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The ins and outs of contract manufacturing

Contract manufacturing is often confused with outsourcing or toll manufacturing. Find out what is contract manufacturing and how to make it work for you.

March 25, 2024
15 min read
Team Katana

Team Katana

Katana Team

Have you ever been doing something, washing a spoon for example, in your day-to-day life, and then suddenly, after being soaked for the 17th hundred time, realized that there has to be a better way to wash a spoon?

And then the eureka moment strikes! You have the perfect idea for a contraption that stops you from getting soaked when washing a spoon. Or a muffler for the vacuum to stop scaring the dog, or a device that lets you actually play musical notes when you start playing air guitar.

The idea could be anything!

But it’s the next crucial thought that kills the dream, “But, I can’t build any of those things.”

The contract manufacturing industry could be the savior you need for all of these whacky but potentially money-making ideas. And using contract manufacturers isn’t exclusively reserved for people who don’t have the means to produce their products. Contract manufacturing can be great for raising capital, focusing on different areas of business management, or simply finding the extra resources.

But what is contract manufacturing?

Let’s explore the advantages of contract manufacturing and its disadvantages, as well as how contract manufacturing software can help this business model.

ERP software for perfect contract manufacturing

Katana ERP software supports manufacturers who outsource all or some of their production to third-party businesses, giving users complete visibility of inventory levels and production line status.

What is contract manufacturing?

A straightforward contract manufacturing definition is where a maker or designer goes into an arrangement or, if done properly for legal protection, a formal agreement with another company who can manufacture their components or products, which the maker or designer will use to complete manufacturing their product while they can continue to handle the sales process.

You’re probably wondering, what’s the difference between outsource manufacturing and contract manufacturing?

The short answer: The difference is very subtle.

The main difference is that contract manufacturing is a form of outsourcing to practice when you don’t have access to the necessary resources to produce products. And outsourcing is usually a tactic to redistribute resources and help with cost savings and other economies of scale. But the definition of contract manufacturer has changed as the landscape of outsourcing has been affected by international business politics, countries’ trading policies, and even abuse of workers in some instances of businesses using outsourcing.

And all of these points are factors that you’ll need to consider when looking into how to outsource manufacturing alongside your current workflows.

But anyhow, back to the contract manufacturing definition.

When two businesses enter this agreement, the manufacturing industry that creates, builds, or constructs the products for the other is referred to as the contract manufacturer (CM). The CM will either make the wares from a design or formula created by themselves (with specifications from the contractor) or use a bill of materials (BOMs) provided by the hiring firm. The typical set-up with contract manufacturing companies is that a company has its products manufactured by a third-party contract manufacturer and incorporates those procured products into its own products or services.

Allowing the contractor to focus on marketing, sales, supply chain, and customer service.

There are different forms of contract manufacturing, but before we delve into that, some people also get confused by what is toll manufacturing vs contract manufacturing companies.

The major difference is in toll manufacturing, getting a manufacturer to produce a subassembly or component, which another manufacturing company then buys so they can complete their own product. So, in toll manufacturing a contract isn’t necessary, it’s just a manufacturer purchasing a part needed to finish their own manufacturing processes. For example, a PC manufacturer might purchase their processors from a different company when building desktops.

The different reasons why you might need contract manufacturing

As mentioned earlier, outsourcing and contract manufacturing are essentially one of the same, and so too are the reasons a business might take this approach.

It is most appropriate for a firm to contract out manufacturing when they’re looking to:

  • Have all their goods built by contract companies
  • Have parts, components, and subassemblies built by a CM
  • Hire services or labor force to follow your products design or formula
  • Get access to manufacturing equipment or a better facility

Why would any business use contract manufacturing in their production?

So, to quickly summarize, using contract manufacturing as a strategy to reach global markets and sell global products offers firms the advantage of these core competencies:

  • Reduced costs
  • The chance to reallocate resources
  • A streamlined business relationship with your contract manufacturer
  • Leaving the manufacturing responsibilities to the CM
  • Reduced manufacturing lead times
  • Using a CM who’s experienced and has the production facilities to meet quality standards
  • Increasing brand awareness

If you’re wondering if contract manufacturing is something your business should implement but aren’t too sure which resources would be most beneficial to redistribute, you can start by assessing your inhouse manufacturing inventory management practices to determine if an area of your business is struggling to keep up with the manufacturing market.

So, before we look into the downsides, you now know the advantages of contract manufacturing. But how do you know if contract manufacturing is right for you? Well, most businesses like the benefit to contract manufacturing because it helps them:

  • Negate high start-up and labor costs
  • Overcome financial or capital difficulties
  • Improve their product quality standards and control as fast as they can
  • Improve product development
  • Concentrate on building their brand
  • Keep up with seasonal demand.

What are the disadvantages of contract manufacturing?

Obviously, it’s not all sunshine and rainbows for those looking to use contract manufacturing organization, and some of the downsides to taking this approach can be particularly disastrous, as it has been in the past for massive corporations such as the Boeing 787 Dreamliner accidents and Apple failing to protect Chinese factory workers at manufacturers facilities.

So, what will you need to be cautious of if attempting to get started on contract manufacturing allows:

  • Limited to no control
  • A risk of being stuck in a contract with the wrong company
  • Competition with competitors trying to hire the same top contract manufacturers
  • Potentially displacing employees in your own company
  • The possibility of inadvertently getting involved in labor and human rights abuses
  • Unutilized resources within your own business

PRO TIP: If you’re going to get started with contract manufacturing, you’re going to need to figure out how to calculate raw materials as you track the inventory moving between the different businesses.

Contract manufacturing examples

So how does contract manufacturing work?

Let’s pretend there’s a designer who likes to build speakers for their home entertainment system, and after some hobby-level tolling, they realize that their speakers are worthy of selling. However, unfortunately for the talented entrepreneur, they don’t have the resources, to produce enough speakers to meet their forecasted demand. The designer creates their BOMs, sets up their e-commerce platforms, and reaches out to two contract manufacturers business:

  • Contract manufacturer #1 – Builds the outer casing out of wood
  • Contract manufacturer #2 – Installs the electrics and speakers.

Traditionally, the designer would place the order for the casing with CM #1 and make the arrangements to send that subassembly to electronic contract manufacturing #2. Once the final product is built, it’d be sent back to the designer.

However, the designer has drawn up contracts with both contract manufacturers to be more in control of the production process. So, the designer orders the raw materials for both companies and arranges the supply chain management. Meaning they can either have the final product dispatched back to themselves for stocking or sent directly from contract manufacturer #2 to the customer.

The benefit to contract manufacturing for the designer being in this arrangement is that it allows them to stay in the manufacturing process to meet deadlines, raise capital to build their own manufacturing facilities to keep production in-house, and in the meanwhile, concentrate on their marketing strategies.

But, as you’re probably imagining, this would be quite a feat to achieve since it’d require a very open channel of communication and a way of tracking the processes from start to finish. Luckily, there are now tools available that can help you manage a contract manufacturing agreement and means you don’t have to relinquish total control of responsibilities during manufacturing.

PRO TIP: If you’re going to start contract manufacturing, you’re going to need to find a way to perfect and arrange production planning for your contract manufacturers to follow.

Contract manufacturing: the smart way

Global contract manufacturing can be tricky if you don’t have the appropriate tools in place to help you pull it off.

Katana ERP manufacturing software is a platform that supports manufacturers in getting control of their entire manufacturing process, from purchase order management to production and delivery of goods to multiple customers.

However, if you’re a business owner who works with contract companies, Katana empowers brand owners to stay in the loop with features that allow you to:

  • Create outsourced purchase orders for your third-party manufacturer to produce your items
  • Implement full or partial outsourced manufacturing processes into your workflow
  • Perform raw material stock transfers between your warehouses and your CMs manufacturers facilities

What does this all mean for you? If you need a contract manufacturer to build your products or have them produce components or sub-assemblies from Katana, you can:

  • Purchase supplies for your contract manufacturer and track inventory levels at their location
  • Track ingredients and products moving between your business and your CM
  • Create and print outsourced purchase orders, request for quotations, and BOMs, consolidate picklists and barcodes or even create your own custom templates

Want to see Katana in action?

Book a demo to get all your questions answered regarding Katana’s features, integrations, pricing, and more.

Get started with contract manufacturing

The basic reason manufacturers spend time and money building their own brands is to improve the customer experience and ensure they have a place to survive on the market.

So, there you have it, everything you need to know about contract manufacturing and if your business needs to implement this tactic, from producing and shipping to hiring CMs for contract packaging.

Just remember, if you do start deciding about contract manufacturers to go ahead and use this approach, in all likelihood, you’ll probably be in a global contract manufacturing agreement, and staying in control of such a large supply chain can be difficult. That’s why it’s crucial to find a system that allows you to monitor your domestic affairs easily and check contract manufacturing partners progress on production.

With that, we hope that you found this article useful, and if you have any questions or concerns, please feel free to get in touch with us!

And until next time, happy manufacturing.

Team Katana

Team Katana

Katana Team
Katana’s cloud inventory platform covers the live inventory, production, accounting, and reporting features that give businesses the knowledge they need to make the right decisions.

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