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What Is Contract Manufacturing?

Updated: August 11, 2023
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What Is Contract Manufacturing?

Contract manufacturing often goes by its better-known name — outsourcing. With contract manufacturing, rather than producing the product in-house, a company uses a secondary manufacturing firm to create their product or a part of their product.

In most cases, the hiring company retains a manufacturer, known as a Contract Manufacturer, or CM, to manage the production of their product. The CM then makes the product and either returns it to the hiring company or ships it directly to customers. The hiring company manages all sales, marketing, and customer service responsibilities.

Forms of Contract Manufacturing

Contract manufacturing can take a few different forms depending on the needs of your business. Some companies want to outsource the entire manufacturing and shipping operation, while others just need a component of their overall product produced externally. Here are the four most common types of contract manufacturing .

Complete Product

Some companies want their entire product manufactured by a CM. For some, this also includes shipping the finished product to the customer directly from the manufacturer rather than returning the product to the hiring company for packaging and dispersal.

Partial Product

Other companies only need a component of their product produced externally. In these cases, after the manufacturer creates the piece of the product, they'll return it to the hiring company. There, the hiring company will complete the assembly of the final product and manage packaging and shipping.

Labor

Occasionally, a company has the necessary facilities to manufacture their product but does not have a sufficient labor force on hand to meet production needs. It's possible to outsource labor alone in these cases, domestically and internationally.

Facility

Similarly, a company might have all the necessary components, including labor, to create their product, but it doesn't have the machinery or facility to do so. In this case, they might hire a CM simply for their location and bring in their own people and supplies to manufacture their product.


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Advantages of Contract Manufacturing

Contract manufacturing offers some impressive benefits to companies who choose to use it. Chief among them are the following:

  • Cost reduction: Probably the most compelling reason to outsource is the cost savings. It's almost always cheaper to hire a third party to manufacture a product than to purchase the machinery, find a facility, and hire employees to do so in-house.
  • Improved capital: Since your company is saving money on manufacturing costs, there's more capital available to invest in research and development, marketing, or other areas of the business.
  • Smaller supply chain: Usually, the CM handles communication with suppliers and distributors, which decreases the steps in your supply chain for easier management.
  • Decreased production time: Many CMs are able to produce mass quantities of products much more quickly than a company could independently, getting the product to customers faster and hopefully increasing overall sales.
  • Quality product: If you select a reputable CM, your product should be of the highest quality.
  • Positive brand recognition: A CM should manufacture a consistently high-quality product that establishes immediate positive brand recognition with customers.
  • Accessible market entry: If you choose a CM in another country, you may have an easier time gaining entry into the global market than you would if you manufactured in-house.
  • Possible distribution: Many CMs also manage product distribution and shipping, saving you the additional time and labor cost of packaging and shipping your product.

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Risks of Contract Manufacturing

While contract manufacturing does offer a number of benefits, it's not without its disadvantages. You'll want to consider the following risks carefully before proceeding with a CM.

  • Lack of control: When you outsource your manufacturing to a third-party company, you lose most of the control. While you can pop in periodically, it can be a challenge to maintain a hands-on approach, particularly if your CM is overseas.
  • Finding the right CM: It takes time to vet CMs and find the right one for your company and product. Make sure you visit the facility and take the time to see how they operate and that you're comfortable with their labor practices.
  • Employee retention: With production outsourced, you may need to cut back on your in-house employees, which can be tough on overall morale.
  • Human rights concerns: Some CMs, particularly overseas in developing countries, do not provide their workers with appropriate wages or work conditions. You'll want to ensure you're working with a company that values its employees and treats them fairly.
  • Ineffective contract: Without a comprehensive contract, you or the CM could face problems with production, payment, and expectations. Consider using the services of a contract lawyer to ensure you and the CM are appropriately represented in your contract.

Important Elements for a Contract Manufacturer

When you meet with potential CMs to negotiate an agreement, look for these necessary qualifications:

  • Clean facility: Visit their facility. Take a tour and check out the machinery and work areas, and ensure it's clean and well cared for.
  • Excellent management: If you can, speak with some of the employees about the management team. You want to make sure the leadership is effective and fair.
  • ISO-certified manufacturing quality standards: ISO certification ensures that contract manufacturers meet certain regulatory standards for production quality and employee support.
  • Distribution capabilities: If your CM will manufacture your entire product, see if they can also manage distribution to customers. This saves you time and money since you won't have to worry about the product coming back to you before heading on to your customers.
  • Flexibility: Particularly if your company faces some changes in demand over the year, find a CM who can be flexible about production numbers and deadlines.
  • Communication: You want a communicative and honest CM.
  • Quality assurance: Ensure your CM has a history of producing top-quality products.
  • Great reputation: Ask around in your industry about the CM you want to work with. Make sure they have a strong reputation, and if possible, positive reviews from companies you trust.
  • Positive cash flow: You want to work with a CM that has a solid cash flow and some capital in the bank to avoid gaps in production or other delays in manufacturing.

When to Use a Contract Manufacturer

Contract manufacturing is not for everyone. Some companies are better off producing their product in-house than finding a CM to manage the process for them. However, many companies can benefit from the production prowess of a CM. You might want to consider using a CM if you:

  • Have high start-up costs: A CM can help you cut back on capital expenditures while you get your operation up and running.
  • Have low capital on hand: If your company is facing financial hardship, consider outsourcing to save some money. You can do so temporarily or permanently.
  • Need a quality product quickly: In-house manufacturing takes some trial and error. If you want a top-quality product on the first attempt, a CM can help you achieve that goal.
  • Want positive brand establishment: If you're hoping to launch a product nationally or internationally, you want immediate and positive brand establishment. Ensure your product quality is high and consistent with a CM.
  • Have seasonal demand: Some companies choose to outsource part of their production to a CM during seasons of high demand while maintaining in-house production for the rest of the year.

The best way to ensure a positive and effective relationship with your CM is to craft an excellent contract . Consider using the services of a contract lawyer to help protect you and your CM and ensure a smooth production process.

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