What to look for in a manufacturing contract

What to look for in a manufacturing contract

From the different types of manufacturing agreements to the type of manufacturer itself, manufacturing contracts are confusing! Dive into some helpful tips!
Terry Jeffords

Contract manufacturers (CM) take ideas and turn them into reality by providing manufacturing services like packaging, warehousing, and distribution. However, CMs are businesses just like yours — they have their own goals, needs, and challenges that can impact how well they work with you as a partner. If you want to succeed with your manufacturing business relationship, here are some things to consider:

What is a manufacturing contract?

A manufacturing contract is a legal agreement between a business and its supplier. It’s essential to running any business and can help you stay on budget and avoid unexpected costs.

A manufacturing contract lays out who does what, when it must be done, how much each party is responsible for, and who pays for what. A good manufacturing contract will also include:

  • Delivery dates: The time frame in which your product needs to be delivered should be clearly defined in the contract so that both parties are clear on what’s expected of them at all times, as well as specific milestones along the way.
  • Quality standards: Established by both parties upfront will help minimize problematic issues later down the road (like getting sued because something didn't meet expectations).
  • Quantity requirements: Be sure they're stipulated clearly enough so there aren't any misunderstandings later on down the line either!

Benefits of a manufacturing agreement with your CM

The benefits of a manufacturing agreement with your CM can be substantial:

  1. Cost-Effectiveness: Contract manufacturing can often be more cost-effective for customers compared to setting up their own manufacturing facilities. Contract manufacturers typically have specialized expertise, equipment, and facilities, allowing them to achieve economies of scale and reduce production costs. Customers can leverage these cost advantages without having to invest in their own manufacturing infrastructure.
  2. Expertise and Resources: Contract manufacturers often have specialized expertise and resources in manufacturing processes, technologies, and quality control. They may have experience in producing a wide range of products and can provide valuable insights and recommendations to optimize production processes, improve product quality, and enhance efficiency. This expertise can help customers streamline their manufacturing operations and deliver higher quality products to the market.
  3. Flexibility and Scalability: Contract manufacturing provides customers with the flexibility to adjust production volumes based on market demand. Customers can scale their production up or down quickly and easily without having to invest in additional manufacturing capabilities or deal with the challenges of excess capacity. This agility allows customers to respond to changing market conditions effectively and efficiently.
  4. Focus on Core Competencies: Outsourcing manufacturing to a contract manufacturer allows customers to focus on their core competencies, such as product design, marketing, and sales, while leaving the manufacturing aspects to the contract manufacturer. This enables customers to allocate their resources and efforts strategically and concentrate on areas where they have a competitive advantage, leading to overall business growth.
  5. Reduced Risks: Contract manufacturing can mitigate risks associated with manufacturing, such as investment in capital-intensive equipment, production variability, and changing regulations. Contract manufacturers are responsible for managing production risks, ensuring compliance with quality standards and regulations, and maintaining necessary certifications, reducing the burden on the customer.
  6. Speed to Market: Contract manufacturers are typically equipped with established manufacturing processes and supply chain networks, which can accelerate the time to market for customer's products. This can be particularly beneficial in industries with rapidly changing technologies or short product life cycles, allowing customers to quickly introduce new products or respond to market opportunities.
  7. Confidentiality and Intellectual Property Protection: A well-drafted manufacturing agreement can include provisions for confidentiality and intellectual property protection, ensuring that the customer's proprietary information, trade secrets, and intellectual property rights are safeguarded. This can be critical in industries where protecting intellectual property is crucial for maintaining a competitive edge.

Read more about how to choose a contract manufacturer in our blog post here.

Key components of a contract manufacturing agreement

A contract manufacturing agreement (CMA) is an important legal document that outlines the relationship between a manufacturer and the company they are producing products for. It's important to note that the specific content and provisions in a contract manufacturing agreement may vary depending on the nature of the products being manufactured, the industry, and the parties involved. It's always recommended to seek legal counsel and customize the agreement to suit the unique needs and requirements of the customer and the contract manufacturer.

Here are some key components that you'll likely include in your CMA:

Essential processes

The contract manufacturing agreement should outline the essential processes that will be carried out by the contract manufacturer on behalf of the customer. This may include details on manufacturing processes, such as production methods, testing procedures, packaging requirements, and shipping procedures. It should also specify the responsibilities of each party regarding materials sourcing, inventory management, and production scheduling. Clear and detailed descriptions of the essential processes are critical to ensure that both parties have a shared understanding of how the manufacturing will be executed.

Licensing agreements

If the customer's product requires the use of any proprietary technology, software, or intellectual property owned by the customer or a third party, a licensing agreement may be necessary. This could include licenses for patented technology, copyrighted software, or other proprietary information that the contract manufacturer needs to use in the manufacturing process. The contract manufacturing agreement should include provisions that outline the terms and conditions of such licensing agreements, including any restrictions, rights, and obligations related to the use of licensed technology or intellectual property.

Non-disclosure agreements

Non-disclosure agreements (NDAs) are crucial to protect the confidentiality of the customer's proprietary information, trade secrets, and other sensitive information shared with the contract manufacturer. The contract manufacturing agreement should include comprehensive NDA provisions that outline the obligations of both parties to maintain the confidentiality of the information exchanged during the manufacturing process. This may include restrictions on the use, disclosure, and reproduction of confidential information, as well as provisions for dispute resolution and remedies in case of a breach.

Purchase orders

The contract manufacturing agreement may reference purchase orders, which are typically issued by the customer to the contract manufacturer to specify the quantities, delivery schedules, and pricing of the products to be manufactured. Purchase orders provide a detailed framework for the manufacturing process, including specifications, quantities, and timelines, and they can be incorporated by reference into the contract manufacturing agreement. The agreement should outline the process for issuing, accepting, and modifying purchase orders, as well as the responsibilities and liabilities of both parties in relation to purchase orders.

Quality standards

The contract manufacturing agreement should specify the quality standards that the contract manufacturer must adhere to in the manufacturing process. This may include industry-specific quality certifications, performance specifications, and testing requirements. The agreement should outline the customer's expectations for product quality, including specifications for materials, workmanship, and performance, as well as the procedures for inspection, testing, and acceptance of the manufactured products. It may also include provisions for addressing quality issues, such as non-conforming products, warranties, and remedies in case of quality-related disputes.

The most popular manufacturing contracts

Although there are other types of contract manufacturing agreements, they tend to fall into one of these four categories: OEM pricing model, fixed materials pricing, component cost pricing, or cost-plus pricing.

OEM Pricing Model:

OEM stands for "original equipment manufacturer." It's a pricing model for hardware companies and contract manufacturers that allows the company to buy a product from another company, then sell it under their own brand.

Fixed Materials Pricing:

This is a common way to get a price quote for your product. The manufacturer will provide a list of materials they use and their prices, then you can decide how much profit margin you want to make on each unit, and the cost per unit will be calculated automatically. This is great because it allows you to see exactly where your money is going at every step of the process.

Component Cost Pricing:

This is a little more difficult to calculate because it depends on how much your components cost. It allows you to price your products based on the cost of the components used to make them. This means that if you buy your parts at a lower price, you'll be able to sell your product at a lower price, too.

Cost-Plus Pricing:

This is a pricing method that allows you to set a profit margin and then add on the cost of materials and labor. This is great if you want to make sure that your product is profitable but don’t want it to be too expensive for consumers.

Make sure you can get out of the contract if you need to

Regardless of the type of manufacturing agreement, when you're reviewing a contract, make sure that the terms allow you to get out of the contract if things don't go according to plan. It's best to create a trial run before signing a long-term agreement. Make sure that the payment terms are clear and easy to understand so there are no surprises at the end of production. Also, give yourself enough time for review and edits—this process can take longer than expected!

Give yourself enough time for review and edits

When you’re reviewing and negotiating a manufacturing contract, you need to make sure that you have enough time to review all of the terms and conditions. This includes understanding how much time it will take to make a prototype, how much money is set aside for design changes, who covers the cost of shipping and insurance, etc. All of these things can affect your bottom line—so be sure to give them ample consideration!

If you have any questions about anything in the contract be sure to contact a registered lawyer.

Things to watch out for

One of the most common issues we see with manufacturing contracts is that they often overcharge because of their negotiating power. For example, if you want them to take on alternate component sourcing, they may offer this component shortage risk mitigation as a service but charge way too much money. In addition, since most CMs pass on the cost of components to their OEM clients with a markup, they aren't incentivized to drive down their materials input cost. In fact, they have an incentive to inflate it! 

Solutions like Amplio's BOM tool provide an easy way to keep an eye on market prices for the components of your BOM. Every OEM and CM needs to keep a record of the BOM on which they're collaborating, and even if you as the OEM aren't manufacturing your product, our BOM tool will show you how much components should cost. You can compare that to what you're being charged by your CM, and if you see big discrepancies, the tool will tell you where you can buy components for cheaper. You can then send that recommendation to your CM and reduce your COGS.

On top of that, contract manufacturing agreements will often stipulate that if a component runs out of stock at the CM's approved vendors, that it's the OEM's responsibility to find the components and ship them to the CM to keep production running. Without a smart BOM tool like Amplio's instantly showing you available inventory, this request from your CM may leave you off-guard and with a costly delay. With our PartSecure service, we even will navigate the secondary market of brokers for you to find components that are out of stock with all authorized distributors.

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