Contract manufacturing is a business practice wherein a company, referred to as contract manufacturer, produces a distinct product for a customer(s) over a time period contractually. For example, Foxconn making iPhones for Apple is contract manufacturing. Foxconn makes the product as per Apple’s design specifications and hardware requirements. Contract manufacturing exists in various industries, including the electronics, medical and pharmaceutical industry. A contract manufacturer may make varied products for different clients. It may even specialize in a particular item or item category and serve just one or multiple businesses.

A business might work with multiple contract manufacturers simultaneously. For example, Apple gets Foxconn to do the basic frame and a few other aspects of its iPhones. But it also works with other companies such as LG for displays and Corning for glass. Similarly, Foxconn also contract-manufactures for Acer, Blackberry, Cisco, Hewlett Packard, etc. Usually, contract manufacturers are located in countries known for their inexpensive labor and longer working hours. And they don’t just manufacture the goods but also source raw materials for production, deal with suppliers, etc.

Why Do Businesses Contract-Manufacture?

Certain companies with huge technical and engineering resources don’t work with contract manufacturers. But most may still do – not necessarily to save money, but to save time. A contract manufacturer can produce large numbers of units within a relatively short time period, which also means it can offer goods at a lower price. Besides being capable of mass production, the manufacturer invariably also possesses the flexibility to accommodate last-minute changes proposed by the client without delaying delivery by much.

For businesses that sell contract-manufactured goods bearing their labels, it may take several months and also cost money to set up their own infrastructure (purchasing expensive equipment and machines) and marshal resources to get a new project rolling. A contract manufacturer would get the same work done within a few weeks, as it’s already geared up for the task.

As aforementioned, manufacturing also means dealing with raw materials and suppliers. The picture comprises dealers, distributors, warehousing and shipping firms, and other agents. Simply put, businesses work with contract manufacturers because they realize manufacturing and supply chain management is something they don’t excel in and that there are other firms that can do a much better job.

Contract Manufacturing Forms

Contract manufacturing can be categorized based on its purpose and scale. The following are some of the variations:

  • Complete Goods Manufacturing

Also called private label manufacturing, this type entails a contract manufacturer producing finished goods for a particular client, and the client then sells the products as its own brand offering.

  • Parts Manufacturing

Components are contract-manufactured so that those could be used to complete another product. Such type of contract manufacturing is common in the electronics and automobiles industry. For instance, a contract manufacturer making camera modules for a particular smartphone is parts manufacturing.

  • Labor Hiring

Companies hire labor force or subcontract labor when they don’t have sufficient manpower for their production processes. This may entail companies erecting a dedicated factory offshore for employees of the contract manufacturer to work from. At times, the contract manufacturer may provide its own facility for dedicated operations to the client.  

Comparing Contract Manufacturers and OEMs

There’s a thin line differentiating contract manufacturers and original equipment manufacturers (OEMs). An OEM essentially produces components that go into other products or serve as accessories. Contract manufacturing primarily entails making finished products (almost). But there are also instances when OEMs may make a complete product.

But, unlike contract manufacturers, OEMs also work on innovation and product development and they design almost all of their products. They therefore may also have their own product portfolio. This is probably the reason why OEMs don’t churn out units in volumes as large and as consistently as contract manufacturers.

Comparing Contract Manufacturing and Outsourcing

Contract manufacturing is a form of outsourcing, but the two terms should be used within different contexts. Outsourcing basically applies to the service industry, whereas contract manufacturing is used with respect to hardware and production and labor-intensive processes. Most importantly, outsourcing is primarily about reduced costs and cheap labor. In case of contract manufacturing, cost-efficiency is only one of the takeaways.

The biggest thing differentiating the two is businesses can perform outsourced operations on their own if they chose to, but they cannot do what contract manufacturers do, for the several limitations discussed above. In short, ancillary or supporting operations are outsourced, while important functions usually go to contract manufacturers.  

Disadvantages of Contract Manufacturing

Contract manufacturing has its negatives too. Businesses could be at the receiving end of sub-par products, especially if they misjudge the manufacturer’s ability or pick the wrong service provider altogether. And if the client doesn’t recognize the quality issues and lets the products reach end consumers, then that cost of quality could even hurt the brand’s market share and reputation.

When dealing with a high-profile contract manufacturer that makes products or parts for multiple clients, small businesses could get secondary treatment during peak production periods when the bigger clients come up with huge orders.

When is Seeking Contract Manufacturing Services Ideal?

Contract manufacturing makes sense for businesses that are:

  • Just starting operations and cannot put up with high manufacturing costs
  • Facing working capital or financial problems and saving money is a priority
  • Keen on improving product quality quickly as there is no time to spend on research and practice
  • Into selling products with seasonal demand
  • Looking to establish their brand by associating with top-tier contract manufacturers
  • More inclined toward selling and marketing and less into manufacturing and supply chain management