Understanding How to Use Outsourced Manufacturing as a Solution

Outsourcing manufacturing operations is a great way to cut costs and increase manufacturing throughput. There are several ways to do this by using different processes collectively referred to as “contract manufacturing.” But are they all actually contract manufacturing? As organizations start to configure their cloud solutions, they will need to have a thorough understanding of each flavor of outsourced/contract manufacturing and how they apply.

In the world of the Oracle Manufacturing Cloud, outsourced manufacturing is grouped into the following areas:

• Sourced Manufacturing from Original Equipment (OEM)
• Outside Processing (OSP)
• Drop-ship Manufacturing
• Contract Manufacturing
• Toll Manufacturing

Each one of these processes is unique. Here’s a quick breakdown of each type:

 
The best way to explain this is to set up three entities: Company A, Company B, and the consumer. Here’s a simple breakdown:

• Company A: The company contracted to produce a good or provide a service
• Company B: The primary manufacturer/company conducting business
• Consumer: The company/entity that is purchasing the product from Company B

Sourced Manufacturing – Original Equipment Manufacturer (OEM)

 
 
Sourced manufacturing involves one company hiring or “sourcing” another company to produce parts, assemblies, or components for the finished product that they produce. Sometimes, they may even source the finished product. Outside manufacturing is another term used to describe scenarios in which sourced or contracted materials are made outside of the company’s control. The outside manufacturer is referred to as the original equipment manufacturer, or OEM. In this relationship between the two companies, the ownership of the manufacturing process, labor, and goods solely belongs to the sourced manufacturer (Company A). The only control that the buying company (Company B) has is based on the terms of the purchasing agreement between both parties. This manufacturing model is best utilized when the sourced manufacturer can make these items quicker and cheaper than by producing those items internally.

Outside Processing (OSP)

 
 
This form of outsourced manufacturing occurs when a manufactured good is sent to another company in an intermediary step within the manufacturing process. To further clarify, Company B starts making the product and then sends it to Company A to perform a specific task. Upon completion, Company A sends the product back to Company B to perform an additional step to complete the product. A common example is a car body shop sending out a metal assembly to a paint shop to be coated with paint. (Think of a car getting its frame fixed and then painted). Once the assembly returns from the body shop, the final changes can be made, and then the assembly is completed to stock. Unlike using an OEM, this intermediary step is bookended by manufacturing operations within the main company’s facility.

Drop-Ship Manufacturing

 
 
With a “drop-shipment,” the company that makes the product ships it directly to the consumer on behalf of the selling company. In this model, the consumer buys the product from the selling company (Company B). Company B then purchases the product from the OEM (Company A). Company A will then ship the product directly to the consumer. This saves time and money for all parties involved in the transaction. The downside of this transaction is that Company B has little to no control over the quality of the product and the packaging of the item as it leaves Company A’s facility on its way to the consumer. Examples of this include buying airline tickets from a travel site or buying goods from e-bay. Amazon has its own flavor of this scenario: products are shipped from the manufacturer and never reside in one of its distribution facilities.

Contract Manufacturing

 
 
Contract manufacturing and a contract manufacturer are two different subjects. A contract manufacturer is a producer of components or products to be supplied to a commercial firm. By this definition, OSP and OEM suppliers are contract manufacturers. However, because of their process and how they are accounted for in an ERP system, they are not performing contract manufacturing.

Contract manufacturing is the production of components or finished goods by a third party on behalf of the main production company. Going back to the model, Company A is the OEM, Company B is the selling company and the consumer is the company that ultimately wants the finished product. The production schedule of the product being made at Company A is set by Company B. The completed product belongs to Company B. Company A will ship the product to Company B or to another location (ex. 3PL or drop-ship to the consumer) upon request from Company B. Company B will pay Company A for materials and labor. Storage and freight will be compensated for depending on the manufacturing contract agreement’s terms.

The following factors separate contract manufacturing from the other processes previously discussed:

• Purchasing/supplier agreements
• Collaboration and visibility into stock levels
• Communication and tracking of the manufacturing process

In this model, Company A will exist in Company B’s ERP system. Company B will publish a production schedule for Company A. Company A will review the schedule and confirm the deliverables. Company B will have a system in place to receive production updates and will be able to view the completed product at Company A. Many systems refer to this communication as supplier collaboration. Company B will own the product once it is completed — not when it is shipped as with the dropship scenario, nor when it is received as with the OEM and OSP scenarios. Industries that use this model include food services, chemicals, and high-tech.

Toll Manufacturing

 
 
Toll manufacturing is like contract manufacturing, but with one key difference: the buying company controls and owns all the materials. The only parts of the process owned by Company A are the labor, equipment, and facilities where the product is being produced. This model gives Company B the most control and Company A the least amount of liability. Company A is only charging Company B for the service and storage of goods. In this system, these processes and procedures are governed by Company B’s ERP system. Company A can manage the manufacturing process in its ERP but will need to make regular updates to Company B’s system. Company B will maintain raw material stock levels and all purchasing agreements for these raw materials and will send them to the toll manufacturer based on agreed-to schedules. They will manage the completed product stock levels and dictate where they need to be shipped (i.e., to a third-party distribution center, Company B managed facility, or directly to the consumer). This model is used in technology manufacturing, food and beverage, and agricultural industries, among others.

How to apply these techniques to the Oracle Cloud

In the Oracle Cloud, each process has its own flow and configuration, which determines what needs to be configured.

• OEM – Standard supplier set-ups; purchasing and procurement departments may make additional agreements (e.g., blanket purchase agreements).
• OSP – Supplier agreements/blanket purchase agreements correspond with the OSP manufacturing steps, which are associated with the contracted supplier. The manufacturing operation sources the labor to the service supplier (OSP). This means that purchasing and manufacturing set-ups and configurations are required.
• Drop shipment – Purchasing (PO and/or blanket agreement) and order management configurations in the cloud. There are no manufacturing setups in this process.
• Contract manufacturing – For a contract manufacturing organization, the supplier and supplier site need to be properly set up and associated with the contract manufacturing organization. Internal business processes need to be in place governing who will manage this organization and the communication channels between the contract manufacturer (Company A) and the owning company (Company B). Ideally, a supplier collaboration portal should be implemented for communication. Blanket purchasing agreements for the contract manufacturing organization also need to be set up. Item structure attachments will need to accompany the blanket agreements. Manufacturing set-ups will only have labor sourcing, as material costs are included as part of the service.
• Toll manufacturing – Same set-ups as contract manufacturing but also includes raw material sourcing and planning. Supply chain manufacturing sourcing set-ups will include material sourcing from a supplier or internal manufacturing organization (for advanced supply chains) to be delivered to the contract manufacturer location. Consigned inventory can also be configured for tracking raw material usage at the toll manufacturer.

Inspirage Can Help

The term “contract manufacturing” is associated with several distinct types of manufacturing collaborations between two or more businesses. The key to applying this correctly in the Oracle Cloud is fully understanding how each type flows through the application. Once the process is firmly established, organizations can properly configure their applications to meet their business requirements. If they fail to do so, their solutions may be too simple or complex to utilize. The Inspirage team can help your organization properly utilize the correct contract manufacturing solution in the cloud.

As the Integrated Supply Chain Specialists, with recognition from Gartner, IDC, and winners of Oracle’s Game Changer award for SCM Service Delivery, Inspirage is uniquely qualified to be your success partner. Whether you are upgrading your on-prem system or have decided to move to the cloud where continuous improvement is built-in, our team is prepared to guide you on your transformational journey. Contact us to learn more.