Contract Manufacturing

In a contract manufacturing business model, the hiring firm approaches the contract manufacturer with a design or formula. The contract manufacturer will quote the parts based on processes, labor, tooling, and material costs. Typically a hiring firm will request quotes from multiple CMs. After the bidding process is complete, the hiring firm will select a source, and then, for the agreed-upon price, the CM acts as the hiring firm’s factory, producing and shipping units of the design on behalf of the hiring firm.

Job production is, in essence, manufacturing on a contract basis, and thus it forms a subset of the larger field of contract manufacturing. But the latter field also includes, in addition to jobbing, a higher level of outsourcing in which a product-line-owning company entrusts its entire production to a contractor, rather than just outsourcing parts of it.

Industries that use the practice

Many industries use this process, especially the aerospacedefensecomputersemiconductorenergymedicalfood manufacturingpersonal carepackaging, and automotivefields. Some types of contract manufacturing include CNC machining, complex assembly, aluminum die casting, grinding, broaching, gears, and forging. The pharmaceuticalindustry use this process with CMs called contract manufacturing organizations. In the semiconductor industry, this practice is called the foundry model.

There are many benefits as well as risks to contract manufacturing. Companies are finding many reasons why they should outsource their production to other companies. However, production outside of the company has many risks attached. Companies must first identify their core competencies before deciding about contract manufacturers. A company’s competencies are what make them competitive in the marketplace. If a company allows another company to take control of them, it loses that advantage.

When deciding about contract manufacture, the company should weigh the benefits and associated risks. For small companies, contract manufacturing may not be a good business strategy. For large companies that are trying to extend into new markets, contract manufacturing may be a good choice.

Benefits

  • Cost savings – Companies save on their cost of capital because they do not have to pay for a facility and the equipment needed for production. They can also save on labor costs such as wages, training and benefits. Some companies may look to contract manufacture in low-cost countries, such as India, to benefit from the low cost of labor.[1]
  • Mutual benefit to contract site – A contract between the manufacturer and the company it’s producing for may last several years. The manufacturer will know that it will have a steady flow of business until then.[1]
  • Advanced skills – Companies can take advantage of skills that they may not possess, but the contract manufacturer does. The contract manufacturer is likely to have relationships formed with raw material suppliers or methods of efficiency within their production.[2]
  • Quality – Contract manufacturers are likely to have their own methods of quality control in place that helps them to detect counterfeit or damaged materials early.
  • Focus – Companies can focus on their core competencies better if they can hand off base production to an outside company.[2]
  • Economies of scale – Contract manufacturers have multiple customers that they produce for. Because they are servicing multiple customers, they can offer reduced costs in acquiring raw materials by benefiting from economies of scale. The more units there are in one shipment, the less expensive the price per unit will be.[2]
  • Quality concerns – When entering into a contract, companies must make sure that the manufacturer’s standards are congruent with their own. They should evaluate the methods in which they test products to make sure they are of good quality. The company has to rely on the contract manufacturer for having good suppliers that also meet these standards.

See also

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