Contract manufacturing occurs when a small business hires another company to produce its products. It enables small businesspeople to begin selling their products without obtaining the large amount of capital necessary to build and run a factory.
With the popularity of shows like Shark Tank and online marketplaces such as Amazon and eBay, an entrepreneur can dream up just about anything, have it manufactured relatively easily, and start selling it to the masses, thanks to contract manufacturers.
These companies agree to make a certain number of a product according to the specifications given to them by the hiring company. A contract manufacturer may be located in the U.S. or overseas.
The hiring company should seek out a contract manufacturer that has expertise in the type of product the company wants to make.
That expertise could take the form of more than just the manufacturing itself; the company may be able to offer help with chemical or engineering processes or packaging. Here are some other things to look for in a contract manufacturer:
• Highly reputable in the marketplace
• Financially sound
• A clean, well-managed facility
• ISO-certified manufacturing quality standards
• The ability to keep up with production demand for a product
HOW DOES CONTRACT MANUFACTURING WORK?
The hiring company usually provides a design or formula to the contract manufacturer to replicate or improve upon.
The hiring company typically focuses on the marketing and selling of the products. For example, a small business might want to sell specialty cleaning products using a formula the owner developed. The small businessperson could hire a contract manufacturer to make and package the cleaners according to their specifications.
The business would then be freed up to concentrate on finding customers for its products and handling sales from a central warehouse. If the manufacturer is able to act as the drop shipper—keeping a supply of the products on hand at a warehouse and sending out orders at the business's direction—the business would basically be a marketer of the products it developed.
Alternatively, the manufacturer may be able to ship products only within a specified geographic area.
THE ADVANTAGE OF CONTRACT MANUFACTURING
Businesses choose contract manufacturing for a few primary reasons, all of which make it easier and less expensive to bring new products to the market and distribute them broadly.
The biggest cost benefit of using contract manufacturing is from not having to build a production facility and staff it with workers and managers.
Aside from that obvious benefit, companies may save money by hiring a manufacturer based in a low-wage country.
The location of the manufacturing plant might also offer savings in energy, overhead, and raw material costs as well as tax savings.
Contract manufacturing frees up people at the hiring firm to stay focused on their core strengths of marketing and, possibly, sales.
If the owner has a background in those areas, they may be able to hire fewer people to assist them. The company may be able to easily introduce its products into the country in which they're made. It could also gain entry to the markets of neighboring countries.
The hiring company also runs the risk of having its ideas appropriated. Some unethical contract manufacturers have been known to give away product ideas from one client to another favored client or to produce its own similar product with only a slight tweak or two.
Business owners should hire an attorney to get a strong legal contract that will protect against any such behavior.
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