Contract manufacturing has seen tremendous growth in the past few decades (“Contract Manufacturing Market Size, Share and Research Report”) simply because it has driven immense reduction in the cost of manufacturing goods, and has granted companies increasing flexibility with how they handle their product manufacturing. The reasons behind this aren’t always as simple as cheaper labor (though that may definitely play a part), or improved operational efficiency (though that can be a factor too), and they need to be thought through when exploring the benefits of contract manufacturing models, whether OEM, ODM or CM (“ODM, OEM, CM – Which type of manufacturer should you pick for your project?”), or when selecting the right manufacturer for your project (“How to Select the Right Manufacturing Supplier for Your Project”).
In this article, we’ll take you through the primary reasons why contract manufacturing in China or elsewhere can deliver improved cost performance, and give you the framework to help you evaluate whether or not outsourcing manufacturing may deliver benefits for your project.
How contract manufacturing pricing model saves money
Let us look at how different factors come together to save you money when using contract manufacturing.
Table 1: Contract Manufacturing Benefits
Contract manufacturing can help you:
- Have better control over manufacturing labor costs
- With cost-effective labor force management and consistency
- Gain economies of scale in material purchasing and subcontracting
- Improve supply chain and inventory management
- Reduce overhead costs
- Enhance scalability and flexibility of operations
- Improve product quality
- Reduce manufacturing timelines
- Get access to expertise and technical insights
Better control over manufacturing labor costs
Cost of labor is a key driver for outsourcing the manufacturing function, especially to a lower-cost destination. If labor is expensive in your home country - and it always is, if you are from the developed world - it makes perfect sense to get your product made in a country with relatively lower labor costs.
For many products, especially in the world of contract manufacturing and medium volume / high-mix production, automation can be difficult to achieve. This means that a certain number of labor hours are often built into a product design, and can be difficult to reduce in a cost-effective manner through automation. In this case, especially if labor is a significant portion of the overall product cost, outsourcing to a lower-cost labor market makes sense.
Cost-effective labor force management
Your contract manufacturer, if you have chosen wisely, is specialized in what they do. Besides often being located in a low labor-cost location, they will have built up a cost-effective labor force that can be easily channeled to projects-such as yours-and to perform to a high standard. Their excess capacity in human resources can be used on your product/project when needed and then switched to another project. The result is less downtime, greater utilization of human resources and lower labor force costs per unit of production.
The greater scale enjoyed by many specialist contract manufacturing firms also allows them to bring additional resources in hiring and training workers, and dealing with increases in demand, allowing them greater flexibility in scaling workforces up or down as needed.
It also makes better sense for them to have a pool of specialized skills in-house. For contract manufacturers, continuing training and development of workers is intricately linked to their business development process. Their manufacturing staff and engineering staff are a critical asset. Due to their wide customer and product range, they are able to maintain a large staff of trained personnel. A smaller company might have to bring in outside expertise – electrical engineers, industrial engineers, welders, etc.-or invest significant resources to build up. In particular, the engineering capacity and capabilities in a contract manufacturer can be crucial for SMEs and smaller customers who lack the headcount to have similar staff in-house.
As the core product or service of contract manufacturers is manufacturing, they are extremely focused on improving the efficiency and utilization of their labor and equipment. This means they also tend to invest heavily in systems, jigs and equipment that can improve labor efficiency and reduce costs. The relatively lower cost of engineering time in places like China also helps to reduce the cost of investing in this type of labor-saving industrial design.
Economies of scale in purchasing and subcontracting
Well established contract manufacturers are used to purchasing various materials frequently and on a large scale. They are likely to have strong supply chains and a network of preferred trusted suppliers who offer good pricing, favorable payment terms, quality materials and timely deliveries that they have built up over years and decades of experience.
This experience in managing manufacturing supply chains means that contract manufacturers often have a network of subcontractors who can make parts and components to a high quality at competitive cost.
Together, these networks of trusted suppliers and subcontractors established over time become part of the contract manufacturer’s competitive advantage. A new business cannot replicate this in a short period of time. These relationships enable them to offer you competitive pricing on manufacturing projects.
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Enhanced scalability and flexibility of operations
Scalability and flexibility are key success factors for a contract manufacturer. If you had to scale up manufacturing, that means investing in additional manufacturing capacity-space, labour, expertise, machinery and equipment. But successful and profitable contract manufacturers have figured out ways and fine-tuned methodologies to quickly scale up and scale down their operations. Because contract manufacturers serve many customers, they often have excess capacity at any given moment that can handle surges in customer demands, whereas a customer handling manufacturing in-house will have to build that extra capacity painstakingly, and then maintain or shrink it at high cost to themselves in case of a decrease in demand.
Chinese contract manufacturers in particularly have access to a large skilled labor pool, a rich supply chain and manufacturing value chain that allows them to more quickly scale projects.
They are likely to have modular and flexible production lines that can be put together and dismantled quickly. They would possess management structures capable of adapting to the changing needs and demands of a stream of new clients (like you). This naturally leads us to the next point.
Reduce overhead costs
Well-run contract manufacturers will have a great deal of focus on operational excellence and reducing overhead costs in order to keep their pricing competitive and to maintain healthy margins. That expertise in turn helps reduce your costs by reducing the pass-along margin CMs need to put on products to be profitable. CMs keep their overhead costs low by:
- Amortizing equipment and overhead costs over a wider range of customers and products
- Ensuring less machine downtime. Servicing many customers and markets helps increase machine utilization.
- Vertical integration allows for reduced upstream supplier margins and brings down transportation costs and lead times while improving cost efficiency.
- A focus on operational excellence due to tighter margins allows many CMs to improve productivity and reduce overhead vs unit of production.
Improve product quality
An overlooked aspect of how contract manufacturers can reduce end-cost is by improving product quality and thus reducing the amount of scrapped units, in-field servicing, recalls, returns or other expensive interventions once the product has left the factory and entered the market. A good CMs can improve product quality and greatly reduce these aftersales service and replacement costs through:
- Greater experience in new product development and bringing new products to market translates into an understanding of best practices and common errors
- Greater manufacturing scales allows many CMs to heavily invest in quality systems and equipment
- Co-location with suppliers in China allowing China-based CMs to quickly and effectively audit quality and control component suppliers to ensure component quality, as well as shorter turnaround on testing samples and modifications
- Vertically integrated CMs have more processes in-house, which allows for greater control, faster feedback and error correction
- Online testing and rigorous incoming quality inspections
Reduce manufacturing timelines
Another factor that can reduce a product’s or project’s overall costs is by shrinking project timelines. The opportunity cost of bringing a product to market late can be high in terms of lost sales, need for expedited production or freight, broken contracts, etc. Contract manufacturers can help to reduce project timelines due to:
- Existing elastic capacity
- Existing supply chains
- Experienced engineering and operational teams
- Co-location with component suppliers ensuring a quick feedback loop and shorter part development cycles
- Vertically integrated CMs will produce many components in-house, helping to control lead times.
Successful contract manufacturers learn to work closely with their clients to ensure time to market deadlines are met. But these timelines cannot be arrived at in the abstract. If any contract manufacturer appears to set these timelines without serious consideration, that should make you cautious.
Experienced contract manufacturers with an excellent reputation for timely delivery are in a class of their own. They know that manufacturing timelines need to be closely aligned with strategic design and manufacturing process decisions. They know the value of well controlled manufacturing schedules and reliable supply chains. This is called supply chain orchestration (Alicke et al.), the coordination of all key activities across the supply chain.
When everything works in unison, and your contract manufacturer has the experience of doing it again and again for various clients, that is when their word on a time to market deadline can be taken to the bank.
Fig 4. Finished Goods Area
Access to expertise and technical insights
This point basically brings us full circle because your ability to reduce manufacturing deadlines also goes hand in hand with getting your contract manufacturer involved very early in the product development process.
Your contract manufacturer knows how best to optimize products for local production techniques and materials. They know the bottlenecks and how to overcome them. They also have the expertise and the technical insights that come from being in business continuously serving other customers like you and helping make their projects a success. That kind of insight and experience is not easily replicated – especially by small and medium-sized companies.
Tooling design, go no-go jig design, design for manufacturing and assembly (DFMA), testing fixture production – there are many aspects of manufacturing and bringing a product to market that require extensive experience to get right, and CMs have built that experience and know-how in-house and can bring it to bear on your project. There is no need to hire external consultants, spend years developing capabilities or learn via trial and error – contract manufacturers have these skills and can apply them immediately. This can save a tremendous amount of money through product optimization, substitution of more cost-effective components, a reduction in assembly time, etc. etc. and can be one of the biggest contributors to product cost savings.
Contract manufacturing as a strategic partnership
As you can see, when all of the above factors come together in a contract manufacturing arrangement, it will help you save money. When you combine a generally lower-cost manufacturing destination like China and pick the right kind of contract manufacturer (“How to Select the Right Manufacturing Supplier for Your Project”) with the relevant specializations and expertise, you can optimize the benefits of contract manufacturing.
It is worthwhile noting that, beyond all the points discussed in this article, there is an umbrella factor that contributes to a successful contract manufacturing project. That is of the contract manufacturer playing the role of your strategic business partner in the project. This matters particularly if you are looking at the long-term.
Beyond the capabilities and expertise, the attitude and approach of the contract manufacturing company also matters. While you may look upon a potential contract manufacturer as strategic business partner, does the other party? That is an important question to answer before selecting a contract manufacturer ("How to Select the Right Manufacturing Supplier for Your Project"). Although not always the common scenario, it is important to consider because then you can reap the true potential benefits of contract manufacturing explained above.
The critical importance of having a contract manufacturer who looks upon your mutual business relationship as a strategic partnership cannot be stressed enough. Establishing such a strategic outsourcing relationship with a contract manufacturer gives you the certainty of pricing and a commitment to produce the deliverables efficiently and effectively. From your contract manufacturer’s perspective, they are able to secure a strategic, committed customer who will bring them continuing business over the long term. Being a mutually beneficial relationship, the vendor knows that their business flourishes when yours does. Hence there will be a strong motivation to assure your success, project after project. In such a strategically valuable arrangement, innovation and a commitment to continuous improvements are a given, often delivering better margins and competitiveness for both the client and the contract manufacturer.
Here at Komaspec, our more than 15 years of experience in sheet metal fabrication and contract manufacturing in China mean that we are a leading choice for companies looking for China-based Contract Manufacturers. With exceptional in-house integration, NPI and DFM experience, and thousands of successful manufacturing projects, we provide service to a range of customers and industries.
We are glad to review your product design together and help you select the fabrication process that best suits your product’s needs.
What is a contract manufacturer vs what is contract manufacturing?
Contract Manufacturing (CM) is an umbrella phrase that covers the original equipment manufacturing (OEM) and original design manufacturing (ODM) models while also standing on its own as an outsourced manufacturing business model.
CMs are generally not category-focused in the same way as ODMs or OEMs are. They do not usually have their own business lines or intellectual property (IP) and do not design new products of their own. CMs are offering manufacturing as a service to customers. Their customers provide the design and the contract manufacturer provides the labor, facilities and general manufacturing know-how to make that product (“ODM, OEM, CM – Which type of manufacturer should you pick for your project?”).
What are the advantages and disadvantages of contract manufacturing?
The advantages of a contract manufacturer include:
- Greater transparency of the supply chain since CMs will take consigned parts, work with customer designated suppliers, offer greater detail on part specification and drawings.
- Greater control over subsystem and subcomponent manufacturing, including the inputs on cost, quality and lead time requirements.
- Complete ownership of the IP since as the buyer, you are providing the design and product specifications. Contract manufacturers do not have competing business interests that may create potential conflicts.
- A simpler business relationship in the absence of shared IP or product ownership. As the buyer you have more room to manage the business relationship.
The disadvantages of the CM model include:
- The need for greater investment in product design, development and tooling. CMs generally do not have an existing system architecture tooling for common use.
- The new product development lead times will be longer due to the initial set up phase because the products are being built from scratch instead of using an existing platform or supply chain. Some CMs specialize in certain areas, such as sheet metal manufacturing or electronic equipment or components. In such cases, there will already be an existing supply chain and some systems in place to help reduce development lead times.
How Much Does Contract Manufacturing Cost?
The most widely used contract manufacturing pricing model is cost plus. Manufacturers estimate the cost of manufacturing your product and then add a profit element to it. The "plus" in cost plus refers to the profit.
Here are the factors that your contract manufacturer would use in estimating the cost of making your product:
- Materials cost is a primary factor and involves the cost of raw materials and purchased or made parts and components which comprise the bill of materials (BOM) cost. It is important to remember that many of these costs are baked into your product at the design level. Your material specifications (specs) and the availability and precision of parts and components will need to be factored in at the costing stage as these will also affect pricing.
- Labor cost is another key component of product cost. Contract manufacturers would need to consider the type and quantity of labor used, and the skills and expertise involved. For example, whether you need skilled welders and machinists or assembly operators will have a definite cost differential.
- Equipment costs too are included in your cost of manufacture. Most likely your contract manufacturer will have the basic machinery, equipment and tooling necessary for making your product. However, equipment amortization costs and the costs of any tooling, fixtures and special equipment may be included as part of the quotation.
- Volume. The number of items to be made clearly has a direct impact on your cost. While it costs more to make a thousand units than to make ten, the ability to benefit from bulk purchases of materials and spreading costs over many items will lower your unit costs for high order quantities.
- Product quality. The quality of the product you expect from your contract manufacturer will also affect the cost computation. Quality control and performance testing can add up significant costs to the calculation. Precision equipment necessary for stringent testing of some products can be extremely costly and your contract manufacturer will charge you for the use of those equipment. Even the best contract manufacturers will end up with some products that are defective. Reworking and scrapping are both going to add to your costs.
- Cost of compliance. Beyond general product quality inspections, some products may require third party testing of the manufactured items in order to comply with laws and regulation in your key markets. The costs borne by your contract manufacturer will also be factored into your cost of production.
- Packaging and freight costs and other shipping costs are naturally part of the cost calculation. The final cost to you may include losses or gains on foreign currency exchange rates, customs duties, tariffs and other taxes.
- Overhead. Keep in mind that your contract manufacturer is going to incur various indirect costs, including utilities, indirect labor costs and cost of consumables to get your product made and shipped. These too need to be factored into your production cost. There are basic ways of doing this and the more sophisticated contract manufacturers have figured out more precise ways to arrive at this indirect cost element.
After your contract manufacturer calculates all of these elements and comes up with a unit cost of production for the volumes you specify, they will add their profit to this.
What is a Contract Manufacturing Agreement?
A Contract Manufacturing Agreement is any manufacturing or supply agreement you enter into with a manufacturer of completed products or components. The contract manufacturing agreement must give precise instructions to the contract manufacturer including product specifications, designs and models, equipment and tooling, materials, components, packaging and wrapping.
The Agreement must include a detailed bill of materials (BOM) as well as pricing provisions. It must spell out product quality requirements, quality control and inspection procedures. You may also want to include product warranty against defects with a defined warranty period from date of shipment. The contract manufacturing agreement must protect your intellectual property (IP) rights and cover the use of confidential information. It needs to include provisions on resolving disputes (“China Manufacturing Contracts: Not So Simple”).
What is an Example of Contract Manufacturing?
Foxconn Technology Group is an example of a well-known contract manufacturing company. Foxconn is known for making products for Apple such as the iPad and iPhone. The company also makes products for other high-profile companies like Microsoft and Amazon.
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