What is contract manufacturing?
Contract manufacturing is often used interchangeably with the term ‘outsourcing.’ outsourcing is the technique of transferring portions of work to outside sources and suppliers, instead of undertaking the entire work within the company, resulting in lower costs and expenses. Contract manufacturing is a form of outsourcing where a manufacturer enters into a formal agreement with another manufacturer (contract manufacturing organization) to produce parts, products, or components, which the former will then use in its own manufacturing process, to complete its own product.
They then undertake their own marketing, sales and distribution, and customer service to bring the final product to the end-users or consumers. In some cases, contract manufacturers may also be specialized organizations that provide contract manufacturing services to more than one business.
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Different types of contract manufacturing
The different forms of contract manufacturing vary based on the nature and operations involved in a business. Some of the most common forms of contract manufacturing agreement:
Production of the entire product
As the name clearly suggests, this involves contract manufacturing organizations building the entire product for a company under the brand name or label of the latter. This type of contract manufacturing is also called as ‘private label manufacturing’.
Production of parts or components
In this type of contract manufacturing, companies depend on a contract manufacturing organization to produce parts or components that will be incorporated into the final product of the company. For instance, a computer hardware manufacturer can use contract manufacturing for producing smaller computer parts and components, which is then assembled into their final product.
Hiring service or labor force
This involves subcontract for labor. If a business does not possess enough manpower in their company to carry out production processes smoothly and quickly, then they can outsource labor. Take the example of big multinational companies in the US who set up their manufacturing unit in Asian countries and subcontract their labor forces to Asian human resource companies. The key reasons why companies adopt this form of manufacturing is the specialized skills that these labor forces have and the comparatively cheaper cost of labor when compared to their home countries.
Using manufacturing equipment or facility
Companies that do not have the facility or the equipment to manufacture can transact with a contract manufacturer for the use of their facility. This saves the company the capital investment needed to set up a manufacturing unit.
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Why do top manufacturers favor contract manufacturing?
The decision to make or buy a product/ parts of a product can often prove to be a tough decision for companies. They often undertake feasibility studies for the management to gain a better understanding of what would be more beneficial for them. One of the key benefits that companies can derive from contract manufacturing is the reduction in cost and expenditure. But this is not the only reason companies opt to get into agreements with contract manufacturing organizations. Some of the other reasons include:
- Improved allocation of resources
- Greater focus on core business functions
- Increased innovation and enhanced product quality
- Reduction in manufacturing time
- Streamlined business relationships
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