Supply Chain Insights LLC (SCI) recently released their 2012 Supply Chain Metrics That Matter on contract manufacturing. In its research, SCI collected financial data from 2000-2012 from contract manufacturers (CMs) listed in the Fortune Global 500. By the end of the report, SCI warns brand owners to “tread carefully” when it comes to CMs. What information did they reveal about the industry?
The business models for most CMS look different today than they did twenty years ago. According to Abby Mayer’s SCI report, “the contract manufacturing industry grew up out of a desire to mitigate risk and improve costs for brand owners.” It is standard for many OEMs today to use CMs for their products. However, between heavy competition and a shift in market needs, CMs are struggling. Rather than focusing on cost, -the bottom line for brand owners – CMs have tried differentiating themselves in capabilities. This approach fails to create financially stability, and creates a lack of resiliency in contract manufacturing.
Variability in Supply and Demand
As stated in the SCI research, “companies want to grow, increase profitability, reduce cycle time, and improve their ability to manage complexity in operations.” Contract manufacturers are failing to reach these goals; SCI research attributes it to CMs’ difficulty in maximizing inventory turns and operating margin.
Based on the current business model, CMs may not pull out of their slump. With the level of competition out there, CMs have to work increasingly harder to keep their contracts. Most of the contracts are short-term, and each is integral to the success of the CM business. If a CM were to lose just one large account, the entire business would suffer. In order to stay competitive, CMs need to lower cost, guarantee on-time delivery, and ensure a quality product. A lot of this is gained by increasing inventory. However, products are changing so rapidly that excess inventory at the end of a contract is often unusable for future contracts. Change in demand of existing supply in itself makes it difficult for CMs to achieve optimal operating margins.
With the way contract manufacturing currently works, the cutthroat competition in the industry, and the changing demands of the market sectors, SCI suggests that contract manufacturing as a whole is instable. Without changing the business model, experts warn brand owners that their businesses are at risk with the current state of contract manufacturing.
Other concerns for Brand Owners and OEMs
With the dependency on CMs, brand owners have a lot on the line when choosing the right contracting manufacturer. Several factors are often misunderstood in this process. In the Industry Week article, “The Top 10 Myths About Selecting a Contract Manufacturing Partner,” Ron Keith discusses common misconceptions. A few correlate directly with SCI’s report.
- CMs need to be managed by the contract-holding company. The SCI report points out that brand owners have given up control not only of product manufacturing, but inventory control, crisis management, and several other aspects of the process to CMs. The report discusses the importance of changing the relationship between CMs and brand owners. “While companies can outsource the role of manufacturing, they cannot outsource the responsibility of managing the extended supplier network.” Keith’s article states, “OEMs that get the best results, and that express the highest level of satisfaction with their CMs, are ones that structure their own operations organization to effectively manage outsourced manufacturing.”
- Cost is not determined by the quote price. Cost is a recurring theme in matters of any business. With CMs competing to win bids on a decreasing pool of clients, per-unit price quotes make a job look less expensive than it is. Keith states, “I’ve seen many instances where going with a per unit quote price that was 2 points lower ended up costing an extra 5 points in other less visible costs – both internal and external.” Price quotes need to be scrutinized to find the true cost of a job.
- It’s OK to choose a CM who is also contracted by a competitor. CMs are the most stable and inexpensive when they can maximize production. Additionally, CMs manufacturing for a competing brand owner gain a level of expertise about the product. Keith states, “OEMs should find the most broadly capable and compatible CMs for their specific business and often times this means building with the same company as one of your competitors.”
- OEMs need to more proactive in their search for CMs. Keith’s article points out that a contract manufacturing sales team may deliver the most dazzling pitch, but the prowess of the sales team is not necessarily a reflection on the production and output of the CM. A complete sales pitch should include a meeting with the operations team, checking references, and any other available way to vouch for a company’s reputation.
Outsourcing isn’t going away any time soon. However, contract manufacturers and their partnering OEMs face dire consequences if they don’t re-evaluate their business models. Unless a brand owner is going to bring manufacturing back to home base, the company will need to become a more active part of the outsourcing process. As SCI states, “It is time to redesign the business model and relationships of contract manufacturers and brand owners.”
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