Contract Manufacturing

Contract manufacturing is the process whereby a company makes an arrangement with another company, either local or overseas, to manufacture part or an entire product on its behalf. In other words, the process involves a hiring company and a contract manufacturer. The hiring firm gives a design to the contract firm to produce, replicate, or improve a product. But the selling and marketing tasks are left to the hiring firm, unless there are further arrangements for that purpose.

contract manufacturing

Reasons for Contract Manufacturing

There may be several reasons behind opting for contract manufacturing, but the main ones are three. These include;

  • Cutting production costs
  • Expertise and differentiation in tasks
  • Market entry

Let us discuss briefly each of the above three reasons. This will give insights as to why contract manufacturing is preferred by various companies around the world.

Cutting Production Costs

Mostly, hiring firms and the contract manufacturers are usually large scale enterprises. Therefore, there is an advantage of economies of scale due to large production and sales. Hence, the anticipated marginal profits are significant to both companies. The hiring company reduces costs through several ways such as energy costs, labor costs, taxation benefits, and access to raw materials from a given country. Sourcing a product from a low wage country is a huge benefit to the hiring company. Though there might be some risks involved, benefits are more likely to outweigh the risks.

Expertise and Differentiation in Tasks

A hiring firm will probably contract a well established manufacturer, with several years in the industry. This is a clear indication that the personnel are well trained and qualified to handle the production appropriately. So, the ideal people are left to perform the task that they have been used to. On the other hand, contract manufacturer allows the workers from the hiring firm to focus on their lines of duties, which they are competent in. Therefore, all players from both companies are able to carry out their tasks effectively. More importantly, the hiring company is given ample time to concentrate on selling and marketing of the product.

Market Entry

Of course, not all countries will allow a company to enter its market and start producing a product. Some countries have strict barriers with the aim of protecting their local companies, which is an ideal decision. However, hiring a contract manufacturer enables a hiring company to enter a country’s market indirectly and get the products manufactured cheaply, and then re-exported to the proximate countries.

Last but not least, the hiring company should examine the delivery procedures of a contract firm even before striking a deal. This is because some contract manufacturers deliver products to customers regardless of their location, while others deliver only to a specified geographical location. Also, the hiring company need to check manufacturer’s delivery modes – whether they ship orders in bulk or for individual customers.