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What is Contract Manufacturing?

November 8, 2018

Contract manufacturing (CM) is not the most common term in the world, but it’s utilized by everyone from small startups to the largest companies in the world and everyone in between.

 

Most entrepreneurs and business leaders have heard of it, but they don’t always have a good understanding of what it is and how it works. Understanding contract manufacturing and how to utilize the services and resources can have a huge impact on your business. So, let’s dive in… 

 

 

What is Contract Manufacturing?

 

Contract manufacturing is a type of outsourcing in which a company enters into an agreement with another manufacturing firm (known as contract manufacturer) that will make an entire product or parts for the hiring company. The contract manufacturer is the company that takes on responsibilities including:

 

  • Design and engineer the product

  • Buy and maintain tooling and machinery

  • Hire and train the production team

  • Produce the product

  • Control quality

  • Manage the orders

  • Manage the supply chain

  • Plan and coordinate logistics

  • And much more

 

In most situations, the company has two options, they can invest in machinery and a factory to make the product themselves, or they can hire an outside company with established production lines in place to make it for them. The second option is what is referred to as a Contract Manufacturer. 

 

The Process

After the vetting process and due diligence of choosing the right contract manufacturer, the company and the contract manufacturer will agree to a contract for the products that are purchased by the company from the contract manufacturer. The following items are the key points of what makes a detailed agreement:

 

  • Volume: The number of units purchased by the company from the contract manufacturer.
     

  • Pricing: What is the price per unit for the agreed upon volume.
     

  • Quality: What are the quality requirements that have been agreed upon between the company and the contract manufacturer. 
     

  • Lead Time: The agreed upon time it takes from the time the order is placed to the time the order is ready for shipment.

 

After the contract is agreed upon and the order is placed, the responsibility shifts from the company to the Contract Manufacturer. The Contract Manufacturer will then take on responsibility for:

 

  • Managing the Order: From the day the order is placed, the contract manufacturer is responsible for tracking the project and providing the company with updates. 
     

  • Orchestrating the Supply Chain: Depending on the complexity of the order, the contract manufacturer will be responsible for coordinating production and final assembly with a number of vendors. 
     

  • Producing the Product: The contract manufacturer bears responsibility for producing the product for the company and working with their subcontractor’s raw materials and other components.
     

  • Overall Quality: The contract manufacturer follows the quality requirements defined by the company. The contract manufacturer uses their quality system to carry out the requirements agreed upon between the two parties. 
     

  • Logistics: Depending on what is stated on the contract agreement, the contract manufacturer might also be responsible for shipping the product to the closest port, to the warehouse or to the end customer. 

With the company agreeing to transfer the responsibility of the manufacturing process to the contract manufacturer, many resources and budgeting can be allocated to the sales and marketing side of the business. 

 

  • The Benefits: The most common reason a company might choose to hire a contract manufacturer is to reduce costs. However, this is not the only reason why a company will hire a contract manufacturer. There are a number of other reasons that focus around improving the overall efficiency.
     

  • Cost Savings: If you outsource your product to a CM, then you won’t need to spend money on operational and maintenance costs of machines and equipment. Also, your company won’t be responsible for the salaries, wages and other benefits for the operators. 
     

  • Allocation of Resources: Since you don’t need to have resources that focus on manufacturing, you can allocate resources that are focused on other areas of your business, such as sales and marketing. With the costs you save from hiring a CM, you can upgrade your marketing budget. 
     

  • Shorter Lead Time: Hiring a CM means that they will use their expertise and supply chain network to provide you with the quickest possible lead time. The CM has existing processes that have been known and proven to work. 
     

  • Quality: Reputable CM’s will have their own methods of quality control in place that will be used throughout the production process. 
     

  • Advanced Skill Sets: Companies can take advantage of their lack of knowledge and skill sets by hiring a contract manufacturer. The contract manufacturer will have relationships in place with raw material suppliers and have a more in-depth understanding of the production lines. 
     

  • Engineering & Development Support: Depending on the size and scope of the contract manufacturer, they might be able to provide you with developmental and engineering to support for your project.

 Who Needs A Contract Manufacturer?
 

There is no equation that is set up to spell out who needs a contract manufacturer but as long as you have a product, then you might want to think about it. While startups might have the perception that contract manufacturing is only for companies like Apple that hires Foxconn, they are in fact misinformed. 

 

While the largest and richest companies in the world can easily invest in their own production lines decide not to and that’s because of the overall benefits of working with a contract manufacturer. Now, just who needs a contract manufacturer?

 

  • Startups: With the majority of startups having limited resources, it’s very important for them to take advantage of the resources that already exist. Contract manufacturers are a great resource for startups to utilize because they can help to develop and build their product more efficiently and economically than any other company. 
     

  • Looking to Improve Quality: A contract manufacturer has a quality system that has proven to work well in the past. If you have quality issues then you should think about switching to a contract manufacturer to help save your company. 
     

  • Need to Improve the Overall Efficiency: Contract manufacturers have the resources, knowledge and services that can improve your overall supply chain. 
     

  • Improve their Profitability: To reach economies of scale, it’s necessary to hire a contract manufacturer that has different clients that use the same or similar materials in their processes. 
     

Conclusion


While the thought of hiring a contract manufacturer seems a little daunting as it transfers the direct responsibility away from the company, the rewards are great, if done correctly.

 

Before your company hires a contract manufacturer, you should carefully vet and perform due diligence on all possible candidates. The most important part of building a partnership with your contract manufacturer is forming a relationship based on trust and a long-term approach.

 

To learn more about the potential of contract manufacturing for your company, schedule a free consultation with EPower Corp.
 

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