Although manufacturing sounds like a great idea, portraying a way to reduce product costs and lead times, it is not however all that it is cracked up to be! It’s a known fact that many global leading brands are perceived as a manufacturer but in reality, they own a suite of brands, and they outsource the manufacturing of those products to companies specialising in that field.
So, what is a contract manufacturer?
Plainly put, contract manufacturing is when a company has an agreement in place with another company to produce a finished product or component for them. It is really a form of outsourcing where one company that predominantly is marketing, sales, and distribution focused, uses another company to make its products for them to sell.
This article will dive a little deeper into contract manufacturing and give some guidance on how to find a contract manufacturer by discussing the following points:
What are the advantages of contract manufacturing?
- Lower overheads in turn maximising profits
o Outsourcing the manufacturing of your products to a specialist will mean you can keep your overhead costs low. This not only results in being able to keep a tight rein on your operational overheads ongoing, but outsourcing means you will not need to heavily invest in suitable facilities, equipment, or labour at the outset to begin manufacturing. This enables profits to be held in the company, assisting in building up cash for use in other areas such as sales and marketing. This in turn will drive more volume of product you have outsourced the manufacturing of.
- Technical Expertise
o Enlisting a company to manufacture your product to the specification you require is often a good choice as this eliminates the need to recruit technical expertise to design products or run machinery. A specialist contract manufacturer will have technicians in their workforce with the experience required to manufacture your product to the required specification.
- Higher quality product
o The likelihood is that if you choose a company that already carries out contract manufacturing for other companies, they will have manufactured similar products previously and will have ensured the product is of a high standard. They can then potentially base your required product on this as well as offer improvements to you to ensure the product is of the highest quality.
- Reduced labour
o Not needing to take on manufacturing personnel is a great benefit meaning you will not need a large workforce to sell a high number of products. A small workforce ensures overheads are kept low and reduces HR headaches for you. These responsibilities are thus passed to the manufacturer you decide to use for your product manufacturing.
- Faster time to market
o Outsourcing your manufacturing will dispose of the time required to set up your own manufacturing plant, thus getting your product to market quickly. This will ensure you get your product to market before your competitors and generate profits quicker.
- Scalability Opportunities
o Supply of your product can be turned on or off as required as sales increase as well as if there is a market downturn. This gives you far greater flexibility in managing your stock levels and tighter control of cash flow.
What are the disadvantages or risks of contract manufacturing?
Although there are many advantages to contract manufacturing, and arguably they outweigh the disadvantages, there are some risks that you should be aware of so they can be managed.
- Partner Reliability
o Ensure you research any company you are thinking to enter a partnership with to ensure they are an established and reputable company and not a start-up that potentially won’t be able to sustain the volumes you may need.
o There are various ways you can research your prospective partner:
o There are various ways you can research your prospective partner:
Research the company financially. There are several web-based companies out there such as Risk Disc or Credit Safe who will be able to assist and ensure the company is financially stable. They may also give you an indication of turnover, profit and net worth which will all assist in building up a picture of the company’s reliability.
The company’s website will give you a good insight into their capabilities and what projects they have already carried out or products they currently manufacture./p>
Ask the company for references or case studies – other companies they already do work for – so you can get feedback first-hand from their customers.
Always ensure you speak with the company and a virtual or face-to-face meeting is beneficial because it will help determine what their level of service will likely be.
- IP Risk
o There is always going to be a level of Intellectual Property (IP) risk when sharing your product information with a contract manufacturer. However, this can be greatly mitigated by using a Non-disclosure Agreement (NDA) which can be drawn up to prevent both parties from sharing sensitive information about the other company. If you do not have your own NDA, you will find that searching online is a great source for finding templates that can be adjusted to suit your needs. An even better option would be to enlist the help of a lawyer who will be able to draft a necessary document. The only downside to this is the possible high fees this may fetch; however, this could be outweighed by the peace of mind a professional document will provide. Often the question arises, ‘how to stop your contract manufacturer from becoming your competitor’. Depending on how far-reaching the NDA is, this could also prevent the manufacturer from making the same product for your competitor or going direct to market with your product. It is always best to have a professional write an NDA for your company so that all areas are covered.
o Treating your contract manufacturer with respect and communicating with them regularly will allow you to identify any changes within the company or any change in strategic direction. Ensuring payment is on time and that you are an easy customer to work with will mean they will value your custom and make it less attractive for them to become a competitor of yours.
o Treating your contract manufacturer with respect and communicating with them regularly will allow you to identify any changes within the company or any change in strategic direction. Ensuring payment is on time and that you are an easy customer to work with will mean they will value your custom and make it less attractive for them to become a competitor of yours.
- Higher Long-Term Costs
o It is understandable and reasonable to expect your contract manufacturer to also make a profit in their business! This could mean that the price you will pay for your manufactured product will be higher than it would cost you if you were to manufacture the product in-house due to the margin on the product. However, as mentioned earlier, there is a large outlay to manufacturing so you should weigh up the difference in profitability over a longer-term period to arrive at a decision.
o The other point to consider here is that your contract manufacturer is likely already buying raw materials and components for other projects they are working on. The quantity of raw material they are purchasing coupled with your proposed quantities is likely to increase buying power and this is where economies of scale could result in a more cost-effective option for you.
- Communication Gap
o Be aware of contract manufacturers promising short lead times for the initial production run to entice you to give your business to them. Ideally, you want time to be on your side when negotiating so that time pressures don’t force you to make a snap decision. Push back to ensure the quoted time scales are actually feasible and consider transportation lead times and delivery costs.
o To help shorten lead times, you could suggest to your proposed contract manufacturer to hold a certain amount of manufactured stock for immediate call-off. This would help shorten lead times and if you get a sudden large order, gives a buffer of stock you can immediately draw down from.
o What they communicate to you may be wrongly interpreted so always ensure it is clear and in writing with a clear timeline. This could include the manufacturing start date, production run finish date, despatch date, delivery date and so forth.
- Less Control
o Another downside to outsourcing is not having complete control of your manufacturing process or being able to prioritise based on your customers’ needs. If the manufacturer also carries work out for other clients, then they may choose to prioritise the making of those products rather than yours. Again, having stock manufactured for immediate call-off will mitigate this potential downfall as does having an agreement in place to ensure this does not occur. There could be merit in including penalties should certain timeframes not be met.
What to look for in a great contract manufacturer?
There are some key attributes to always look for in a great contract manufacturer which include the following areas.
- Experience
o Pick a company that is reputable and preferably has experience manufacturing the exact type of products you require. You will find this makes initial set-up and speed to market far quicker than a company that does not specialise in manufacturing the products you require and may even result in them needing to procure the correct equipment./p>
- A company that wants to help
o Speaking with a potential manufacturing partner you will quickly identify whether the company is willing to help and propose a solution to your needs by the level ofcommunication and responsiveness to your enquiry. It is always beneficial to have a company to work with that will provide quick response times and if this isn’t apparent when you begin your conversations then it would be questionable whether the level of service is going to be very high once you begin working together fully.
o Often you will find that the large players out there in this field can be complacent and have a ‘too big to care attitude’ whereas the next tier down you find contenders large enough to service your needs well, deeply care, have a quick response time to your enquiry, understand what you require from the start and are known as the go-to company in this sphere. Perhaps they are known as ‘the widget company’ or ‘the wipe company’ rather than their actual company name. There is a good reason for this, they are known and recognised for what they are good at, and their company name hasn’t become a well-known brand in the industry because what they do best is ‘own brand’ for their customers, or in other words are a contract manufacturer.
- Honesty
o Pick a company that you feel good about and that you can trust. Ask the question, does this company’s values align with our company values? This will make for a great working relationship and will speed up bringing the product to market when there is a high element of trust.
- References
o Ask the company whether they can provide some names or case studies of other companies they manufacture for. There may be agreements in place where certain customer names cannot be disclosed but usually, a quality partner will be able to provide references or case studies and, in some cases, may even allow you to speak with other clients they have so that you are given full assurance about what they can provide.
Some additional thoughts…
Should I use an overseas contract manufacturer?
This is often a question that arises to which there is no right or wrong answer. Frequently companies look for contract manufacturers in China and other eastern countries. However, the following insights would be worth considering before deciding whether to look abroad or stay closer to home in your quest.
- Leadtime
o Will using an overseas supplier result in the lead time to receive the product being long and thus speed to market being jeopardised meaning you could lose out to the competition?
- Language barrier
o Will it be difficult to communicate with another country especially if they do not speak your native tongue? Could emails and messages be interpreted differently resulting in incorrect product specification, for example?
- Quality
o Product quality is something that is crucial to a successful product launch as you will want great reviews and repeat business. Using far eastern countries to manufacture products has sometimes resulted in poor quality products due to quality standards and manufacturing competency being low in those countries. To overcome this, it would be wise to deal with these companies through a third-party agency that is reputable and knows the ropes in the country you are considering.
- Cost
o Cost is often very competitive from a far eastern country although countries nearer by, such as European counties, you will notice costs being higher. This is due to higher labour costs and energy costs. Although far eastern countries can seem competitive, it is always advisable to add in any transport costs to your facility including import tariffs and charges, so you arrive at the true cost price.
- Currency Fluctuation
o Currency fluctuation can work either in your favour or be a disadvantage. You may negotiate a good deal at the outset and when you come to pay the invoice, the exchange rate may have changed resulting in either a better price being obtained or you having to pay more than originally budgeted for. One way to mitigate this would be to get the company you are considering working with to quote in your country’s currency.
- Transport Costs
o This is always one to look out for. Ensure you know how the contract manufacturer is quoting. For example is it DAP, FOB, or EXW pricing as each of these will differ in price depending on whether transport costs are included and delivery location. You don’t want to be in the position of placing an order only to find there are delivery costs on top of the quoted price. Using a different country to where you are located could easily result in high transport costs especially if sea freight needs to be used where there is no road link.
- High MOQ
o Always find out what the Minimum Order Quantity (MOQ) is at the outset. Some manufacturers will be prepared to negotiate on this but remember that the most cost-effective means of transport will be filling a full container of product so any order quantity below this will likely lead to higher transport costs and thus higher overall product costs. It will also only be cost-effective for some manufacturers to set their machinery and production process up for a certain quantity of product to be made otherwise it will result in high costs. If you are unable to attain full container volumes then it is very likely that a better and more cost-effective option would be to use a company for manufacturing that is closer to home.
- Payment Terms
o This point is often one that can slow the negotiating process down when using a new company abroad that you have little, or no relationship built up with. More than likely the manufacturer will want you to pay for the order before despatch or even part of the order prior to production. This means that a high element of trust is required which you no doubt will be very uncomfortable with, especially as the company is on the other side of the globe! Therefore, it is a lot more attractive to work with a partner closer to home with potentially smaller MOQs and shorter lead times which ultimately reduces the risk. The other disadvantage of having to pay upfront is the resulting cash tied up in stock that you have not got and probably won’t receive for several weeks. To help with this you could speak with your bank which may be able to assist with a Letter of Credit. This means that your bank will act as an intermediate between you and your proposed manufacturer which will remove the risk to a certain extent.
To help with this you could speak with your bank who may be able to assist with a Letter of Credit. This means that your bank will act as an intermediate between you and your proposed manufacturer which will remove the risk to a certain extent.
- Timezone
o Although not a massive challenge, time zone differences between countries can slow communication down resulting in taking a long time to negotiate and agree product specification etc. This is because there may only be two or three hours within a 24hour day where time overlaps when you both are working.
Hopefully this article gives some insight in to choosing the right contract manufacturer for your company to work with and will help you to avoid some common pitfalls.
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