Article
Guide to outsourcing production
Content
Introduction
This guide aims to briefly introduce some of the most critical considerations in connection with the possible outsourcing of (parts of) your production. Which of the specific considerations will be relevant to you depends, of course, to some extent on your industry and your product. Still, some of them must be regarded as “mandatory reading.”
While a brief introduction to such a comprehensive topic cannot be exhaustive, this guide is designed to serve as a solid starting point for many of the most important considerations.
The guide is primarily aimed at startups, entrepreneurs and people with limited knowledge of the subject. Still, it may be helpful as a short checklist or a source of inspiration for people from more established companies with some understanding of the subject.
DEFINITION
Outsourcing refers to a company outsourcing the production of a product to an external partner, a contract manufacturer, either domestically or abroad. The term contract manufacturer is equivalent to the more common English term contract manufacturer.
The services offered by a contract manufacturer may be limited to the actual manufacturing processes (casting, milling, design and sourcing of electronic components, assembly, etc.). Still, they often include supportive services such as logistics or technical advice. Some contract manufacturers also offer actual product development services to provide their customers with complete solutions from design to finished product – these are also known as Original Design Manufacturers (ODMs). Contract manufacturers only offering production services are also known as Original Equipment Manufacturers (OEMs).
Possible benefits of outsourcing production
Reduction of Time to Market
Time to Market refers to the time it takes from a product idea to a finished product. By utilising a contract manufacturer’s existing production capacity and technical expertise, you avoid the cost of financing and building this capacity internally, along with the many considerations and tasks involved: establishment of facilities, equipment procurement, recruitment of personnel with the right skills, establishment and development of a supplier base and supply chain, acquisition of necessary product and manufacturing certifications, organisational structure, and the work of integrating all these elements into a well-functioning and sustainable production setup. Additionally, a contract manufacturer’s experience and technical expertise can often be a precious resource during the product development phase, helping you increase the value of your product, shorten the required time for product development, optimise your product design, and ensure a more streamlined transition from development to actual production. As mentioned above, some contract manufacturers also offer actual product development services.
Lower Costs
In most cases, a contract manufacturer should be able to produce your product at a lower cost than you can. In some cases, this may be the primary reason why you are considering outsourcing. These lower costs can be due to a lower wage level (often when outsourcing production to another country), more incredible experience, better facilities, capacity costs spread over a larger production volume, etc.
However, some of the savings from manufacturing the product may be lost to other costs, such as increased shipping and logistics expenses, taxes, customs duties, the need for stricter quality control, etc. Therefore, when evaluating the profitability of outsourcing, it is crucial that all relevant costs associated with the product’s journey from manufacturing to the consumer are considered.
Total Landed Cost
The sum of all costs associated with manufacturing and delivering a product until it generates revenue.
Scalability and Flexibility
For many companies, the desire to scale production is an essential reason for outsourcing production. In other words, it enables them to quickly and relatively risk-free access greater production capacity as their market grows. By “relatively risk-free,” we mean that they do not risk the significant investment that scaling production themselves can entail when they are unsure what the future holds – or to what extent. However, it is essential to be aware that there may be a correlation between the size of the revenue you bring to a contract manufacturer and the priority you will be given relative to the manufacturer’s other customers. It is essential, therefore, to discuss and align expectations regarding topics such as revenue volume, possible fluctuations, and (expectations for) future growth before agreeing.
In addition, it is important to be aware that different contract manufacturers may vary not only in their willingness to scale production further but also in their ability to do so. This can be influenced by their financial situation, personnel resources, supply chain, strategic priorities, and the culture and competencies of owners and management. As in so many other cases, some homework will need to be done to ensure that a potential future partner is evaluated fairly accurately.
Focus
Outsourcing kan hjælpe jeres organisation til at fokusere på de vigtigste aspekter af jeres forretning ved at overlade en række opgaver forbundet med håndtering af produktion, forsyningskæde og levering til en dygtig og pålidelig kontraktproducent. Det er dog værd at være opmærksom på, at de indledende stadier med etablering og udvikling af partnerskabet og dets setup kan være mere tidskrævende end forventet.
Possible benefits: Summary
Reduced time to market
Reduction of Time to Market through existing external production capacity, technical expertise, and possibly product development competencies.
Lower costs
Savings on variable and fixed costs through contract producers’ economies of scale, expertise, experience, and possibly lower personnel costs
Scalability and flexibility
Better opportunities for (and fewer risks in) scaling production.
Focus
Capacity to focus on the most critical aspects of your business by delegating (parts of) production and supply chain management.
Possible disadvantages of outsourcing production
Trust and Control
Outsourcing the production of a product naturally involves some distance from the centre of events. Several of these benefits have been discussed above, but there are, of course, disadvantages.
Although good collaboration with the contract manufacturer can give you a good sense of “how things are going” and at the same time can and should ensure that you are deeply involved at essential points and milestones in the project, some of the control you would have in in-house production must be replaced by trust in the external partner – and all other things being equal, the importance of that (well-founded) trust will increase with the complexity of the development and production you need to succeed with together.
It is, of course, a good idea to establish mechanisms or procedures that ensure that you have the necessary insight into the process, for example, through (possibly contractual) agreed milestones, timeframes, and reporting requirements.
Language and Culture
Suppose you are considering outsourcing your production to another country. In that case, you must ensure both the contract manufacturer and you have a clear and shared understanding of what has been communicated and agreed upon. Language barriers and cultural differences can be sources of misunderstandings, which can be harder to address than one might think.
Note that in several countries where it is not the norm to speak English at the same relatively high level as in Denmark, the person responsible for communicating in English may not necessarily have the necessary expertise to discuss the project in all its details without consulting more technically proficient colleagues.
Intellectual Property (IP)
By taking the initiative to assess a contract producer’s integrity and credibility, you’re not just mitigating the risk of involuntarily sharing your intellectual property but also taking control of the situation. This relational level of protection empowers you to make informed decisions about who you work with.
In addition to doing this through meetings, visits, and communication, one should gather as much information about the company as possible (financial situation, references, possible press coverage, etc.). Note that language barriers, cultural differences (discussed above), and other specific circumstances in another country or region will typically make assessing a potential partner’s credibility more difficult.
Understanding the legal protections available for your intellectual property can provide a reassuring layer of security. It’s essential to be aware of the differences in how effectively different countries’ laws and authorities protect intellectual property rights. Still, with this knowledge, you can navigate these complexities with confidence.
Before deciding to primarily or exclusively protect one’s intellectual property rights through legal means, it is crucial to have competent (local) legal advice with a deep understanding of the scope of the protection available from both laws and authorities. At the operational level, to a certain extent – and if the product allows for it – one can protect oneself by, for example, sourcing different core components from different suppliers and using a contract producer for standard parts and assembly.
The feasibility of this method varies significantly from product to product. Still, the basic idea is to break up one’s intellectual property into several pieces so that no component supplier or even a contract producer responsible for final assembly will have too easy a time copying one’s product.
Inadequate Quality Control
Not all contract manufacturers will live up to the strictness of quality control that you expect or would implement if production were internal. This can lead to increased costs and delays.
While most contract manufacturers and suppliers have some form of quality assurance system, the level can vary significantly. This is particularly true in some countries where the bottom line may be lower than what we are accustomed to in Denmark. To mitigate potential deficiencies and errors, it’s essential to proactively ensure the necessary level of quality assurance at the contract manufacturer and verify that the related procedures are followed.
If the existing procedures at the contract manufacturer do not meet your requirements, there is potential for improvement. By exploring the manufacturer’s willingness to commit to raising the level of quality assurance, you can develop a plan for implementation and expectations. This collaborative approach can enhance quality control and a more successful outsourcing experience.
Many contract manufacturers are able to produce and quality-assure their production in accordance with the highest standards, but this level of quality will, of course, be accompanied by a corresponding price range and/or requirements for the turnover you bring with you.
As in other areas, it is essential to ensure that capability and price range suit your needs. See also the sections on strategic “fit” and relationship building below.
Longer lead time
Lead time is the time it takes from the beginning to the end of production or delivery. It depends on supply chain management, production processes, the capacity of the contract manufacturer, and shipping time. Some parts of lead time can be optimised through planning or building appropriate storage of production inputs. Still, sudden changes in demand cannot be fully addressed through planning or storage agreements.
SUPPLY CHAIN RISKS
Any production setup—internal or external—relies on the timely delivery of the right components and materials. The risk of delays, price increases, and other problems caused by supply chain issues varies depending on the manufacturer’s supply chain and ability to handle it. As in different areas, it is a good idea to familiarise oneself with the manufacturer’s competencies and resources and, where possible, seek references that can provide a reasonably accurate picture of their past performance with existing customers.
Price increases
A contract manufacturer may choose to increase prices for various reasons, such as increased costs for materials, components, or labour or to increase revenue from a project that requires more resources than anticipated. This may result in sudden price increases that the outsourced company may need help predicting or addressing with short notice. It is a good idea to have future price increases contractually regulated.
Commitments
Contract producers typically ensure a certain income from a customer to guarantee their own profitability. This can be expressed in an agreement that the customer commits to buying a certain minimum of produced units annually, ordering a more specified minimum of units per order, and that the collaboration can only be terminated after a certain number of years.
This can pose a problem if such an agreement does not include clauses under which these obligations can be deviated (e.g. if the producer does not meet certain requirements). It should be noted in this context that it can be quite important to ensure that the contract establishes that any production tools belong to the customer, as ownership of these can be crucial to one’s ability to move to another producer without significant time costs.
Possible drawbacks: Summary
Trust and control
There is less control over production and less insight into processes and workflows, and it is dependent on the contract manufacturer’s willingness to share information.
Language and culture
There are possibilities for misunderstanding due to language barriers and cultural differences.
Intellectual property (IP)
Risk of copying or production and selling the same product to other customers and oneself.
Inadequate quality control
Risk of contract manufacturer’s inability or unwillingness to continue to meet agreed quality requirements.
Longer lead time
Under certain circumstances, it can be longer – mainly due to the geographical distance between the producer and the end market.
Supply chain risks
Risk of, among other things, delays and quality issues due to problems in the manufacturer’s supply chain
Price increases
There is a risk of unforeseen price increases due to, for example, the contract manufacturer’s increased costs or dissatisfaction with the project’s progress.
Obligations
Contract manufacturers will often require the customer to commit to purchase volume and agreement length. This can be a problem if the cooperation does not work. Agreements should include clauses ensuring the customer can terminate the cooperation under certain conditions. Ensuring the customer can
Requirements Clarification
Product Development
If you are considering outsourcing your product development or parts of it to a contract manufacturer, it’s a good idea to define what functions and other properties are required, as well as the requirements the product needs to meet (for example, the cost per unit the developed product must be able to be manufactured for). If parts of the development process include user-driven design, criteria for the first product version should be established, a plan should be made for how initial product versions will be produced, how user feedback will be obtained and incorporated into development work, and how work will be coordinated between your employees and the contract manufacturer’s employees.
Unit Price and Tool Costs
Whether or not you communicate a target price to the individual candidates during the bidding process, it’s a good idea to have an idea of what you need to achieve to make everything work – in the market and for your company. In addition to their own profit, the unit price offered by the contract manufacturer will typically include expenses such as materials and components, labor, capacity costs, quality control, and any costs related to customs, shipping, etc. You may not necessarily be given an overview of the various items that make up the overall price or the weight with which they are included – and even if you are given one, it may not be 100% accurate. The price you want the manufacturer to be able to manufacture your product for is first and foremost dependent on your own needs, but it will be helpful in negotiations with a potential manufacturer if you have an understanding of the elements that are included in their pricing. Tool costs can vary, especially between different countries. For certain larger tool costs (such as die casting), it will often be specified how many product units need to be produced before a new tool needs to be purchased.
Lead Time
The required production and delivery time depends on the individual product. A number of factors all play a role in assessing what is an appropriate lead time for both production and delivery. Factors include manufacturing processes, product complexity, contract manufacturer production capacity, supply chain, minimum order quantity required, and of course your own need to be able to bring your product to market in the best possible way.
Strategic Match
What type of contract manufacturer do you need? What services and how much capacity do you need in the short, medium and long term? Is the manufacturer able to meet the requirements? And at what price and when? In the event that they do not meet all your requirements, are you such an interesting customer that they will be willing to develop with you? Does their current customer portfolio and history indicate they are a good match? These are examples of the considerations you should make when assessing whether a potential manufacturer is a good match for your company, your product, and your future plans. It will generally be a good idea to base your strategy for both sales and your company’s development on which characteristics and competencies and which type of relationship you are seeking with a manufacturer. This can form the basis for a list of characteristics that you can use to systematically evaluate whether there is a good match between you and a given candidate.
Communication
What are your expectations regarding response time, transparency, and communication efficiency? Some expectations can be quantified and included in an agreement. Other requirements – for example, a generally proactive and positive approach to your inquiries – may be difficult to define, measure, and commit a manufacturer to, but if you know what you are looking for, it will be easier to ask the right questions and easier to assess a potential partner’s ability and willingness to meet your needs. As indicated above, this is a topic that requires special attention if you are considering a manufacturer in another country or with a different culture.
Relationship
The considerations in this section are partially addressed above in the sections regarding trust and control and strategic match. When determining what type of relationship you want to create with a potential manufacturer of your product, consider what is required to make your project a success. For the production of a relatively simple product that is already fully designed and requires only or largely sourcing of standard components and relatively simple assembly, the requirements for the relationship will be different if a complex product with a large number of custom-made parts and components needs to be designed, developed and manufactured. The more coordination and collaboration the project requires, the greater benefit you will be able to draw from a close and trusting relationship. This will usually require a higher degree of transparency and openness from both sides.
Certifications and Standards
Make sure you have clarity about which certifications and standards are required or relevant in the markets you wish to sell your products in. Even in cases where it is not legally required for a product or the production of a product to comply with a given standard, it can be conducive or even essential to the success of your product. Certifications and standards may relate to a wide range of aspects of both your company, your product, and the conditions under which it is produced.
Requirements clarification: Summary - important areas
Needs related to potential product development
Tool cost unit prices
Lead time
Strategic match
Communication
Relationship
Certification and standards
Selection of contract manufacturer
Research
Sparrring with individuals who possess relevant production experience can provide valuable insight into the challenges and opportunities associated with manufacturing a particular product or type of production. There are often numerous opportunities to gather knowledge from experts in the field, such as suppliers in similar or related areas, or those who have worked within relevant industries. In addition, there are a wide variety of resources that can prove useful in the quest to find potential producers, including industry organizations and networks, social media platforms, professional networks, relevant trade shows and conferences, industry and production journals, business incubators, consultants, and your own personal network.
Create a shortlist of 5-10 candidates
Research potential suppliers and compile a list of 5-10 candidates who offer the desired services and possess the relevant resources and expertise. In this initial phase, factors that are relatively easy to obtain information about can be considered, such as location, product portfolio, customer cases and references, essential personnel resumes, and company reputation.
Reduce to 3 candidates
When narrowing down your shortlist, conducting thorough research and evaluating candidates’ services, skills, and finances is recommended. This can be done by contacting industry organisations, contacting references on the manufacturer’s website, or researching company databases. Direct communication with potential manufacturers can also be an excellent way to gain insight into the company, its employees, and its competencies. You can initiate contact with a brief project overview and a few questions to open up relevant discussions.
Preparation of tender material
Make sure to gather all necessary documentation; product and part specifications, drawings and models, certification requirements and more, and include material that, together with ongoing dialogue, puts the manufacturer in the best possible position to understand your product and its requirements. In many cases, it may be relevant to secure a signed non-disclosure agreement (NDA) before submitting material.
Visit
Physical visit provides an important opportunity to confirm or re-evaluate one’s impressions and previous assessment of the producer. It is also an important first step in potential collaboration to obtain a deeper understanding of the producer’s setup, culture, and processes by getting to know people better, seeing the place, and discussing important issues face-to-face.
Assessment of Bids
Assessment of bids involves evaluating price, delivery times, payment terms, and other concrete and obvious parameters. It also involves assessing the quality of the considerations that underlie the bid. That quality can, for example, be expressed in accommodating the topics and possible challenges that have been discussed in correspondence and at meetings, and it can be expressed by the framing of the overall process, as it appears in the bid, displaying care and professionalism.
Negotiation
Negotiating with potential partners, of course, involves discussions of the specific terms of an agreement in order to reach a consensus on the project’s scope, timelines, costs, and goals. There are thick books written on the subject, and it is beyond the scope of this guide to explain the art of negotiation. However, it is important to be aware that this is again one of the areas where understanding the other party’s culture, traditions, and language can be extremely important.
Selection of contract manufacture: summary
Research
Preliminary list
Candidate narrowing
Preparation of tender material
Visits
Evaluation of offers
Negotiation
