This article explores the world of contract manufacturing — how it began, where it is going, the challenges, the rewards and the players. The reader will gain a good grounding in what contract manufacturing is, as well as a firm grasp of the risks, rewards and controversies.
Keywords Brand Ownership; Contract Manufacturing; Flextronics; Globalization; Intellectual Property; Offshore manufacturing; Outsourcing; Product Life Cycle
Manufacturing: Contract ManufacturingOverview
Contract manufacturing is the process of hiring a manufacturing firm to produce one or more components, assemblies or completed products. The hiring company is usually an Original Equipment Manufacturer (OEM), which uses the products produced by the Contract Manufacturer (CM) as subassemblies for its own products, or to sell as is (perhaps with its own packaging) to its customers. OEMs usually provide the CM with completed designs and oftentimes a prototype, though CMs are increasingly providing even these services to the OEM.
An OEM's selection of a CM is generally based on cost, expertise, quality and other factors related to the specific part or product to be produced. An OEM may negotiate a contract with a single manufacturer with which it has an existing relationship, or may put out a request for proposal (RFP) to multiple CMs, depending on the need, the size and complexity of the project, and whether or not the OEM has a good relationship with a CM that has the capabilities needed. A typical OEM, depending on the size and breadth of its offerings, may use many different CMs for various purposes and products.Reasons for Contract Manufacturing Expertise
One of the key reasons for outsourcing manufacturing is to obtain specific expertise. With the increasing complexity of equipment, some CMs are specializing in very narrow skill sets and capabilities. Rather than investing in expensive equipment and hiring the skill sets needed, it often makes sense for an OEM to outsource to the expert, gaining better quality, faster turnaround and very often a lower cost than manufacturing in-house. A good example is convertible automobile roof systems. Virtually all automakers contract out this manufacturing, which is dominated by German firms (Armitage, 2007).Lower Cost
Another reason for contracting manufacturing services is to achieve a lower production cost. This may be done by leveraging off-shore manufacturers whose labor, land and materials costs are very often much lower than in the U.S. CMs also may get much better pricing from component suppliers, wherever they are based, since those suppliers typically buy the required materials in very large volumes. Overhill Farms, in Vernon, California, is a manufacturer of food products for brand owners, and purchases close to a million pounds of poultry per week (Schultz, 2007). That is buying power.Speed to Market
Cost and specialization aside, speed to market is often the biggest driver. The ability to get an idea to market fast is often a critical success factor for profitability. CMs can ramp up much more quickly than the OEM, especially those that have widely diverse capabilities and have many factories that can handle spikes in design. Flextronics, for example, has manufacturing facilities in over 30 countries serving the automotive, computing, medical, mobile and many other industries ("About us," 2006). The ability to tap into this vast resource ensures OEMs a much quicker turnaround on products than would otherwise be feasible.Innovation Possibilities
Outsourcing also allows OEMs to focus on innovation, rather than production. This enables a company to expend its internal talent on identifying emerging market needs, developing new products to fill those needs, promoting the new products aggressively and creatively, and moving them rapidly from design into production and out to the market. On the extreme end of contract manufacturing are companies like UK-based Innocent, a smoothie company with 71% of the UK smoothie market. Innocent outsources all of its manufacturing and focuses its own resources on sales and marketing, a strategy that has brought it enormous success. Penn refers to "OEMs" like Innocent as "Brand Owners" (Penn, 2007).
Another, high profile, example of speeding market innovations to market through contract manufacturing is Microsoft's launch in 2001 of the now ubiquitous Xbox. Microsoft, of course, is a software company. No factories, but lots of money. Contract manufacturing monolith Flextronics is the actual maker of the Xbox, and rapidly churns out the game boxes from a state-of-the-art manufacturing facility in the heart of poverty-ridden Guadalajara, Mexico, allowing Microsoft to compete effectively with manufacturing giant Sony and its Playstation (O'Brien, 2001).
While racing to market with lots of dollars to beat the competition works for companies like Microsoft, with lots of market data to support a rosy outlook for sales, other innovative products may have a more uncertain market. Manufacturing outsourcing, in these cases, can be a much less risky alternative to in-house production. If the product flops in the marketplace, or doesn't perform at a profitable level, the OEM's losses are minimized since it has not made investments in new factories, equipment, hiring and training.
Lastly, contract manufacturing has enabled much smaller companies to bring new products to market. Without the need to invest in equipment and workers, new companies with minimal funding can now enter the manufacturing game, even producing to demand in many cases.History
The electronics industry was the first to engage in contract manufacturing with the outsourcing of circuit board assembly in the 1980s. IBM was the first to outsource an entire product when it contracted with SCI to build its personal computers.
Pharmaceuticals and medical devices were next to experience a boom in contract manufacturing. While lack of capacity had historically pushed outsourcing of specific product lines in the past, pressure to speed products to market has driven more outsourcing in these industries in recent years. Outsourcing has not only saved these companies money, but has also enabled them to focus more on R&D and brand building.
During the 1990s, outsourcing became a mainstream business topic, covered in business school curriculums and debated in business publications, including the pivotal paper "Make versus Buy: Strategic Outsourcing" by James Brian Quinn and Frederick G. Hilmer (Baatz, 1999). While outsourcing had been around long before this period, these discussions drove it from a contingency practice to a strategic model, prompting businesses to focus on their core competencies and to consider outsourcing everything else.
Also key to the growth of CM was the emerging Internet and Internet-related technologies that enabled real-time communication, collaboration and data sharing. The ability to resolve issues quickly and communicate instantly regarding product and process design was critical to success. By 1999, according to a Purchasing Magazine survey, "54% of computer, peripheral, communication, automotive, medical and industrial control equipment OEMs outsource(d) some or part of the manufacture of their equipment" (Baatz, 1999).
Military and aerospace prime contractors are some of the latest companies to delve into contract manufacturing beyond simple circuit boards. While there are more restrictions and encumbrances on these companies due to national security and accountability, they are...
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