Decision-time For Contract Manufacturing
March 1, 2007
Decision-Time For Contract Manufacturing
By Martin Schultz
Contracting out meat processing or keeping it in-house is a complex decision with extensive ramifications
In today’s pressure-cooker business environment, manufacturers succeed by concentrating on activities in which they have built up substantial expertise and outsourcing operations they may handle less efficiently.
The essence of contract manufacturing is that it naturally adapts to an equation in which a processor combines internal and external production activities. Moreover, by enabling processors to focus on their core competencies, contract manufacturers offer a long list of other benefits over in-house manufacturing. These include lower guaranteed costs, tight portion control, high food-safety standards, flexibility, access to outside expertise and lower capital investment.
For a contract-manufacturing partnership to succeed in the long term, each partner to the contract must derive some advantage. For example, the typical contract manufacturer in the meat industry operates very large-scale production. West Liberty Foods, in Iowa, is one of the largest sliced-meat processors in the U.S. In broad terms, what West Liberty would prefer in an ideal world is to partner with a minimal set of regular customers — foodservice operations and retail grocery chains, for example — each of whom would accept very large quantities of sliced-meat product on a regular basis. In the economies of scale that govern sliced-meat operations, the larger the quantities packed, refrigerated or frozen, shipped and distributed, the more efficient the operation, the lower the cost and the greater the profit margin.
In the same ideal world, the customer would receive all the benefits that accrue from efficient logistics and huge capital investment that retailers and foodservice would prefer to avoid. These benefits include the highest-standards of food safety the meat industry could contrive, consistent quality standards, accurate portion control and a strong focus on customer service.
The real world
Contract manufacturers in the meat industry do not operate in a world of fantasy. What they generally aim for is to optimize operations, dividing production into several components: manufacturing, private labeling and contract manufacturing, depending on the market, the type of customer and the constantly changing variables of supply and demand. But regardless of operational method, what all contract manufacturers seek is to satisfy customers, while maintaining high standards of production. Yet the advantages of contract manufacturing for customers and consumers remain constant.
“Everyone benefits,” explains Tony Mata, a consultant to the National Cattlemen’s Beef Association (NCBA) with a Ph.D in agriculture and bioscience. “The consumer benefits from a wider choice of brands, quality or range of prices than they would get if the store relied on branded products alone.”
For the retailer, says Mata, “contract manufacturing offers opportunities to store-brand or private-label in product categories he would otherwise forego.” As Mata points out, in a supermarket, it is not the leading brand that is contract-manufactured
“Take a pegboard, eight-ounce, sliced corned beef product. The difference in price between the national brand and the private-label brand may be as little as 20 cents, but this might be all the advantage the PL brand needs.”
For the consumer, the increased competition is a direct benefit of contract manufacturing. For the retailer, the choice offers the possibility of increasing his margin. This opportunity margin increases with other products. For example, with a four-ounce package of beef jerky, the spread between the national brand price and the store brand might be as much as $2.
Why would a retail chain choose contract manufacturing for any portion of its meat products? Partly, suggests Mata, it is to help “build [its] own brand by offering consumers better pricing with an equivalent or slightly different quality product.
“Of course, if the margins for a private-label brand are very small, the retailer might decide not to introduce his own private-label brand at all; and on the other hand if the margin is likely to be extremely attractive, he might decide just to stock private label and not have any national brand for a particular product on his shelf.”
Typically, if a foodservice operation or a retail chain decided to produce its own branded product, it would incur all the costs of production, including investing in equipment, production staff, transportation, refrigeration, raw materials, food-safety testing costs, packaging — the list is fairly long and the cost can become prohibitive. On the plus side, all the resulting profit is the retailer’s alone. On the minus side, all the risk is also the retailer’s.
Yet, if that same operator approached a contract manufacturer, the risks, costs and rewards would be offset. But what the retailer would get in addition is the contract manufacturer’s experience, a much-reduced investment, and the benefits of safe food handling, large-scale cost efficiency and quality assurance that come with this kind of partnership.
Relationship is key
Even with aggressive assumptions about the benefits of contracting out the manufacturing, it may be difficult to attain the expected advantages. This may be essentially because it’s never an easy task to organize either complex relationships or complex objectives. In our ideal world, the partners would establish optimum procedures that would create the circumstances to direct the outcome of the relationship. They would achieve this by setting up parameters that focus on essential performance measures.
The problem is that objectives are usually not perfect. Far from it. They are typically unrealistic or even keyed on incorrect assumptions such as the wrong measures, for instance, with the result that outcomes become questionable.
This is often why such challenges may tempt meat processors to keep manufacturing in-house, even while the potential reward derived from contract manufacturing remains too great to ignore. At this point, what many processors do instead is to step back and assess the whole strategy of approaching contract-manufacturing relationships.