Manufacturing is typically broken down into two models: contract manufacturing and vertical manufacturing. In a vertical manufacturing model, brands own the factories that produce their goods. Contract manufacturing, conversely, is a production model where a brand contracts out manufacturing to an external firm to deliver final outsourced finished goods. Contract manufacturers doing final assembly are often called co-packers. Contract manufacturing can be thought of as equal parts production model and equal parts business model. At the simplest level, the difference between an in house operation and contract manufacturing operation can be highlighted like this:
In House Operation
In-house manufacturing means that a brand owns and operates the factories that manufacturer their products. Because of this, they are directly responsible for coordinating with upstream suppliers.
While external vendors such as 3PL's are often used to transport raw materials from upstream material suppliers to the manufacturing plants (almost any brand with in-house manufacturing still uses 3PL's except for a few major giants s/a Coca Cola, Anheusaur Busch Inbev, which own logistics in house), .
Benefits of in-house manufacturing include wider margins, more visibility and control over the supply chain, and ability to align all of your manufacturing plants with your brand's vision.
Conversely, a standard contract manufacturing model can be depicted this way:
Contract Manufacturing Model
In a contract manufacturing model, the brand outsources some part, if not all final production, to a contract manufacturer. There's then a joint responsibility between the brands and their contract manufacturers to source upstream suppliers and coordinate the transfer of goods to the contract manufacturing factory.
Contract manufacturing, while once balked at because of higher margins and operational complexity, has now become the default method of manufacturing for most brands. Imminent benefits to the contract manufacturing model include: being able to quickly spin up manufacturing lines without huge CapEx, having the agility to change suppliers or processes relatively easy to keep up with consumer demand, and having the flexibility to launch additional products or increased production.
Contract manufacturing has enabled new brands to quickly get off the floor and start producing goods without first requiring massive amounts of investment in infrastructure.
However, contract manufacturing has been historically notoriously difficult to scale. Operational complexity grows exponentially as you go from one contract manufacturer to two to three. The complexity of your operation compounds as you start to launch more and more products.
That said - a number of the world's largest enterprises have proven that contract manufacturing can scale and can be incredibly financially and operationally lucrative as well. The two companies probably best known for their contract manufacturing base are Apple and Nike. Both Apple and Nike have scaled from being small, fledgling startups (running a glorified import business in Nikes case, and manufacturing in-house in Apple's case) to being two of the arguably best known brands with massive contract manufacturing bases.
Both companies were able to do this through two strong, over-arching philosophies: strong process and strong supplier relations. Strong supplier relations allow for tremendous alignment between brands and their manufacturing base. This often ends up with brands getting favorable terms around financing, allowing them additional flexibility in their balance sheets and inventory levels. Brands typically use this flexibility to keep less active inventory on hand, therefore increasing their operational margins and lowering enterprise risk.
If strong supplier relations allows brands to move with financial flexibility, strong process enables brands to move with agility as contract manufacturing scales up. A brand's process when utilizing contract manufacturers can be split into four/five main operations: product development, new product introduction, mass production/continuous ordering, production scaling, and production wind down.
Most of these processes have historically been governed by a team of production/product/supply chain managers with a holster of spreadsheets helping them along the way. About 40 years ago, software giants Oracle and SAP released the first versions of ERP/MRP/Procurement systems to help guide these processes. In the early 2010's - these giants started re-releasing cloud versions of their softwares and new players like Ariba, ScoutRFP, Coupa, Bonfire, Anvyl, Arena, Backbone, etc joined the incumbents in building process automation software for different stages of the production chain.
These softwares were adopted en masse by brands - each in the pursuit of building a process within a company's identity while scaling a contract manufacturing base. As platforms like Shopify continue to enable the e-commerce infrastructure and more companies pop up that don't consider manufacturing and supply chain to be a core competency, there's strong reason to believe that the use of contract manufacturing will continue to grow.
Rather than shy away from it and think that as a brand, one day you'll have to internalize manufacturing - lean into developing strong supplier relations and putting process (and process software) in place to help you scale your operations, and watch contract manufacturing help you scale your business faster than you could have otherwise.