What Is Contract Manufacturing?
With the popularity of shows like Shark Tank and online marketplaces such as Amazon and eBay, entrepreneurs can dream up just about anything, have it manufactured relatively easily and start selling it to the masses.
While the process might come with different names, many know it as contract manufacturing. Farming out your production to an outside firm can help you produce and sell products without having to invest in machinery, equipment or specialized product knowledge, such as cosmetic chemistry for a skincare line.
You will use contract manufacturing if your company arranges to have a local or overseas manufacturer make all or part of a product that your company produces and sells. The hiring firm usually provides a design or formula to the contract manufacturer to replicate or improve.
The hiring company takes care of all marketing and selling of the product unless other arrangements have been made.
A Contract Manufacturing Example
A company can contract out the manufacturing of specialty cleaning products, for example, to a local or overseas manufacturer. This frees up the company to focus on what it's good at, which is typically marketing and selling the products.
Within three years, a company contracting out its manufacturing could, with enough capital to invest, scale its business and achieve sales revenues of the U.S. $4 million, sell to 27 countries, and generate more than 33 percent of its overall business overseas.
One of the contract manufacturing benefits is the reduced need for staff at the hiring company. In this company example, the above scenario might only require four people on staff at the hiring company: a general manager, an export manager, a bookkeeper, and an administrative assistant. For a price, contract manufacturing relieves the hiring company of the burden of production staff, machinery, knowledge and much more.
The Benefits of Contract Manufacturing
Companies often choose contract manufacturing for a few primary reasons, all of which make it easier, less expensive and more efficient to bring new products to the market and distribute them broadly.
Companies can achieve savings by contracting with a manufacturer that already knows the manufacturing process, has invested in the appropriate equipment and runs similar but non-competing products in its facility, to take advantage of economies of scale. Their location might also offer savings in energy costs, taxation benefits, overhead or raw material. Also, cost savings can result in labor-intensive production processes by sourcing the product in a low-wage country. Some risk such as political or economic turmoil might exist, but provided you do your homework, the benefits can outweigh the risk.
More Focus on Core Competencies
Contract manufacturing frees up people at the hiring firm to stay focused on their strengths or core competencies of selling and marketing. Having a product made in a factory setup or country that offers cost-savings and understanding how to enter a market that may otherwise be prohibitive might be outside the capability of many firms.
Easier Market Entry
You may have barriers to entry in China for goods coming from, but your product can be made there inexpensively and re-exported to all contiguous countries.
Find out if the contract manufacturer can drop-ship your product directly to customers everywhere or even to a specified geographic area. Some may handle individual shipments to customers, while others only deliver a large lot to a central warehouse where the hiring firm takes care of shipments.
If you're giving your product ideas to a contract manufacturer to produce, you might feel you're feeding your best ideas to a potential competitor down the road or in another country. Some unethical contract manufacturers have been known to give away product ideas from one client to another favored client.
Get a good legal contract in place to ensure you are protected against any fraudulent behavior. A contract manufacturer can witness firsthand the demand for and potential of a product in his or her market. If it looks attractive, without a legal contract, there's nothing to stop the contract manufacturer from producing its similar product with a tweak or improvement here or there to differentiate it from yours.
A contract outlines your legal rights and recourse should this occur. Take care to identify which country the contract is governed by if in fact, you are negotiating across borders.
Other Risks to Consider
Cultural differences that include but are not limited to language barriers if you are contracting overseas can cause a multitude of issues. If working with overseas contract manufacturers, you also have a lack of control over the quality of the manufacturing process, and you certainly won't be the only customer of the contract manufacturer.
Here's what to look for in a contract manufacturer:
- A good, clean, well-managed facility
- ISO-certified manufacturing quality standards
- Drop-ship capabilities to send the product directly to customers
- The ability to be flexible and respond to market fluctuations
- The ability to keep up with production demand for a product
- Synergies with the hiring company
- Highly reputable in the marketplace
- Financially sound
- The ability to solve your specific production challenges
If the idea of not producing your product and leaving it up to someone else makes sense for your business, you can leverage contract manufacturing to develop and scale your import and export business.