Reading: Contract Manufacturing

In contract manufacturing, a hiring firm makes an agreement with the contract manufacturer to produce and ship the hiring firm's goods.

KEY Points

  • A hiring firm may enter a contract with a contract manufacturer (CM) to produce components or final products on behalf of the hiring firm for some agreed-upon price.
  • There are many benefits to contract manufacturing, and companies are finding many reasons why they should be outsourcing their production to other companies.
  • Production outside of the company does come with many risks attached. Companies must first identify their core competencies before deciding about contract manufacture.


Terms

  • Contract manufacturing:  Business model in which a firm hires a contract manufacturer to produce components or final products based on the hiring firm's design. A business model where a firm hires another firm to produce components or products.


A contract manufacturer ("CM") is a manufacturer that enters into a contract with a firm to produce components or products for that firm . It is a form of outsourcing. 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.

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Benefits

Contract manufacturing offers a number of benefits:

  • Cost Savings: Companies save on their capital costs 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 China, to benefit from the low cost of labor.
  • Mutual Benefit to Contract Site: A contract between the manufacturer and the company it is producing for may last several years. The manufacturer will know that it will have a steady flow of business at least until that contract expires.
  • 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 ofefficiency within their production.
  • Quality: Contract Manufacturers are likely to have their own methods of quality control in place that help 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.
  • 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.


Risks

Balanced against the above benefits of contract manufacturing are a number of risks:

  • Lack of Control: When a company signs the contract allowing another company to produce their product, they lose a significant amount of control over that product. They can only suggest strategies to the contract manufacturer; they cannot force them to implement those strategies.
  • Relationships: It is imperative that the company forms a good relationship with its contract manufacturer. The company must keep in mind that the manufacturer has other customers. They cannot force them to produce their product before a competitor's. Most companies mitigate this risk by working cohesively with the manufacturer and awarding good performance with additional business.
  • Quality: 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 ensure the contract manufacturer has suppliers that also meet these standards.
  • Intellectual Property Loss: When entering into a contract, a company is divulging their formulas or technologies. This is why it is important that a company not give out any of its core competencies to contract manufacturers. It is very easy for an employee to download such information from a computer and steal it. The recent increase in intellectual property loss has corporate and government officials struggling to improve security. Usually, it comes down to the integrity of the employees.
  • Outsourcing Risks: Although outsourcing to low-cost countries has become very popular, it does bring along risks such as language barriers, cultural differences, and long lead times. This could make the management of contract manufacturers more difficult, expensive, and time-consuming.
  • Capacity Constraints: If a company does not make up a large portion of the contract manufacturer's business, they may find that they are de-prioritized over other companies during high production periods. Thus, they may not obtain the product they need when they need it.
  • Loss of Flexibility and Responsiveness: Without direct control over the manufacturing facility, the company will lose some of its ability to respond to disruptions in the supply chain. It may also hurt their ability to respond to demand fluctuations, risking their customer service levels.


GLOSSARY

Benefit

An advantage, help or aid from something Employee benefits and (especially in British English) benefits in kind (also called fringe benefits, perquisites, perqs or perks) are various non-wage compensations provided to employees in addition to their normal wages or salaries. An advantage, help, or aid from something.

Business model

The particular way in which a business organization ensures that it generates income, one that includes the choice of offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies.

Capacity

The maximum that can be produced on a machine or in a facility or group.

Capital

Money and wealth. The means to acquire goods and services, especially in a non-barter system.The uppermost part of a column. Money and wealth; the means to acquire goods and services, especially in a non-barter system. Already-produced durable goods available for use as a factor of production, such as steam shovels (equipment) and office buildings (structures).

Corporate

An incorporated entity is a separate legal entity that has been incorporated through a legislative or registration process established through legislation.

Demand

The desire to purchase goods or services, coupled with the power to do so, at a particular price. The desire to purchase goods and services.

Design

To plan and carry out (a picture, work of art, construction etc. ).

Economies of scale

A process where an increase in quantity will result in a decrease of average cost of production (per unit). The characteristics of a production process in which an increase in the scale of the firm causes a decrease in the long run, average cost of each unit. The cost advantages that an enterprise obtains due to expansion. As the scale of output is increased, factors such as facility size and usage levels of inputs cause the producer's average cost per unit to fall. The characteristics of a production process in which an increase in the scale of the firm causes a decrease in the long run average cost of each unit. The characteristics of a production process in which an increase in the scale of the firm causes a decrease in the long-run average cost of each unit.

Economy

Collective focus of the study of money, currency and trade, and the efficient use of resources. The system of production and distribution and consumption. The overall measure of a currency system; as the national economy. The system of production and distribution and consumption. The overall measure of a currency system.

Efficiency

The extent to which a resource, such as electricity, is used for the intended purpose; the ratio of useful work to energy expended. The extent to which time is well used for the intended task. Improved efficiency was a principle goal of progressives, one they thought attainable by the application of scientific and rational thought to social problems. The extent to which time is well used for the intended task.

Facility

The physical means or contrivances to make something (especially a service) possible; the required equipment, infrastructure, location etc.

Flexibility

The quality of being flexible; suppleness; pliability.fluctuation A motion like that of waves; a moving in this and that direction.

Good

An object produced for market.

Intellectual property

Any product of someone's intellect that has commercial value: copyrights, patents, trademarks, and trade secrets. Intellectual property (IP) is a juridical concept that refers to creations of the mind for which exclusive rights are recognized. Any product of someone's knowledge that has commercial value: copyrights, patents, trademarks and trade secrets.

Language barrier
A figurative phrase for the difficulties faced when people who have no language in common attempt to communicate with each other.
Lead

Potential opportunity for a sale or transaction, a potential customer.

Lead time

The amount of time between the initiation of some process and its completion, e.g. the time required to manufacture or procure a product; the time required before something can be provided or delivered.

Loss
The negative difference between revenue and expense.
Management

The act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively. administration; the process or practice of managing.administration; the process or practice of managing Administration; the process or practice of managing.

Manufacture

The action or process of making goods systematically or on a large scale.

Outsourcing

The transfer of a business function to an external service provider The transfer of a business function to an external service provider. The transfer of a business function to an external service provider.

Performance

The act of performing; carrying into execution or action; execution; achievement; accomplishment; representation by action; as, the performance of an undertaking of a duty. The act of performing; carrying into execution or action; achievement; accomplishment; representation by action, as the performance of undertaking a duty.

Price

The price is the amount a customer pays for the product. The quantity of payment or compensation given by one party to another in return for goods or services. The cost required to gain possession of something.

Process

A series of events to produce a result, especially as contrasted to product. in reference to capabilities, a process is how the capability is executed. An outgrowth of tissue or cell.

Product

Any tangible or intangible good or service that is a result of a process and that is intended for delivery to a customer or end user. a chemical substance formed as a result of a chemical reaction. Anything, either tangible or intangible, offered by the firm as a solution to the needs and wants of the consumer; something that is profitable or potentially profitable; goods or a service that meets the requirements of the various governing offices or society.

Quality control

Quality control (QC) is a procedure or set of procedures intended to ensure that a manufactured product or performed service adheres to a defined set of quality criteria or meets the requirements of the client or customer. A control, such as inspection or testing, introduced into an industrial or business process to ensure quality.

Raw materials

A raw material or feedstock is the basic material from which a good product is manufactured or made, frequently used with an extended meaning. For example, the term is used to denote material that came from nature and is in an unprocessed or minimally processed state; e.g., raw latex, iron ore, logs, crude oil or seawater. A raw material is the basic material from which a product is manufactured or made. Materials and components scheduled for use in making a product. A raw material is the basic material from which a good product is manufactured or made, frequently used with an extended meaning.

Risk

The potential (conventionally negative) impact of an event, determined by combining the likelihood of the event occurring with the impact, should it occur. The potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). To incur risk [of something].

Security

The condition of not being threatened, especially physically, psychologically, emotionally, or financially. proof of ownership of stocks, bonds, or other investment instruments.

Services

That which is produced, then traded, bought or sold, then finally consumed and consists of an action or work.

Standard

Something used as a measure for comparative evaluations. A level of quality or attainment.

Strategy
A plan of action intended to accomplish a specific goal.
Supplier

One who supplies; a provider.

Supply provisions

The amount of some product that producers are willing and able to sell at a given price, all other factors being held constant.

Supply chain

A supply chain is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. A supply chain is a system of organizations, people, technology, activities, information, and resources involved in moving a product or service from the supplier to the customer. Supply chain activities transform natural resources, raw materials, and components into a finished product that is delivered to the end customer. A system of organizations, people, technology, activities, information, and resources involved in moving a product or service from the supplier to the customer. A system of organizations, people, technology, activities, information, and resources involved in moving a product or service from supplier to customer. A system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from suppliers to consumers. A system of organizations, people, technology, activities, information. and resources involved in moving a product or service from supplier to customer.

Wage

An amount of money paid to a worker for a specified quantity of work, usually expressed on an hourly basis.

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