Although companies in many industries rely on contract manufacturing to some extent, few are using it to create genuine competitive advantage. Apple and Amazon employ contract manufacturing to great success, offering high-quality branded electronics (and, in Amazon’s case, a wide range of other private-label products) without incurring the costs and risks associated with owning and operating their own network of manufacturing plants. Working with contract manufacturers can also provide speedy access to new markets and intellectual property, improve innovation speed and results, reduce supply chain costs, and bring products to market more quickly.
It is in the global picture that contract manufacturing is especially critical. In instances where a country restricts imports, contract manufacturing in that locality opens up new markets, a critical aspect of the emerging multi-localism phenomenon characterized by the preference for local communities, industries, products, cultures, and customs (as discussed in-depth in the Kearney Global Business Policy Council research report entitled “Competing in an Age of Multi-Localism”). It is also a tool to reduce supply continuity risk, as it can be utilized to manage demand fluctuations and overcome localized risks such as catastrophic weather, geopolitical crises, and even disease outbreaks.
Yet all of this potential is not being met at present. Below, we look at a number of different industry sectors in light of how extensive or limited their use of contract manufacturing has traditionally been and how much we expect this usage level to change moving forward as companies attempt to achieve competitive advantage in light of projected industry trends and the new environment confronting us all.
Based on Kearney experience and supplemental research, we have analyzed how contract manufacturing is employed in five industry sectors that strongly rely on this practice.
Our analysis shows that these sectors can be placed into one of two groups: those that employ contract manufacturing to a high extent of use and capability and those that do so on the low end. By high extent of use and capability, we refer to the fact that high-tech, pharmaceutical, and industrial companies often employ contract manufacturers for manufacturing for specific product segments if not their entire manufacturing output. On the other end of the spectrum, most companies in the food and beverage and personal care and beauty sectors utilize contract manufacturers to provide excess capacity for peak periods, to make products that have low margins or are at the end of their life cycle, and to manufacture new products that are being market-tested at low quantities.
We expect companies in all five sectors to increase their contract manufacturing activity moving forward for different reasons. Leading contract manufacturers that work in the food and beverage sector are increasing their innovation capabilities, which will lead to co-development opportunities. The amount of private equity investment and consolidation competing in this contract manufacturing cluster is likely to make their services more cost-effective as well, which should attract food and beverage brands looking to reduce the capital they have tied up in their own plants. In addition, as an “essential” industry, food providers need to be able to call upon additional manufacturing capacity in the event of emergencies. Similarly, personal care and beauty companies are increasingly focusing on their branding and marketing competencies by moving away from plant ownership.
Several forces are coming to bear in the pharmaceutical industry. As drugs come off patent, we see companies seeking new cost control and efficiency improvement efforts. A shift toward personalized medicine will lead to lower-volume production runs of specialized medications. Additionally, the COVID-19 pandemic has brought about drug supply security concerns that are expected to lead to a shift toward more localized manufacturing.
In the high-tech world, product life cycles continue to shrink while consumers demand ever-higher levels of customization, which should lead contract manufacturers to further advance both their innovation and production capabilities. We see these manufacturers also deepening their work with other industries that continue to add features to their products, such as automobiles and home appliances.
Enhancing the Value
Wherever a company may be with regard to contract manufacturing, there are likely opportunities to improve its breadth and depth—bringing benefits around risk mitigation, cost and working capital efficiency, and speed to market.
Companies should undertake targeted efforts to achieve more benefits from their contract manufacturing strategy. For example, they can work to optimize the split of internal and contract manufacturing across their product portfolio or geographies. They can employ fit-for-purpose partnership models and contracting strategies. Procurement-focused projects can help to improve contract manufacturers’ sourcing abilities or even pool spend for categories across the broader internal and external manufacturing network to take advantage of the materials supply base. Other focused joint process improvement work, such as manufacturing four-walls improvement, can also be undertaken.
In Kearney’s experience, ensuring that all parts of the extended organization are working harmoniously to enable the desired manufacturing strategy significantly improves both cost efficiency and quality of service. End-to-end operations improvements associated with a contract manufacturing transformation effort can bring a 10% to 25% reduction in total landed costs. Improved planning processes and technological alignment with contract manufacturers can reduce working capital requirements by at least as much. Through collaborative innovation and other techniques, time-to-market for new and improved products can be reduced by 25% to 50%.
Transforming contract manufacturing in order to enhance capabilities requires a blend of art and science. In general, it starts with a scan of industry trends to identify best practices along with a contemplative, honest assessment of the company’s current state. The desired future state can then be defined in order to identify gaps and determine how to reshape the manufacturing strategy. From there, the more tactical work begins as projects to build new capabilities and capture value are identified and scoped and the actual program execution begins. See the figure for more detailed descriptions of staging, sample activities, and a potential timeline.
Crucial Supply Chain Strategy
Each and every company has to decide how best to use contract manufacturing in support of its broader supply chain strategy to achieve competitive advantage. Those that succeed will do so by obtaining flexibility and agility across their manufacturing network to scale output up and down as needed in response to market conditions. They will employ it for risk mitigation by establishing agreements that allow them to pivot away from countries and regions in turmoil. They will look to maximize their own design and marketing expertise to act as sophisticated brands while allowing highly specialized manufacturers to build and move their products.
Leading-edge manufacturers utilize contract manufacturers to produce goods in local markets all over the world in order to mitigate cross-border risks and maximize sales. Those businesses that fail to step up to these possibilities and continue to employ contract manufacturing as a cost
Arun Kochar is a partner and Jesse Chafin is a principal in the strategic operations and supply chain practice of Kearney, a global management consulting firm. The authors express thanks to Nadia Govotsos and Arpit Sharma for their contributions to this article.
