• Introduction
• What is Contract Manufacturing?
• How Does Contract Manufacturing Work?
• The Main Types of Contract Manufacturing
• Different Types of Contract Manufacturer
• Examples of Contract Manufacturing
• Advantages of Contract Manufacturing
• Disadvantages of Contract Manufacturing
• Selecting the Right Contract Manufacturer
• Komaspec
• Frequently Asked Questions about Contract Manufacturing

Contract manufacturing is a term used to describe the various ways a company can delegate product manufacturing to a third party. For the hiring company, outsourcing manufacturing is a tactic used to gain superior flexibility in growing or shrinking production capacity, scaling more rapidly and benefiting from economies of scale. Contract manufacturing can describe a variety of practices, everything from outsourcing component production, manufacture of medicines, co-packing of fast moving consumer goods, and any other kind of activity – anything which has to do with moving production from one part to another.

It’s because of that flexibility and the potential for cost reduction that many of the world’s biggest brands outsource a big proportion of production to contract manufacturers. Plenty of less well-known companies, including start-ups and SMEs, also take advantage of contract manufacturers.

Contract manufacturing is a business practice in which a company delegates the production of components or whole products that it sells to a third-party manufacturer. Instead of investing in their own manufacturing facility, equipment and staff, they use the services of a specialist contract manufacturer.

Contract manufacturing is a form of outsourcing, and it’s used when outsourcing offers advantages over investing in-house production.  

Contract manufacturing is a powerful tool that allows businesses to:

• Easily, quickly capitalize on the resources of a manufacturer with a low initial investment.
• Focus less on production and concentrate more on their core competencies.
• Reduce overhead and in-house head count (size of workforce)
• Leverage the capabilities of companies with expertise in manufacturing, and larger economies of scale than if production was not outsourced

By employing a contract manufacturer, a company avoids the need to invest in production equipment, personnel and facilities themselves. This makes it far easier to trial a new product or launch a new business. There are other situations in which contract manufacturing can be beneficial as well.

The process behind contract manufacturing is simple. A company hires a factory to handle production of its own products, parts or components.

A hiring company will approach a contract manufacturer (or several if they wish to compare different offers) with their production requirements. Usually, this will be a design or example of the product or component(s) they wish to have manufactured. The contract manufacturer(s) will then offer a quote to handle production.

Note that some contract manufacturers may also contribute to design.

When a deal is accepted, the contract manufacturer will handle everything involved in production that is specified in the contractual deal.

The contract manufacturer will usually deliver the finished products to the hiring company after they are manufactured. In drop-shipping arrangements, however, the contract manufacturer will deliver finished products directly to the end receiver.

Contract manufacturers are normally used to produce parts, product components or entire products. Other less well-known forms of contract manufacturing are contract assembly and contract packaging.

Part or Component Contract Manufacturing

In this arrangement, the contract manufacturer will produce parts or components for a product. They will then deliver those parts or components to the hiring company for assembly or to another third-party assembler.  

Many businesses use contract manufacturers for part and component manufacturing. The practice is most well-known, however, in businesses that produce complicated products with many parts.

• Aerospace - The aerospace industry is one example of where the practice is common. Airplanes and even parts of airplanes feature an array of specialist parts that need to be built to exacting standards. It’s common for aerospace companies to outsource component and part production to contract manufacturers with specialist skills and equipment.

Other less complicated products may feature specialist parts or a choice of parts may be offered with a particular product. These are other examples of when contract manufacturing might be used.

• Bicycles - A bicycle brand may offer a particular bicycle with a choice of brakes, wheels or lights, for example. In this situation, the brand may use a contract manufacturer to provide a selection of components to offer with their bicycles.

Product Contract Manufacturing

Product contract manufacturing is when the manufacture of an entire product is delegated to a contract manufacturer. This is obviously a far more comprehensive service than part or component manufacturing. The hiring company takes a completely hands-off approach to the production of its goods.

The finished goods will be sent to the hiring company, which will then sell them. In some cases, the contract manufacturer may even ship the finished goods directly to the customer. This is known as a drop-shipping arrangement.

Product contract manufacturing allows the hiring company to sell a product it does not have the resources to manufacture in house. This creates much more agility in the marketplace. It also allows the company to focus on other areas of business, like marketing or product development.

In most cases, the hiring company will have as little involvement in the manufacturing process as possible. They will leave the contract manufacturer to handle everything from the sourcing of raw materials up to the delivery of the finished product. The level of involvement may vary, however, depending on the needs of the hiring company and what the contract manufacturer can offer.

Turnkey Manufacturing

Turnkey manufacturing is a term used to describe contract manufacturing where the hiring company has no involvement at all in the production process. With turnkey manufacturing, the hiring company will hand over everything from design finalization, raw materials sourcing, production, quality assurance and packaging of goods.

The term is used quite loosely, however. On some occasions, people simply use it to refer to product contract manufacturing.    

Contract Assembly and Packaging

Contract assembly and contract packaging are two other forms of contract manufacturing.

• Contract Assembly - In contract assembly, parts or components of products are sent to a contractor that is responsible for the assembly of a final product. Often, those parts are sent by contract parts manufacturers. This practice is often followed for products that have complicated or difficult assembly processes. Heavy machinery is a good example. Assembling heavy machinery can be complicated, or it may require specialist equipment or skills. Contractors that have the facilities to handle these processes are often used.
• Contract Packaging - Contract packagers (or co-packers) simply package completed products. Often these companies are used in industries that have specialist packaging requirements. The pharmaceuticals industry is one example. Strict packaging requirements have to be adhered to in this industry. Packaging requirements vary from product to product and from region to region. The complications involved often make it better for pharmaceutical companies to employ the skills of a co-packer.

We’re experts in packaging and shipping sheet metal parts – check out this information if you need help.

Fig. 1: Komaspec's Contract Manufacturing Facility

When a contract manufacturer is simply referred to as a ‘contract manufacturer’, this usually means they don’t specialize in a particular product category. Usually, the hiring company will approach the manufacturer with an initial design, and the factory will then make arrangements for the manufacture of the product.

Completely original, innovative custom products are a great example of when a contract manufacturer will be used. This is an exciting type of production where a brand will look to gain a competitive edge by selling products that consumers can’t get anywhere else. In this situation, a company will approach a manufacturer with a unique design. The manufacturer then arranges the production process completely from scratch.

Komaspec are familiar with new product introduction. We can help with everything from design optimization and prototyping right up to mass production. Contact us if you’d like to discuss a new product design.

More specific types of contract manufacturers are original equipment manufacturers and original design manufacturers.

Original Equipment Contract Manufacturer (OEM)

An OEM manufacturer is a manufacturer that specializes in a particular product type or category. They have the ‘equipment’ to complete production but not the designs. In OEM contract manufacturing, the hiring company will approach an OEM manufacturer with ready prepared designs. The OEM manufacturer will then be contracted to complete production based on the designs they’re supplied with.

Original Design Contract Manufacturer (ODM)

An original design manufacturer is a manufacturer that has already existing designs for a product and the equipment to manufacture it with. A hiring company will approach an ODM manufacturer to produce a product they routinely produce and then sell it under its own brand name. In some cases, small amounts of customization may be included as part of production.

This form of production is often referred to as white label production, and it can be done very effectively. Companies that are in fashion may find they have good sales and boost their reputation by introducing white label products like pet accessories.  

Have a look at Shopify’s guide to white label products.

To read more about the difference between OEMs, ODMs and CMs, have a look at our article.

Electronics Manufacturing Services

Electronics manufacturing is a particular subset of contract manufacturing, covering the production of electronic parts, components and products.

Where products require electronic parts or components, the production of these is often delegated to a specialist electronics manufacturer. These companies have the equipment and expertise available to produce specialist parts at speed and at minimal cost. These companies can be hired on a contract basis to produce parts and components for bigger products.   

Circuit board assemblies are a common type of electronic component produced by contract manufacturers.

Fig. 2. Circuit Board Assemblies

Two well-known examples of the use of contract manufacturing are the alliances formed by Apple and Nike.

Both of these companies have outsourced their production effectively to specialist contract manufacturers. This has allowed them to streamline their operations and significantly reduce costs. They can also concentrate on the core competencies they’re so well known for, like design, branding and technological innovation.

Apple and Foxconn

One of the most well-known examples of contract manufacturing is the partnership between Apple and Foxconn. Foxconn, a Taiwan-based company, manufactures a significant portion of Apple's iPhones (roughly 2 in 3). This partnership allows Apple to focus on design and software development while Foxconn handles the manufacturing process. Foxconn is a highly capable supplier that is able to maintain high-quality standards. This safeguards Apple’s reputation. The alliance also helps Apple reduce costs. 

Nike and Their Contract Manufacturers

Nike, a world-renowned brand, does not physically produce the shoes that bear its name. Instead, it relies on a network of contract manufacturers. Nike provides the design and the requirements, possibly specifying some suppliers and materials. Then they leave their third-party manufacturers to handle production. Nike’s approach has little impact on brand identity. It also allows Nike to reap financial rewards while focusing on design and marketing.

Companies that use contract manufacturing gain a number of advantages that help them grow and become more profitable.

The key advantages can be categorized as follows:

• Cost-Efficiency: Contract manufacturing allows businesses to outsource production to locations where it’s cheaper. Overhead costs associated with machinery, maintenance, and labor are reduced. Lower costs translate into more competitively priced products and higher profit margins.
• No Need for Investment: As well as reducing the overall cost of production, a company that outsources doesn’t need to make a big initial investment in facilities, equipment and staff. In many cases, outsourcing makes it possible to make business ventures that would otherwise be too risky.
• Expertise and Technology: Many overseas manufacturers are now the go-to experts in their field of production. Contract manufacturers can bring very useful experience and advanced technologies as well. By having access to these assets, businesses can improve product quality, speed up time-to-market, develop their designs or open up other new possibilities.
• Quality: Similarly, contract manufacturers may have more advanced quality control procedures that allow a company to boost their product quality levels.  
• Economies of Scale: Contract manufacturers that produce a large volume of similar products may gain economies of scale when ordering raw materials. This can translate into cost savings for the hiring company. Similarly, overseas suppliers may also have better access to supply chains. They may be able to source alternative materials, get materials faster or offer other benefits.
• Focus on Core Competencies: Resources saved managing manufacturing can be redirected to other vital business areas, like research and development or marketing. Businesses can hone their craft in the areas that make them successful without being distracted by the day-to-day management of production.

The key thing that contract manufacturers provide to hiring companies is a competitive edge in the marketplace.

Higher product quality and more efficient production processes translate into cheaper and better products. This boosts a company’s reputation among consumers. Being able to focus on other areas, like innovation, while a third-party handles production also allows a business to progress more quickly.

Companies that develop a good, long-term relationship with a reliable manufacturer are in the best position.

Fig. 3: Advantages of Contract Manufacturing

Contract manufacturing provides significant benefits, but it’s not without its challenges. Companies need to carefully consider the disadvantages and potential risks. It is worth noting, however, that these can be overcome by choosing a reliable and capable manufacturer.

The main disadvantages are:

• Loss of Control: Outsourcing production means handing over a significant portion of the business process to a third party. Without visibility and input into production processes, and with a poor choice of manufacturer, product quality and production times may become unreliable.
• Dependency: Over-reliance on a contract manufacturer can lead to overdependence. There may be disruptions if the manufacturer faces issues like production delays or financial instability. Dependency can be a creeping issue that develops over time as a company increases its reliance on its third-party manufacturer.
• Communication Challenges: With outsourcing, there are often cultural barriers and communication challenges. These can lead to misunderstandings and a lack of alignment in business objectives, especially if the customer lacks a full set of documentation or a very organized project management / supply chain team.
• Capacity Constraints: Third-party manufacturers may not be able to keep up with capacity requirements in future if a company increases its demand. Similarly, a contract manufacturer’s capacity may fluctuate over time if it deals with other clients. Good, early communication is important to allow time to plan the production schedule.     
• Hidden Costs: While the basic cost of production is usually cheaper with contract manufacturing, hidden costs can sometimes be a problem. Costs such as logistics, import/export fees or costs related to quality control and regulatory compliance can potentially offset the savings made from using an external manufacturer.

Understanding the risks in contract manufacturing is the first step toward mitigating them. The most important thing is for businesses to vet potential contract manufacturers and establish clear expectations from the start.

Selecting the right contract manufacturer is absolutely critical. The choice of manufacturer will significantly impact a business's success.

Key considerations include the manufacturer's:

• Cost-Effectiveness: Can the supplier provide a good product at a competitive price?
• Expertise: Does the manufacturer have experience producing the type of product you need? Does it have the right equipment and certifications?
• Capacity: Can the manufacturer meet your production volume requirements? Can they also meet your future requirements?
• Quality control measures: Does the manufacturer have robust quality control processes? Are they fully aware of your quality requirements?
• Communication capabilities: Is the manufacturer responsive and easy to communicate with? Can you avoid mistakes associated with communication difficulties?
• Certification: If you sell into a regulated industry, can the supplier meet your requirements?

Have a look at our in-depth article on how to choose a contract manufacturer.

Fig. 4: Contract Manufacturing Considerations

Contract manufacturing can be used in lots of different ways. Outsourcing production to a contract manufacturer can get new products off the ground. Otherwise, it can be the step that takes an existing product line to the next level.

If you outsource your production to a third party, you could:

• Avoid the costs and difficulty of manufacturing products in house.
• Focus on other areas of your business, like innovation, design and marketing.

If you decide contract manufacturing is right for your business, you need a reliable experienced partner with the capability to deliver what you need. Komaspec is a specialist metal and plastics manufacturer based in China. We’re contract manufacturers for big and small businesses all over the world.

Request a Quote

Fig 5: Manufacturing Automation at Komaspec

What industries commonly use contract manufacturing?

The industries that most commonly use contract manufacturing are the electronics, pharmaceuticals, automotive, aerospace, defense, semiconductor, medical and food manufacturing industries. Contract manufacturing is widely used, however, and can be found in a wide range of industries. The strategy is particularly useful for businesses requiring specialist manufacturing processes or compliance with stringent quality standards.

How does contract manufacturing impact supply chain management?

Contract manufacturing can simplify supply chain management by reducing the amount of involvement a company has in it. A business is able to focus on product development and marketing, while the contract manufacturer handles sourcing, procurement and materials quality as well as production.

How is quality control handled in contract manufacturing?

Quality control is crucial in contract manufacturing. Good quality control procedures ensure that all products meet the required standards and specifications before they’re sent to customers. Contract manufacturers should have dedicated quality control teams and robust testing processes to ensure product quality and consistency. A business should also be able to introduce new quality control procedures to a contract manufacturer’s production line if they need to.  

How does contract manufacturing support business scalability?

Where contract manufacturers have the capacity to increase production volume, contract manufacturing supports business scalability by providing the option of increasing future production volume. Businesses can respond quickly to increased demand without making significant investments in production infrastructure.

What is the difference between contract manufacturing and private label manufacturing?

While both involve outsourcing production, the key difference lies in product ownership. In contract manufacturing, the hiring company owns the product design and specifications. In private label manufacturing, the manufacturer produces their own product that retailers sell under their own brand name.

How does contract manufacturing contribute to cost savings?

Contract manufacturing can lead to significant cost savings by reducing capital expenditure on machinery and facilities, lowering labor costs and enabling access to specialist manufacturing technologies. These savings can then be reinvested in other areas of the business, such as research and development or marketing.

What should a company look for in a contract manufacturer?

When choosing a contract manufacturer, the most important factors to consider are a manufacturer's:

• Level of expertise
• Quality control processes
• Manufacturing capabilities
• Capacity

Industry specific experience may also be important for highly regulated applications or technically demanding products.

What types of contract manufacturing are there?

When you begin looking for contract manufacturers, you will come across a variety of acronyms, like OEM, ODM and CM. 

• OEM stands for Original Equipment Manufacturer, which is a manufacturer supplying a new design for a customer
• ODM stands for Original Design Manufacturer, which is a manufacturer supplying a largely “off the shelf” or private label solution.
• CM stands for Contract Manufacturer, which is a more general term for anyone providing contract manufacturing services.
• Co-packer - this is a manufacturing that is specializing in the packaging or bottling of fast-moving consumer goods (such as shampoo, water, juice, etc.)
• EMS - Electronic Manufacturing Services, which refers to companies that design, test, manufacture, distribute, and provide return/repair services for electronic components and assemblies.

What is a contract manufacturing agreement?

A contract manufacturing agreement is a legal agreement between the hiring company and the contract manufacturer. It outlines the terms and conditions of the manufacturing arrangement. This may include specifications for the product or component, quantities to be produced, manufacturing timeframes and quality control processes.

• Contract Packaging Association. "Why Use a Contract Packager or Manufacturer." Contract Packaging Association, www.contractpackaging.org/education/why-use-a-contract-packager-or-manufacturer.
• Seetharaman, Deepa. "Foxconn, Apple and the partnership that changed the tech sector." Nikkei Asia, Asia Nikkei, asia.nikkei.com/Business/Foxconn-Apple-and-the-partnership-that-changed-the-tech-sector.
• Wix Team. "What Is Dropshipping?" Wix Blog, Wix, www.wix.com/blog/what-is-dropshipping.
• Shopify Team. "What Is White Labeling? How to Start Your Own Brand with White Label Products." Shopify Blog, Shopify, www.shopify.com/blog/white-label.