Co-manufacturers in S&OP/ IBP: Friends or Enemies?

Feb 23, 2024 | S&OP/ IBP

Contract Manufacturer

Did you know that Nike outsources 100% of footware and apparel manufacturing? The contract manufacturing industry is like secret AI, growing fast but just a few talk about it.

Research indicates that this market was valued at $211.9M in 2021 and it is expected to grow to $362.72M by 2029, at a CAGR (compound annual growth rate) of 6.95%.

In the 2023 Supply Chains to Admire, Supply Chain Expert Lora Cecere highlights that “over the last decade, with a 3% margin and a 1% growth rate, contract manufacturers experienced a 200% increase in growth during the pandemic.”

In addition to being challenging, this substantial growth implies that chances are that your company is or will be working with co-manufacturers—also known as co-mans.

In this article, we will cover the following:

  • Which is your co-man type?
  • What are the advantages?
  • What are the challenges?

Which is your co-man type?

Having been on both sides—working with clients’ contract manufacturers and having contract manufacturers as clients, I can attest that companies use different terminology.

Contract manufacturing is when a company fully or partially outsources production. There are mainly two types that are contract manufacturing itself and toll manufacturing.

In working with multiple co-mans, the same company could adopt both contract and toll manufacturing.

Contract Manufacturing

In contract manufacturing, the company outsources production including the sourcing and management of the raw materials.

The co-man’s role consists of processing by following the specifications provided and ensuring quality and availability of the raw materials. To do so, the co-man has a procurement team responsible for acquiring the right raw materials for production.

For example, I have seen this type of contract manufacturing with supplements where the co-man assisted with the formula development (R&D), ingredients acquisition and management as well as production of the finished products.

For some of the supplements, the contract manufacturer helped with the packaging as well.

Toll Manufacturing

In toll manufacturing, the company also outsources production to a third-party. Unlike contract manufacturing itself, the company pays the third-party a toll or fee for the processing services only, as it is the company who takes cares of the procurement of raw materials.

This business model is common among large companies. For example, Johnson & Johnson (J&J) selects and qualifies their raw material suppliers to then “dictate or mandate” them to the co-mans for processing. By doing so, J&J ensures that the raw materials’ quality meets the company’s standards.

Private Label

Great Value, Equate, Sam’s Choice are all private labels at Walmart, for example. Private label is when a co-man produces goods under the company’s brand. This is very common in retail.

What are the advantages of contract manufacturing?

When companies are experiencing fast growth—either organic or by acquisition—the demand outpaces supply.

Contract manufacturing is a potential solution to add production capacity quickly to reach balance between demand and supply in S&OP/ IBP.

In advanced S&OP, the team runs what-if scenarios to understand the impact on the financials of adding capacity through co-mans.

With contract manufacturing, the company avoids capital expenses (CapEx) and it has more flexibility to scale up or down in comparison to owning manufacturing facilities.

There are companies that use the contract manufacturing model to gain a competitive advantage with a longer strategic perspective.

Nike is one of the most well-known examples for being a pioneer in this area. Other high-profile examples include Adidas and Under Armour.

Contract manufacturers offer additional advantages including their expertise in manufacturing and taking care of running the plant, by managing machines, labor, and schedules.

All these advantages make contract manufacturers “friends”. However, they can also turn into “enemies” when considering the challenges.

What are the challenges?

Working with contract manufacturers poses challenges in two key areas: inventory management and planning. Let’s look at each of them.

Inventory management

Inventory management is fundamental because it impacts the bottom and top lines in the P&L. Having waste and incurring in unnecessary costs lead to a lower operating income and margin.

Inventory management also impacts the top line. If the products are not available when needed, there could be lost revenue and lost profit.

a big warehouse

So how well are your co-mans managing inventory? You want an answer for both contract and toll manufacturing.

As in contract manufacturing inventory management is on the co-man’s hands, you want to ensure that their performance meets your company’s requirements.

This implies not only a strong qualification process but also an on-going supplier performance evaluation. From the financial perspective, I wrote about potential liabilities in this article.

Although in toll manufacturing the co-man doesn’t source the raw materials, the efficient use of resources is important to avoid unnecessary losses.

In this case, the company owns the raw materials/ inventory and the co-man should be a good guardian of it.

Planning

When working with co-mans, there is less control as opposed to having internal manufacturing. The company depends on the co-man’s schedule.

For example, the company may have an urgent order for a large customer, but the co-man is unable to prioritize such an order, even when the company is willing to pay higher fees.

This example also helps to illustrate the importance of building a collaborative relationship with your co-mans. Another example is effectively communicating changes in packaging and more broadly, all related to change management.

Of course, another challenge is the data for S&OP coming from the co-mans. They generally have their own part numbers and may use different formats, reports, frequency, among other factors.

This increases the time that planners put into cleansing, formatting, and aggregating data coming from different sources.

Conclusion

Contract manufacturing has had an explosive growth. There are two main types that are contract manufacturing itself and toll manufacturing.

The key difference lies in the sourcing of raw materials. Working with co-mans has its challenges in inventory management and planning. When addressed successfully, contract manufacturing can catapult your company to substantial growth like Nike.

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