• Patrick

What is Contract Manufacturing?

If you are a fan of Shark Tank you would have heard participants talk about the importation of products or landing costs. Entrepreneurs on the show hire factories as contract manufacturers. For many companies contract manufacturing is among the best ways to bring physical products to market.

Contract Manufacturing:

A contract manufacturer (CM) is a factory that produces goods for a hiring firm. The hiring firm and contract manufacturer enter an agreement. The contract manufacturer will provide it’s expertise and equipment to the hiring firm for an agreed price, quantity or time.

The Benefits:

Lower Risk:

Outsourcing manufacturing frees the hiring firm to focus on design, marketing, sales or other core tasks. The hiring firm does not need to invest time, money or personnel into setting up a factory to manufacture a product. If your CM isn’t producing to your expectations you can try another. If you’ve invested into in house manufacturing you are locked into recouping your investments.

Specialized Expertise and Equipment:

A vertical broaching machine cutting internal keyways in bicycle spiders.
A vertical broaching machine cutting internal keyways in bicycle spiders.

Good contract manufacturers bring specialized expertise and equipment to the table. They may offer improvements to your design or suggest new ways of manufacturing. Skilled labor may be cheaper if the contract manufacturer is located abroad. Working with several companies at a time allows CMs to benefit from the economy of scale, giving them capital to invest in expensive specialized machines. The use of specialized machinery and labor leads to newer processes or lower overall costs and more efficient production.

Scalability and Added Value:

Contract manufacturers are found in almost every industry and they are usually well connected. Contract manufacturers build strong relationships with their suppliers and subcontractors. They can outsource parts of projects or acquire finishing services like packaging, coloring, painting etc. As your company grows you can hire more contract manufacturers or work with CMs to provide you with private factories. Using a CM can reduce the need for managing suppliers, and subcontractors.

Cost Savings:

CMs have to be competitive to survive. Their clients will acquire several bids or quotes before deciding, forcing them to reduce costs and optimize production. They will also pursue ISO certifications or licenses to stay competitive. They value relationships; their business depends on having a good portfolio of returning clients.

The Negatives:

While you are likely to find a good CM, not all are created equal. They may offer “too good to be” prices or produce substandard quality or charge more than standard rates. Others may promise or hype expectations knowing once you agree to a contract you are stuck to the terms.

Conflict of Interest.

Contractors often cater to a specific niche market. They may produce products for your competitor. They may even offer your design to a competitor, or they themselves may bring copy-cat products to market.

Lack of Transparency:

CMs may not be fully transparent with you, telling you a certain narrative or dodging certain questions. They may be condescending and use jargon to purposely cause confusion to upsell the process. Contract manufacturers may focus on larger clients first, forcing you to wait. They may blame sub contractors for delays rather than taking responsibility. It’s even possible they outsource the whole job.

Cultural and Language Barriers:

CMs are located throughout the world. You must consider the cultural and language differences. Although CMs will often have English speaking business staff, cultural differences may cause problems. Some countries have aversion to conflict, they may agree to something but not actually commit to it. There may also be holidays or traditions that you should consider. In China and Taiwan production ramps up before the Chinese New Year. The reason is it's taboo to have unfinished work or unpaid bills follow you into the New Year.

You Won’t Have Complete Control.

Some factories may simply be “dinosaurs” “set in stone” no matter how many times you explain how a product should be produced. They have procedures that haven’t changed in years. They often have dated ERP or management software, which makes managing them a nightmare. On the flip-side this can be good as you can often have them produce simple parts at lower cost, but it’s usually better to look elsewhere.

Working with Contract Manufacturers:

Here is a small list to get a head start on working with us or any other contract manufacturer.

-A quick disclaimer, Anoesis nor I are qualified to offer you legal advice. You should contact a legal professional for details on handling disputes or protecting your IP and brand in foreign countries. The information provided here is information acquired from my own experience and research.

  • Bill of materials (BOM)

  • Provide a Product Requirements Document

  • AVL

  • Technical Files

  • Create or request a NNN Or NDA

  • Mold Contract

Bill of materials (BOM):

It’s essential to have a well organized list of parts. Providing a digital file like an excel or google spreadsheet minimizes possible data entry errors when integrating with contractors ERP software. The BOM should provide part number, vendor name, quantity and a description. It’s also wise to note which parts are most critical. Using an A, B, C approach is a good idea, A being the most important. In the electronics industry a BOM separated into major component categories then sub component categories.

Provide a Product Requirements Document:

A PRD purpose is to give designers or engineers details of how a product will function. This insight will enable them to better use their expertise in developing the product. Necessary tolerances and key features should be provided.

AVL: AVL stands for approved vendor list. If your contract manufacturer will source parts on your behalf it’s essential that you provide them with an up to date list of your preferred vendors.

Technical Files:

Provide 3D and 2D CAD drawings. Providing an IGES or Step file is often the safest and most efficient method. This might be a surprise but some of our clients still provide us only with 2D drawings. They may not have the 3D files, or prefer to work with the 2D files for safety. While we can directly program our CNC machines with the 2D drawings, we prefer to use CAM to program. We have to import the 2D drawing into CAM software, which usually consists of making a 3D model from the 2D drawing. This is a huge waste of time and cost.

Create or request a NNN Or NDA:

If you're working with foreign companies it’s always wise to protect your assets legally. While an NDA (Non-disclosure-agreement) may be useful is Western Countries, It’s not really effective in China. A NNN (NON-use, Non-disclosure, Non-Circumvention) agreement has more legal ground. However, the courts will be heavily biased and it will be an expensive endeavor to sue a manufacturer based abroad. This is why you should build trust with your contract manufacturer before you commit to manufacturing.

Mold Contract:

Molds are an expensive investment and should be protected. Molds are used heavily in the plastics industry. Our clients often use extrusion molds. A mold contract is a legally binding contract between you and the manufacturer. This establishes your ownership of your company's molds and will afford you some rights if you have to contact the authorities to remove the mold on your behalf.

My Advice:

Most of the negatives of working with CMs can be avoided through referrals. Working with a trusted sourcing company or consultant is often a good solution as their reputation depends on their suppliers.

If your product contains IP then a NDA/NNN should be prepared. Or manufacture crucial parts with a local CM or job-shop. If the CM is unwilling to agree to legal terms it’s best to look elsewhere. While litigation is an option, foreign laws or ruling courts may be biased against you.

You should have a general understanding of industry pricing and general practices. It’s best not to take the lowest bid but rather choose a contract manufacturer based on value to price and relationship. Lower bids often have attached service fees that often outweigh the potential savings.

Visiting the factory will quickly give insight on whether the CM is right for you. Hiring a technical translator is wise even if you can speak the local language. My advice is to shop around, never feel obligated to work with a contract manufacturer. You should be looking for a contract manufacturer that wants to build a positive relationship with you.