What Is a Manufacturing Contract?
A manufacturing contract is a business agreement for a manufacturer to provide specific services to a client. A company or an individual may hire a manufacturer as an independent contractor to construct their product, so they use this document to outline details relating to their services. It can help you set expectations and create a binding legal agreement.
What Makes a Manufacturing Contract Legally Binding?
- Supply chain agreements to set approved materials and suppliers for a product
- Mandatory process terms to establish assembly, testing, and packaging specifications
- Quality standards for product characteristics such as durability, longevity, and purity
- Purchase orders to outline product shipment price, quantity, and delivery terms
- Licensing agreements to state the intellectual property rights remain with the client
- Termination clauses to set guidelines for contract renewal and termination
- Non-disclosure agreements to prevent the disclosure of trade secrets and other confidential information
What Is Contract Manufacturing?
Contract manufacturing is when a business relies on an independent contractor to handle a company’s production processes. The manufacturer specializes in making specific products or components, so the business can focus on other aspects of its operations.
A company provides specifications for the product it wants the manufacturer to create. If the manufacturer warrants it, clients may have access to customizable solutions, allowing them to tailor their products accordingly.
Explore the pros and cons of contract manufacturing for businesses:
Pros of Contract Manufacturing
- Lower Production Costs: A business doesn’t have to build its own production plants or factories, meaning it can save on machinery, labor, and facility costs.
- Greater Production Capabilities: It can meet production goals it may otherwise struggle with even if it doesn’t have sufficient production capacities.
- Better Quality-Control Standards: Contract manufacturers offer quality-control standards, leading to better products for a client’s customers and fewer quality issues.
Cons of Contract Manufacturing
- Finding the Right Manufacturer: Depending on the product’s specifications, finding the proper manufacturer may be challenging.
- Loss of Control: It loses control over the manufacturing process and may be unable to resolve production problems independently.
- Loss of Intellectual Property: When the manufacturing process is outsourced, the assets pass through multiple additional parties instead of staying in-house.
Companies can use well-written contract manufacturing agreements to mitigate the risks of contract manufacturing and reap its benefits.
Types of Manufacturing
Private Label Manufacturing
- Scenario: You, the reseller, own the brand and sell the manufactured product under your own name.
- Process: You contract a manufacturer to create your desired item through a full-scale production process.
- Benefits: Ideal for businesses that want to focus on branding and marketing, leaving production to the experts.
End-to-End Manufacturing
- Scenario: You outsource production to a manufacturer who actively participates in your product journey.
- Process: The manufacturer gets involved in the design process, offering feedback on marketing, management, and meeting specific product specifications.
- Benefits: This model fosters speed and cost-effectiveness for companies developing new products, as the manufacturer contributes to overall success. Securing a reliable supply of materials is also crucial, often formalized through a supply agreement.
Individual Component Manufacturing
- Scenario: You outsource the production of a specific component crucial for your product.
- Process: The manufacturer builds a single, specialized aspect that your company cannot handle itself. This is common for electronics or other intricate parts.
- Benefits: Ideal for companies lacking in-house capabilities for specific components, ensuring high-quality production by a specialized manufacturer.
Labor/Service Manufacturing
- Scenario: You hire a contract manufacturer as a subcontractor for a specific part of the manufacturing process or a crucial component.
- Process: This model is often used for complex products requiring various specialized parts. The general contractor manages the overall process, while the subcontractor focuses on their area of expertise.
- Benefits: Allows companies to leverage the expertise of multiple manufacturers, ensuring high-quality production for intricate products.
Contract Manufacturing Examples
Several industries and individual examples help illustrate contract manufacturing.
In the Pharmaceutical Industry
The pharmaceutical industry commonly uses contract manufacturing to create products. Some drug companies don’t have large-scale production capacities. A smaller drug company may, for example, partner with a larger one to produce its medication.
This partnership allows a single-drug company to use the assets of a large multinational corporation to get its medication to market. The smaller company could then market the drug under its name or engage in private-label services with the larger company.
In the Food Industry
Contract manufacturing is especially prevalent in the food industry. Food manufacturers must often use several components or ingredients to make their final product. A company that creates a specific food for sale may not make every ingredient itself.
Most food manufacturers outsource some parts of their manufacturing process. In most cases, the product is eventually sold under a single brand name, while the contract manufacturers receive payment for their work.
In the Automotive Industry
Most major automobile companies use contract manufacturing throughout their business model. One company may use dozens of contractors and subcontractors to construct the various parts of an automobile, including the braking system, engine, transmission, and infotainment system.
Motor vehicles are highly complex products. Partnering with different manufacturers provides flexibility and scalability for automakers to create the best possible product.
In the Information Technology (IT) Industry
Manufacturing computers and other high-end electronics usually requires multiple manufacturers working together. Each component requires specialized knowledge and machinery to make. Working together with a manufacturing contract can help reduce costs and difficulties in getting a new product to market.
Tips for Choosing a Manufacturer
Implement the following tips when choosing a contract manufacturer to use:
Research Your Options
Create a list of desired traits for a manufacturer. They’ll vary in experience, capabilities, and price, so you should consider the factors that matter most to your business. From there, you can research and consider multiple manufacturers to find the one that’s right for your product.
Communicate and Negotiate
Talk to multiple manufacturers to determine how they perform their services. Ask about the techniques they use to maximize efficiency and the consistency they achieve with product deliveries. During your discussions, you can also negotiate the cost of their services to get the best price.
Compare Manufacturers
Consider the pros and cons of each company to determine which will give you the best return on investment.
What to Include in a Manufacturing Contract
A contract manufacturing agreement is a legally binding agreement outlining the key conditions and terms of the business arrangement. It creates and governs the relationship between a manufacturer and their client. It sets mutual expectations and responsibilities as part of an outsourcing agreement between the two parties.
Explore common elements within this document:
Services Provided
This contract describes what services the contractor will provide, the cost of those services, and other pertinent details specific to your situation. It should include product guidelines and specifications. You can also consider turnaround times and specific production dates in your agreement.
Fees
Your manufacturing independent contractor agreement should outline the fee structure for creating the product. It should also set the due date and how the client will pay it.
Sample Guidelines
Specify if the manufacturer should send a sample to the client before completing the larger order. This way, the client can determine if the contractor’s work meets their standards.
Delivery and Acceptance Protocols
Outline the process for delivering and accepting the products. Specify how long the client has to inspect the products. Include details for returns if the client has to send the products back due to quality issues.
Confidentiality and Indemnification Clauses
Your agreement should include confidentiality provisions, non-disclosure agreements, and other protections for intellectual property. It should also include indemnification clauses for any damage or danger the manufacturer causes.
Renewal and Termination Dates
Many manufacturing contracts last for years. Your agreement should clearly state the length of the contract and the conditions for renewal or termination.
Enforcement and Breach of Contract Provisions
Your contract should spell out what constitutes a breach of the agreement and what can happen if one party breaches it. You may consider an arbitration clause or choice of law provision as well.
Manufacturing Contract Sample
Download a manufacturing contract template as a PDF or Word file below.
Frequently Asked Questions
Is toll manufacturing the same as contract manufacturing?
Toll manufacturing and contract manufacturing are different. Toll manufacturing occurs when the parent company supplies its manufacturer with the necessary raw materials and design but maintains some control over the production. In contract manufacturing, the manufacturer typically has control over the entire process.
Is contract manufacturing risky?
The primary risk of contract manufacturing is to your intellectual property. Intellectual property theft is more likely to occur because more individuals outside the company can access sensitive company information.
