contract manufacturers may also be referred to as original equipment manufacturers (OEM).
Potential benefits of using a contract manufacturer (CM)
Improving time to market
By leveraging the CMs existing production capacity and expertise you avoid spending time building production capacity in-house – ie. establishing facilities, buying equipment, finding and hiring staff with the required technical skills, developing a supply chain for your product capable of delivering raw materials and components that live up to your requirements, acquiring the certifications needed to manufacture your product for the markets you want to target, building an organiaztion and fusing all of these elements into a viable production setup.
Additionally, the CMs experience and technical expertise can be a valuable asset during product development allowing you to increase the value of your product, speed up your product development process, optimize your product for manufacturing and ensure a smoother transition from development to production. Some CMs will provide product development services in addition to technical consulting and manufacturing.
Ideally, the CM will be able to manufacture your product more cost-efficiently than you – in some instances this will be the primary reason why you are looking to outsource production in the first place. The lower cost may be due to lower labor costs (e.g. if the CM is in another country where wages are lower), more production experience, better facilities, overhead costs spread over larger production volumes and so on.
However, whereas the unit cost may be lower, there could be other additional costs related to shipping and freight charges, clearing customs, duties, taxes, quality control, defective products and so on. Thus, when assessing potential cost savings, it is important to factor in all costs related to using a CM.
Total Landed Cost (TLC)
The sum of all costs associated with making and delivering products to the point where they produce revenue.
Scalability and flexibility
For many companies, an important reason for using a CM is the ability to manufacture according to market demand while avoiding the cost of maintaining production capacity when it is not needed. However, there may be a correlation between the business you provide for the CM and the priority your product is given in relation to the CMs other customers. The volume, fluctuations and growth of the business you (expect to) provide the CM with is an important aspect of the partnership and should be discussed before entering into an agreement. Additionally, different CMs will vary not only in their willingness, but also in their capacity to scale production according to your needs. Aspects of their business that influence this capacity include their financial strength, their human resources, their own suppy chain, their strategic priorities and the culture and capabilities of both management and owners. As in other cases, correctly evaluating these aspects of the CMs business and their impact on its ability to scale with your needs, will require a certain measure of due diligence.
Streamlining your organization
Working with a proficient and reliable CM can allow your organization to focus on other aspects of your business by relegating some of the tasks related to managing your production and parts suppliers to the CM which in many cases will have the setup and experience needed to manage these aspects of your value and supply chain more efficiently.
Of course, the initial stages of establishing cooperation with a CM are likely to require both time and attention; and generally speaking, both establishing, maintaining and developing the value of the partnership require care and attention – and sometimes more than planned or even hoped for.
- Improve time to market by leveraging CM’s existing production capacity, technical expertise and development capabilities.
- Lower your cost of sales and overhead costs by taking advantage of economies of scale, the efficiency and experience of the CM and lower labor costs depending on the CMs location.
- Improve your ability to scale production capacity faster according to market demand and the development of your business.
- Focus on core business by relegating part of your production and supply chain management to CM.
Potential drawbacks of using a contract manufacturer (CM)
Control, visibility, flexibility
Using a contract manufacturer to some extent also means removing yourself from the action. As noted above there are a lot of advantages to this, but there are instances where this is not necessarily beneficial. Of course, by working closely with the CM throughout the process, you should have a strong sense of “how things are going” and at many critical junctures you can and should be involved – but to some extent you will have to substitute trust for control. All other things being equal, as the complexity of the manufacturing outsourced increases, so does the value of (well-founded) trust. Additionally,
Language and culture
If you are using a CM in another country, it is vital to ensure that both you and the CM understand what is being communicated. Both language barriers and cultural differences can be the source of misunderstandings. Note that in a CM in another country, the person who is charged with communicating with clients in English might not be the one who is responsible for your product – in fact they might not have the technical expertise required to fully appreciate its finer details.
Intellectual property (IP) risks
Roughly speaking, the risks of unwillingly sharing your IP with an unscrupulous contract manufacturer, can be mitigated on three levels: On the relational, the legal and the operational level.
The relational level requires you to ascertain that you can trust the CM. This can be done through visiting their company – perhaps several times – seeing their facilities, workflows, getting to know the company culture and the people who will ultimately be safeguarding your intellectual property. Such trust should also be built on research of the CMs history, financial situation and customer references. Note that language barriers and cultural differences can make it very difficult to gauge the credibility of a CM.
The legal approach to risk mitigation can seem straightforward but it is important to understand that the legal system and the enforcement it provides can vary greatly from country to country. Relying solely or primarily on legal protection of your IP requires robust legal expertise, experience and sound understanding of the local regulatory and legal environment.
Protecting your IP on an operational level can be done by distributing the knowledge of your IP to several suppliers or CMs. For example, by sourcing various components at different suppliers and only outsourcing final product assembly to a CM that is easier to perform due dilligence on and ultimately to hold legally accountable.
Trust and dependency
As noted above, both trust and control are key parameters when evaluating a potential CM and how to structure the partnership. The opportunity to build trust will grow with time, but to some extent so will your dependency on the CM. This dependency can affect your ability to take action or change course in most of the areas mentioned above. You should make sure that you have considered not only the advantages, but also the potential ramifications of this dependency and how to mitigate them. One approach can be to use more than one CM partner (which of course comes with its own additional workload and challenges) or keeping some capabilities in-house. Another approach, used by many, will be to start out by outsourcing simpler smaller tasks, and allowing the partership to grow as the CM earns your trust through actual performance and behavior.
However, whereas the CM accepts the risks of establishing, owning and maintaining the production assets (including skilled staff), the hiring company accepts the risk of being dependent on the CM. Generally speaking, the more complex the tasks outsourced, the greater the dependence on the CM (making it harder for the hiring company to move production in-house or elsewhere).
Clarifying your requirements
Evaluating your requirements:
- Lead times
- Technical expertise
- Company size fit
- Product portfolio
- Scale-up potential
- Supply chain
Finding a contract manufacturer (CM)
- Talk with people with manufacturing experience
- Create a list of 5-10 potential partners
- Narrow it down to about 3 partners
- Create a design package
- Analyze responses
- Get customer references
- Select a partner
Negotiation, contract and expectations
Title 1Make sure that you are clear about both your own technical and commercial requirements and the
Performance and relationship