Contract Manufacturing Agreement is not the most popular term. So, if you are the person who doesn’t know for sure what it is or how it works. Don’t worry, because you’re not alone.
As a matter of fact, most people are not even aware of what it is. They may reach a point that it is a critical business concept, but when asked how businesses use contract manufacturing in reality, they are hard to give a correct answer.
Let us address that lack of knowledge about contract manufacturing agreements and how businesses utilize them in this article.
What is a Contract Manufacturing Agreement?
First, we need to know what contract manufacturing is. It’s known that companies hire contract manufacturers when they want to make the strategic decision to focus on product development, customer service and other aspects of the product creation instead of on the actual manufacturing the whole process by themselves.
A contract manufacturer creates products under contract for other businesses. Contract manufacturers use the process, specifications, formulas and similar information to mass-produce products for their clients and cater to the original equipment manufacturer or market. They major in particular fields like electronics or pharmacology or food and beverage and other subfields.
Most contract manufacturers do different things depending on the demands of their customers. Some other different types of contract manufacturing are included in industries:
- Personal care
- Food and beverage
- Parts fabrication
- General fabrication
Thus, A contract manufacturing agreement is a contract that establishes between the product creator or developer and the manufacturer. It sets the various terms under which the manufacturer will produce the product, the quantity to be made, pricing and the delivery mode. The agreement also addresses compliance with statutory regulations overseen by government agencies such as the Environmental Protection Agency or the U.S. Department of Agriculture and the Food and Drug Administration. A contract manufacturing agreement also covers up shipping, ordering, payment terms and inventory management.
Working with a contract manufacturer helps companies with limited resources still have the ability to create great products. In addition, contracting gives the hiring company access to experts who can oversee the entire manufacturing process, handle quality control and lead times.
Key components of contract manufacturing
Manufacturing contracts can have considerable variation. For example, you might sign a contract for one specific product line, or you could sign a few separate agreements with various providers in a particular region. No matter your specific requirements, you need to create a manufacturing contract that sets out the exact terms of the relationship between your business and other organizations.
Any contract manufacturing agreement should include aspects such as:
- Intellectual property
- Project costs
- Responsibilities of all parties
- Liabilities of all parties
- Turn around time
Contract manufacturing agreement must also cover certain elements to make the agreement legally binding. Ensure your agreement includes these elements so that all parties are protected in case of a disagreement or break promises. Essential legal terms include:
- An offer of work
- Acceptance by all parties
- Intent to make a legal relationship
- The transaction of currency or goods
Additionally, most manufacturing contracts will cover some or all of the following components, based on the company’s specific situation and the products they desire:
- Fundamental processes: Your manufacturing contract should define terms for critical functions. Outlining this in the agreement will help ensure that all parties are on the same page and satisfied with the result. Key processes can include:
- Lead times
- Licensing agreements: This aspect of a deal is crucial if an organization expects its contract manufacturer to use trademarked intellectual property. The contract manufacturer cannot legally manufacture a product without this agreement, so using licensing agreements to avoid trademark infringement lawsuits.
- Nondisclosure agreements: A nondisclosure agreement ̣(NDA) is vital if you deal with proprietary services or products. This is particularly common in the technology field. For example, Apple would include an NDA in any contract with a third-party manufacturer to guarantee they can surprise users when they reveal the latest products.
- Purchase orders: These documents set out the terms of a transaction between an organization and its manufacturers.
- Quality standards: When you are contracting out your organization’s manufacturing, you need to ensure you receive the best-quality services and products. In the end, most manufacturing contracts have various stipulations that specify quality standards. In the long run, this saves your effort and time and reduces the possibility that the customer gets worthless products.
- Supply chain agreements: Your organization’s product probably does not end and end in the same place. To enhance efficiency and communication throughout the entire production process, you can establish a product’s supply chain in a contract agreement. For instance, you may need to involve skills and services from various business partners to design, market, package, and produce your goods.
- Termination clauses: The manufacturing contract will come to an end at some point. The initial agreement should address what happens to intellectual property and patents to ensure that the relationship between all parties does not come to a contentious end. It’s also helpful to outline the circumstances in which the contract can be terminated, such as insolvency or a breach of the contract.
CM and OEM
OEMs have several roles in manufacturing. They may strictly focus on the research, development, and innovation of their products and retain intellectual property (IP) rights. The original equipment manufacturers may market complete products or produce specific sub-components or assemblies for other companies to use in their end product.
The main benefit of OEM is that the designer retains total creative control over the design. In addition, OEM products can be made according to specifications, whereas ODM products are restricted to a predetermined format. The only restriction is the designer’s imagination (and budget).
The risk of OEM manufacturing is that it is much more resource-intensive. OEM designers often spend millions of dollars into research and development over several years to create unique products. Due to this, OEM designers have to guard their designs as intellectual property, lest they be copied and sold by another company with a lower price.
Contract Manufacturing is a fairly broad term and is generally a step beyond OEM manufacturing. The buyer has a new product that is not on the market and contracts with a manufacturer to produce the item. An example is Apple which designs every aspect of the iPhone but contacts Foxconn to do the assembly. In Apple’s case, like many other buyers, Apple is also developing and sourcing components separately and sending them to fox con to be used in the final product.
Benefits and risks of using a Contract manufacturing
Organizations may choose to create a manufacturing contract for a few main reasons. First, these contracts will reduce the amount of money and make it more efficient and easier to bring new products into the market and achieve broad distribution. The primary benefits of using a manufacturing contract include:
Cost savings and Maximize Profits
Your company can save a lot of money if you contract with a manufacturer already invested in the right equipment and technology and aware of the manufacturing process. You might work with a manufacturer that produces similar but noncompeting products. Based on the manufacturer’s location, you could also enjoy savings many in terms of:
- Energy costs
- Labor costs
- Raw materials
- Taxation benefits
Contract manufacturers can drop-ship a product to customers in a specified geographic area, or they may even deliver your product to all of your clients. Some producers handle individual customer shipments, while others may ship the product to a central warehouse, and then you will take care of shipments by the hiring company.
Easier market entry
It may be challenging to enter the market where you produce your goods, but you can still launch them at low prices and export them to nearby nations that could be harder to reach if you manufacture your products elsewhere.
Reduction of manufacturing time
If you choose a contract manufacturing agreement for a specific part of your product, you will be considering cutting down on the whole production period. However, you already have another facility working on the manufacture of that section, so all you need to do is ensure those sections are on hand when you need them to be placed in your process of producing the final product.
Reduced manufacturing time also results in faster delivery of the final products or services to your customers. As a result, the delivery speed to the market will be increased. It’s especially beneficial for companies that manufacture and sell products with very high demand.
Focus on core competencies
When you use a manufacturing contract, you can free up people at your own company so that they can segment their true strengths, such as marketing or selling. Otherwise, your company may not have the capability to make your product in a country or factory setup that saves you money.
More Flexibility Within Your Company
A contract manufacturer will ultimately take on your manufacturing process, so you’ll create more opportunities within your firm.
When you end up outsourcing the manufacturing procedure, you’ll create more time for your employees to make more innovative prototypes and design additional groundbreaking products. In addition, your employees will experience the flexibility to focus on what’s truly important.
As a small business or startup, it’s challenging to scale your product with limited resources at hand. Since contract manufacturers have significantly more help, they’re supposed to be able to scale your goods.
If you’re in a peak in demand or seasonal decrease in order, contract manufacturers can professionally scale production needs to whatever is necessary. With these efficient, scalable measures, you’ll be able to bring your product to new levels and be in control of demand fluctuation.
Manufacturing contracts can go with some risks as well. For example:
General and Delivery Risks
Many contracts are related to consumer products, and with these products come certain potential liabilities and risks. The contract manufacturing agreement must set these risks and the party responsible for addressing or responding to them. For example, one main risk involved in product delivery is that the manufacturer may not ship the products on time for the customers to meet its obligations to distributors and retailers. This could cause the customers to default on its sales agreements.
Intellectual Property and Liability Risks
A contract manufacturer or its employee could take away intellectual property and use it for its good or sell it to another company. If the final product fails to meet regulatory requirements, causes harm to its users or has excessive warranty usage, the associated litigation or recall costs must be high. The agreement must address any remedies that one party can obtain from the other if these situations happen.
This is why it’s so important to get a legal contract in place if you plan to work with a contract manufacturer. A legal agreement will protect you against any fraudulent behavior. Without a good warranty, the manufacturer could simply tweak your product and sell it if they see your product’s demand in the market. A contract details your legal rights as well as recourse if the manufacturer breaches the contract. You will need to ensure that you know which country governs your agreement if you negotiate with overseas manufacturers.
When Should You Use Contract Manufacturing?
You will see that, no matter how the advantages of contract manufacturing are lauded and proclaimed, not all businesses can apply it. You will also see how even the large companies like Apple, Google and Microsoft that can afford to manufacture independently are still resorting to contracts to manufacture.
This is the result of utilizing contract manufacturing after a detailed deliberation. The million-dollar question then becomes: when should you opt to use contract manufacturing?
Contract manufacturing is the best option when:
- Your business is at the beginning of its operations, and production costs are high while your resources are low. If you barely have enough working capital and can decrease production costs if you use contract manufacturing, contract manufacturing is the most sensible decision. However, once the company has become more established and cash flow is healthy, you may start to wonder whether to end the contract manufacturing agreement and manufacture the product by yourself.
- Your business is facing financial issues or working capital difficulties. If this is your case, you need to save as much as you can, and working with a contract manufacturing deal will help you save money and time and effort. This can be a permanent or temporary arrangement, at least until the company is back on its normal.
- You want to hone your product quality as fast as possible. You have no time to waste on perfecting your “formula” or spending a lot of time and money on “testing” with the manufacturing. Outsourcing gives more and better guarantees that the product will be better or even the best possible quality given the available advanced production technology.
- You want to establish your brand early. When developing brands, it’s a matter of trial and error. It may take many attempts to build a product before it stands out in the market. If your capability cannot afford to spend so many resources on that trial and error, you should skip past that and proceed immediately to come up with an innovative product with the help of a CM. At some points, your company may take advantage of being associated with a trusted and reputed CM. Users are more likely to refer to the product and brand once they find out that those products are in a contract manufacturing relationship with a CM that they also approve of or feel optimistic about.
- Demand for the product is uneven. Some products are very high in demand during certain seasons. Therefore, you may opt to use contract manufacturing during these busy seasons and not worry about downtime on the other, slower seasons.
How To Choose The Right Contract Manufacturer
There are some critical characteristics that you should always look for in a contract manufacturer. Knowing the risks and benefits of outsourcing, finding the right partner can make your company’s business and reputation stand out.
When touring a contract manufacturer’s facilities, the location needs to be well-managed and clean. In addition, all machines and equipment should be well-maintained, the staff must be experienced and knowledgeable, and an organized, structured production procedure.
Contract manufacturers need to maintain ISO-certified manufacturing quality standards—the ISO 9001:2015 standard means establishing the criteria required for a company’s quality management. As a result, certified contractors provide higher quality parts, components, and products to their customers.
Having open communication between both parties is essential to the success of any business agreement. More reputable contractors are experienced in maintaining contact with their clients about the design, manufacturing process, and properties of the products that were hired to produce. As a result, they can quickly respond and solve the production requirements with little friction or slowdown.
Aware of the Market
Reputable contract manufacturers are tuned into current trends in the free market. They respond to the market changes and adapt when it comes. Their presence in the industry generally establishes their brand in the market, creating an excellent reputation that investors can feel confident in investing in.
Things to Consider
Before signing an agreement with a contract manufacturer, you need to consider several things carefully. These include if a contract manufacturer has access to the best technology, capabilities to meet your standard needs, the delivery plans and how long it will take to arrive. If a manufacturer cannot do its job well, look for another partner who can serve you better.
Moreover, any manufacturer with which you work should be willing to work for you on a trial basis before signing an agreement. An unwillingness to do so is a negative signal, as it indicates a lack of transparency. Likewise, if they are unwilling to work out payment plans, discuss customizations or provide quality assurances, be careful; these are also negative signals.
Every contract manufacturer wants to show their customers that they are trustworthy and a good choice for a long-standing partner. They are also happy to show that they are organized and can track all their customer orders. If you don’t feel the impression of such attitudes and capabilities in a potential contract manufacturer, steer clear.
Untrustworthy contract manufacturers could cause many unexpected big problems. For one, they could show you products or services of subpar quality. In addition, if you reveal your technology and specifications for production, a dishonest manufacturer could force you to participate in intellectual property disputes.
Sample Contract Manufacturing Template
Here is the sample contract manufacturing agreement that we give you for granted. Including the basic key elements and essential terms for a successful trade agreement, you can use this temple as reference material to help you build your business thriving.
To summarize, there is one thing that you must keep in mind is that not all manufacturing businesses can make succeed in working with a contract manufacturing agreement. That is why it is important to conduct deep and detailed studies on whether your business needs to contract with a contract manufacturer or significantly benefit the company.
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