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 they want 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
Some of the pros of contract manufacturing include:
Lower Production Costs
When a business uses a manufacturer that already has the capacity to make a product, it can save on production costs. It won’t have to build its own production plants or factories, meaning it can save on machinery, labor, and facility costs.
Greater Production Capabilities
Many companies don’t have sufficient production capacities to keep up with demand. When a business uses a manufacturing contract to collaborate with manufacturers, it can meet production goals it may otherwise struggle with.
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
Some of the potential cons of contract manufacturing include:
Finding the Right Manufacturer
It can be challenging for a company to find the proper manufacturer to meet its quality expectations and production needs. Depending on the product’s specifications, it may be challenging for a manufacturer to make.
Loss of Control
When a company outsources the manufacturing to an independent contractor, it loses control over the manufacturing process. It may be unable to resolve production problems independently, leading to delays or communication problems.
Loss of Intellectual Property
A company’s designs and trade secrets are valuable. Instead of staying in-house, these assets pass through multiple additional parties when it outsources the manufacturing process. As a result, it increases its risk of costly disclosures and intellectual property theft.
Companies can use well-written contract manufacturing agreements to mitigate the risks of contract manufacturing and reap its benefits.
Types of Manufacturing
A manufacturing contract may outline the following types of manufacturing:
Private Label Manufacturing
Private-label manufacturing is when a reseller or retailer contracts manufacturers to make their items via a full-scale production process. The reseller or retailer owns the brand, and they get to sell the manufacturer’s creations under their own name.
End-To-End Manufacturing
In this model, a company outsources an item’s production to the manufacturer. The manufacturer is often part of the design process and may even offer feedback on how the product should be marketed and managed. The manufacturer is responsible for both meeting certain specifications and contributing to the overall success of the product.
This model is ideal for companies wanting to save on overhead costs and work quickly to develop their product.
Individual Component Manufacturing
In this model, the manufacturer constructs one component of a larger product. This process is especially common for companies whose product requires one specialized aspect it cannot handle itself.
It’s especially common when a product has one electronic component. This element is typically outsourced to a company with the current capacity to produce electronics for another product.
Labor/Service Manufacturing
In a labor or service manufacturing model, the contract manufacturer acts as a subcontractor. The general contractor typically hires them to handle a specific part of the manufacturing process or a particular component for the larger product.
Labor or service manufacturing is common with highly complex products that require several specialized components.
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 part in the process.
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 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 in 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 when payment is due 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.
