Advantages & Disadvantages of Contract Manufacturing

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Product manufacturing plant
Product manufacturing plant (Image: terex/iStock/Getty Images)

Contract manufacturers produce complete products and components for other organizations that market the products to their own customers. The marketing organization may design and engineer the product, providing the contract manufacturer with a specification, or it may purchase a product developed by the contract manufacturer. Contract manufacturing is a form of outsourcing that enables businesses to increase their production capacity, acquire new products they cannot manufacture themselves or reduce their production costs. In some cases, companies may use contract manufacturers in low-cost economies or developing countries, a practice that may result in domestic job losses or a dilution of the local manufacturing base.

Cost Advantages

A contract manufacturer may offer cost advantages over a company’s internal production facilities. The manufacturer may, for example, be based in a country with low labor costs. Some contract manufacturers specialize in specific types of products, setting up high-volume production lines that allow them to produce products at a low unit cost. A company can also obtain a cost advantage by outsourcing production rather than investing expensive capital in production equipment and hiring skilled labor.

The Problem of Hidden Costs

Although companies may gain an apparent cost advantage by using a low-cost contract manufacturer, they must also consider the additional costs of dealing with an outsourcing partner. A company using a contract manufacturer in a low-cost country, for example, may incur shipping costs that cancel out any unit cost advantages. The company may also have to appoint staff to manage and monitor the performance and quality of the contract manufacturer.

Operational Advantages

A company can gain significant operational advantages by using contract manufacture. If demand for products increases, for example, a company can hire additional production capacity to meet short-term demand without investing in its own facilities. Companies developing new products can use contract manufacturers to produce pilot runs for test marketing before setting up full-scale production facilities. Companies can also improve the quality or performance of their own products by outsourcing production of components they cannot manufacture with their own resources.

Risk Factors in Contract Manufacturing

Although there are important operational advantages, companies must also be aware of potential risks in contract manufacturing. Loss of control is a major challenge. Contract manufacturers may not be able to maintain production schedules or meet agreed quality standards, particularly in distant locations where day-to-day control is impractical. Contract manufacturers specializing in particular types of products may work for a number of companies that are competitors, increasing the risk of losing sensitive commercial or technical information.

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