Contract manufacturing: the ins and outs of making it work

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

Contract manufacturing is the process of hiring another manufacturing company to produce an aspect of your product.
Published: 28.08.2019

Have you ever been doing something, say 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 isn’t 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.”

Well, contract manufacturing 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 of making their own 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 world of contract manufacturing, the advantages and disadvantages, and how to make it work for your business.

PRO TIP: Using contract manufacturing means you’ll possibly need to track different levels of inventory (what you have, and your contract manufacturer has).

If you think you can handle this complex task without the help of tools, you can use a free inventory spreadsheet template which can aid you with this task and later be used for importing data if you decide to upgrade to a manufacturing ERP software.

What Is Contract Manufacturing?  

Contract manufacturing definition is usually explained as one manufacturing company hiring the services of another to help with order fulfillment.

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 products, parts, components, or subassemblies, which the maker or designer will use to complete manufacturing their product while they can continue to handle the sales process.

First things first, you’re probably wondering what’s the difference between outsourcing and contract manufacturing?

The short answer: The difference is very subtle.

The main difference being 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 reduce costs.

But even those definitions have changed as the landscape of outsourcing has been affected by international politics, countries trading policies, and even abuse of workers in some instances of businesses using outsourcing.

And all of these points are things you’ll need to consider when looking into how to outsource manufacturing.

But anyhow, back to the contract manufacturing definition.

When two businesses enter this agreement, the manufacturing business who 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 concept created by themselves (with specifications from the contractor) or use a bill of materials (BOMs) provided by the contractor.

The typical set-up with contract manufacturing 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. Thus, 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.

The major difference is in toll manufacturing, a maker produces a subassembly or component, which is then bought by another manufacturing company 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 Forms of Contract Manufacturing

The difference of contract manufacturing vs toll manufacturing is that toll is when only subassemblies are purchased and don’t necessarily require a contract.

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 a contract manufacturer;
— Have parts, components, and subassemblies built by a CM;
— Hire services or labor force; and
— Get access to manufacturing equipment or a better facility.

Why Should Businesses Use Contract Manufacturing?  

All of the following are advantages of contract manufacturing except for some of the examples aren’t that much of an advantage anymore since there are tools out there that can help makers retain control during the manufacturing processes.

So, to quickly summarize, using contract manufacturing as a strategy to reach global markets offers firms the advantage of:

— 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 factory to deliver quality products; and
— 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 manufacturing inventory management practices to determine if an area of your business is struggling to keep up with demand.

So, before we look into the downsides of using contract manufacturing, you now know the advantages. But how do you know if contract manufacturing is right for you?

Well, most businesses that take advantage of contract manufacturing usually do so to;

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

Disadvantages of Using Contract Manufacturing?

Using contract manufacturing as a strategy to reach global markets offers firms the advantage of: resource redistribution, focus on other key aspects of the business, and improving product quality.

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

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

— Limited to no control;
— A risk of being stuck in a contract with the wrong company;
— Competition with competitors trying to hire the same contract manufacturer;
— Potentially displacing employees in your own company;
— Just like the Apple example, the possibility of inadvertently getting involved in labor and human rights abuses; and
— 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 

Contract manufacturing examples can help you determine if this is the perfect strategy for your business.

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:

— 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, make the arrangements to send that subassembly to CM #2, and 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 manufacturing process.

So, the designer orders the raw materials for both companies and arranges the supply chain requirements.

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 of 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 factory floor to keep manufacturing 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 is a manufacturing scheduling software built by manufacturers, for modern manufacturing businesses.

However, not only has it been designed the fully optimize a maker’s shop, it’s capable of handling the supply chain requirements, production operations, and inventory monitoring of a business using a contract manufacturer.

And how are you able to do this with Katana?

Simply log into Katana, access “Settings” and go to “Locations” to set up which places (be they your warehouses or a contract manufacturer’s facility) you’ll be selling, manufacturing or buying from.

Depending on your sales orders, you can generate a manufacturing order (MO) from the “Make” screen and depending on if your manufacturing contractors have access to Katana, it’ll go directly to your partners.

Once your contract manufacturer has finished production, they can update you, allowing you to go ahead and update your Katana dashboard.

Then, after you updated the production status to finished, all you need to do is simply create a stock transfer to record the shipment of the products from your “Manufacturing location” to the other contract manufacturer or back to your sales point.

It really is that easy to simplify even global contract manufacturing while using Katana.

Using Katana means you don’t have to tremble with anticipation as you wait for your contract manufacturer to finish the production.

Katana allows you to keep in constant contact with real-time updates, see exactly what stage production is at, and even be involved, for example, the CM runs out of raw material you can immediately order more.

Essentially, Katana allows you to oversee manufacturing in a factory on the other side of the world, as easy as if you were on the production line.

But Katana doesn’t stop there, when you implement the software into your shop floor you can take advantage of other powerful features such as:

— A centralized point to manage your entire business;
— Integration with your accounting software such as QuickBooks for tracking your finance;
— Synchronizing your e-commerce platforms, like Shopify and WooCommerce;
— Get instant automatic calculations on your manufacturing costs;
— Autonomous tracking of finished goods and material inventory; and
— Total control of your floor-level 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 implementing this tactic.

Just remember, if you do decide 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 easily monitor your domestic affairs and check partners progress on production.

This is why Katana offers a 14-day free trial, so you don’t have to immediately commit and at your own pace you can discover why Katana is the perfect solution to overcoming any issues you may encounter with contract manufacturing.

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.

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