Contract manufacturing is defined as outsourcing or contracting out the manufacturing services of a business to an external firm, business or third-party vendor. Manufacturing services include manufacturing the product to required specifications, engineering the product and designing and manufacturing the product.
The classic value chain of a manufacturing business is comprised of the following activities: inbound goods, manufacturing, outbound goods and marketing. Other activities such as human resources, finance and R&D are peripheral, and support the core activities of the manufacturing firm. Manufacturing would be the core and secluded activity of the business, with third parties involved in the raw and processed materials necessary for the conversion of the manufactured product. Contracted services in manufacturing is restricted to labor and other allied services.
Contract manufacturing is advantageous for a business, for the business has higher value for its products due to the manufacturing excellence. This is also determined by macro-economic factors such as globalization, increased collaborative environments in the supply chain and the cost economics of dependence on others. Businesses turned to third parties to gain cost advantages, proximity to customers and competence advantages with the vendors.
Contract manufacturing is employed by businesses in consumer as well as industrial goods industries. Industries such as electronics, automobiles and pharmaceuticals utilize contract manufacturing in their collaborative efforts with suppliers. For instance, soap manufacturers outsource to third party vendors and package the soap with their own brand names. Heavy engineering industries such as aerospace involve third-party vendors not only in manufacturing but also in design of components.
Various factors such as increased communication flows between partners through information technology and the need to be near customers have necessitated the presence of third-party vendors in contract manufacturing.