In this kind of transaction, the second company is referred to as the OEM, or original equipment manufacturer.
Contract manufacturers are often used when an original equipment manufacturer (OEM) needs assistance with their manufacturing process. This is a practice often called outsource manufacturing. Outsourcing can be beneficial for both companies involved. The outsourced firm can be a company in the same country as the OEM, but often times it is a foreign company. Sometimes the OEM is not a manufacturing company or does not physically make the product being outsourced.
By purchasing the product from contract manufacturers, the OEM saves money on engineering, infrastructure and assembly costs. In recent years, the global economy has seen more and more OEMs looking to foreign contract manufacturers to manufacture their products. Although many people think of outsourcing as the process of buying products from a company outside of the country, contract manufacturing actually includes any transaction where an OEM has its product manufactured by another company.
Companies in the aerospace, computer, telecommunication, energy, automotive, medical, military and electronic industries utilize contract manufacturing to produce devices that are needed on a daily basis. A few types of contract manufacturing are CNC machining, complex assembly, grinding and aluminum die casting.
Contract manufacturing is many benefits. The amount of money saved is tremendous because the hiring company does not need to pay for a facility or the equipment. They also are not in charge of training, managing and paying a labor force. Many companies look to less developed countries for their inexpensive labor costs.
Another benefit is the contract, often lasting between three and five years. This guarantees steady work and revenue for the hired company. Contract manufacturers have many specialized skills that the hiring company does not possess and are likely to already have business relationships with suppliers, production efficiencies that include quality control and quality assurance processes. The final benefit of contract manufacturing is the ability of both companies to focus on their core competencies.
Contract manufacturing has its disadvantages as well. As soon as the OEM signs the contract it loses control over the manufacturing and quality of the product. This is why it is important to have a good relationship with the other company in the contract. Another disadvantage is the potential of losing your intellectual property because you are allowing others to see your formulas and technologies. Another risk of outsourcing, especially to foreign manufacturers, is the difference of time, language and cultures as well as long lead times.