A contract manufacturer (CM) is a company that takes over parts of the production process of another company, operating under a mutually beneficial service agreement. In today’s global business landscape, selecting a CM can be an involved and lengthy process. It is not only about selecting the best price offer or the most helpful crew of people to delegate manufacturing tasks to; many factors need to be taken into account in order to make a strategic choice.
This article provides an outline of what needs to be taken into account when choosing a contract manufacturer and a handy spreadsheet template for comparing both pricing and qualitative factors.
A contract manufacturing business model is based on an agreement called the Manufacturing Services Agreement (MSA). The hiring firm selects a number of candidate production companies and approaches them with a request for quotation (RFQ) on their product. Manufacturers then provide their price offers for all components involved, and a fixed price is negotiated for a set quantity of produced goods.
This is based on the CM’s available personnel, equipment, materials, tooling, and shipping options. If agreed upon, the CM may also outsource the manufacturing of some parts of the bill of materials (BOM) to subcontractors. In essence, working with a contract manufacturer is a way to hire an off-site factory.
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Companies delegate their production process to a CM for a number of reasons:
While there are benefits to outsourcing production to a CM, there are also some risks associated:
As your product becomes more defined in consecutive stages of prototyping, it is time to find candidates for the right contract manufacturer. There are several online portals but more direct links can be established by inquiring into personal networks and visiting trade shows.
Here is a list of popular ways to find the right CM:
After the orientation phase, select five to ten potential CMs to partner up with. Besides going by the overall impression, this is best done by establishing a supplier selection criteria. The team will decide on the importance of each criterion, and subsequently, potential CMs will be rated according to a decision matrix.
The selection criteria may include:
We created an example of a comparison matrix that is coupled to a fictive BOM of Apple’s Airpods Pro—the same BOM template we used in our guide to the bill of materials.
In the sheet named ‘CM Comparison’, potential manufacturing partners are ranked according to different criteria with various weights depending on their importance. This provides an overview and can help put an end to biased opinions due to overvaluing factors such as lowest cost, being the largest CM, or having the most attractive corporate culture. The process can be democratic by involving senior members of the management and the development teams to determine the selection criteria and their respective importance.
A comparison also helps to point out potential red flags. For example, even though the fictive Black Wizard Factories scored third highest and offered all capabilities, they should be eliminated from the process due to the inflexibility of communication. With its short communication lines, cutting-edge equipment, automation possibilities, and outstandingly pro-active corporate culture, the fictive Hodon Group would be the best choice according to this chart.
Out of an initial list of five to ten contract manufacturer candidates, requests for a quote are typically sent to the top three to five of them after signing NDAs. For large projects it is not enough to only send out the CAD data; an RFQ needs to contain detailed descriptions for the CM to get a good understanding of the project.
The document starts with the equivalent of a cover letter that provides an overview of the company, the team, funding, a description of the product, its state of development, as well as what needs to be done by the CM. It also lists several criteria that the factory is to meet.
The second part of the RFQ contains as much information about the product as possible: a BOM spreadsheet, drawings, CMF specifications, a prototype, Gerber files in case of electronics, and intended margins. 3D printed prototypes can also be great tools to communicate the intent of product design to a factory.
Lastly, the request should include a time schedule for all milestones involved in the road to production.
Once quotes are obtained, offered prices for all items of the BOM should be added to a comparison table so that they can be compared and worked on individually. See the sheet named ‘Price Comparison’ in our example.
The total COGS is dependent largely on product costs, fixed costs, and labor costs. The ‘Volume’ cell in the sheet is crucial here: by changing the order quantity it will automatically update the COGS. After all, fixed costs matter less the higher the order quantity. This may give additional insight into the best manufacturer if there is a prospect for scaling up production in the future.
After receiving the initial quotes, it is good practice to contact the different CMs in order to work on the quotes and reduce overall prices. In order to drive total cost down, a great strategy is to focus on the three to five most expensive components. This is the small percentage of the total package that will determine the largest overall benefit.
A single-sourcing deal will also work as an argument in the hiring firm’s advantage. This means that, in contrast with sole-sourcing where only one manufacturer is available to produce a part, a CM is administered an exclusive license to make the product.
Similarly, making the CM aware of competitive quotes can be an incentive for them to come up with a more advantageous offer. And besides component prices, consider bargaining for better warranty, assistance, transportation, and payment plans. Every company deals with negotiators in entirely their own way, so the situation at hand will determine the amount of flexibility with a deal.
Before deciding on which contract manufacturer to offer a contract, it is critical to do at least one in-person visit to the factories of one to three of the candidates. The reality of the situation overseas will shine a new light on the collaboration. The benefits of a factory visit are numerous:
It is common that a dinner is organized between the hiring firm’s representatives and the factory owner or executives. Besides being a convivial way to gain familiarity, this is where discussions will flow towards the signing of the MSA. It is advisable to send along someone from the purchasing department for negotiation, a translator/interpreter, and someone from the engineering department for technical advice regarding the product.
Choosing a contract manufacturer requires great care, expertise, and an involved team. Rather than a vending machine that provides products on simple inputs such as design drawings and funding, working with a CM is a long-term collaboration involving numerous aspects.
Sending a request for a quote is only one of the key steps to a signed agreement; the importance of communication, negotiation, teamwork, decision matrices, and factory visits cannot be overlooked.
