April 1, 2007
By Martin Schultz
Contract-manufacturing partnerships that span years or even decades are most likely to survive.
Contract-manufacturing, which in earlier decades was more familiar to the meat industry as co-packing, refers to a business relationship between two parties. Contract-manufacturing involves a series of intricate factors that endeavor to persuade a manufacturer, retail chain, or wholesaler to pay a company to produce a specific product in a specific process for a specified period.
The process by which this works is that another manufacturer or a retailer might decide it needs help developing and producing a brand to compete with a national brand. In this case the retailer could decide to negotiate with a contract manufacturer (CM) because the contractor may have superior expertise, a price that beats the potential partner’s cost of production, better logistics or some combination of competitive advantages. But what the contract manufacturer offers a potential partner, above all, is confidence that a product that matches an existing formula, or a successful new product, will be created.
When a potential customer approaches a CM, a great deal of research on the product, its formulation, its anticipated cost and its target market would have led the partner to that particular manufacturer. The choice might be based on the processor’s manufacturing capabilities, specialties (in a particular product area), experience with specific types of formulations, reputation, safety record, time to market or logistics capabilities.
These are not exclusive advantages. Many competitors often offer the same capabilities. Depending on the product category, competition can come from other established CMs or from a new breed of niche operators. This trend is becoming particularly evident in the sliced-meat industry.
“These are the smaller, niche companies — the guys who are trying to create a piece of the market for themselves,” explains Ed Garrett, CEO of Iowa-based West Liberty Foods, the largest sliced-meat processor in the U.S. “The niche contract-manufacturer is going after what I call ‘the entertainment food’ dollar. He wants to produce party trays of pre-sliced varietal meats for retail sale to customers who may be planning a Saturday night get-together by the pool.
“Here, price is less of a problem,” Garrett suggests. “What the consumer wants is variety, freshness, good-quality meat, pleasing appearance. What the niche CM wants is short production runs with a high unit cost. It’s ‘get in, get out’ relationships.”
Who owns the specs?
What differentiates one type of CM from another ultimately is the quality of the relationship they establish with their partner. One of the biggest tests is how they mutually treat the sharing of specifications on process or formulations — a highly complex area. Most CMs that have developed longstanding relationships consider a partner’s specific formulations sacrosanct. In general, regardless of category, CMs treat specs as exclusive agreements.
“We do not share a partner’s specs with any other company,” declares Shawn Dellevoet, director of business development at Toronto, Canada-based Morrison Lamothe. “But situations can influence how we handle the relationship.
“For example, we are a savory and dessert pie manufacturer, so the pastry recipe is ours,” Dellevoet notes. “The filling formulation belongs to the customer. We may use our pastry recipe for various pie formulations while each separate customer’s filling would remain exclusive.”
Another factor to consider in determining exclusivity is size. As Dellevoet goes on to suggest, “Small retailers don’t have sufficient leverage to impose exclusive formulary conditions on a contract manufacturer.”
If they approach the CM to create a product entirely from scratch without offering their own specific formulation, the entire formulation would remain the exclusive property of the contract manufacturer.
“In fact,” Dellevoet adds, “we might supply the identical pie product to five separate retailers, each of whom would expect us to package the product with their individual brand.”
In addition to ownership of the product specs, there is also the question of how much customization the CM will undertake to improve the product’s uniqueness. Simply, the larger the customer, the more product customization that customer can expect to receive. Obviously, cost becomes a primary consideration, as does expertise in interpreting the marketing data that influences product design. How much customization costs ultimately depends on the form it might take, which could range from simple or complex product differentiation to regional differentiation in the product content, appearance and packaging, along with variations in the packaging and branding.
Pricing is key
If the nature of the relationship inspires a strong level of mutual confidence, there is an open sharing of information about products, processes, production capabilities and formulations, which benefits both parties.
And one of the biggest factors impacting the relationship is how the business is priced. A contract manufacturer, having understood the customer’s need, can simply give a price without disclosing how he arrived at it — a “take it or leave it” type of proposition. Or the two partners can arrive at an “open book” price, based partly on the CM’s costs and partly on what the customer can bring to the table (perhaps using his own trucks to ship product, for example). On another level, the shared-costs concept can be employed more consistently across the whole range of component costs, from initial work-up through formulation, production, packing and shipping. Finally, there’s the cost-plus approach, in which both sides accept the full risks of the venture, calculating the base costs, then adding overhead and margin to arrive at a final shared cost.
Yet even though price is a key component in defining the nature of the contract-manufacturing partnership, it is still just one of many factors in the relationship’s ultimate success.
“Consistency, quality — these are the factors that help to build trust in a long-term partnership,” notes Garrett. “As a contract manufacturer, we have to take out their concerns, their worries. We have to understand them, their business, their customers. We have to be able to react to their business before they need to know. We have to be managing their supply chain. Then the relationship can grow.”