Contract manufacturing: addressing capacity risk

Traditionally, contract manufacturers (CMs) have been mainly used by CPG companies during holiday seasons. When a confectionary producer had increased demand for chocolates in the run up to Christmas, it was then they would need external support to meet those demands. Now with margins diminishing and competition intensifying, an increased focus on product innovation and marketing has become critical for CPG firms. In order to carve out capacity and internal resources, a more strategic approach to manufacturing is required.


Winds of change

Part of this more strategic approach is a growing role for contract manufacturers, which we see being driven by a number of key factors:

  1. Focus on new launches

CPG companies have increased their focus on launching entirely new products, instead of simply incremental innovations. Today 41% of product launches are all new launches, according to an analysis of the Mintel Global New Product Database, and 34% are a line extension of existing products. New products have also been a major contributor to revenue and profit streams (more than 25% according to research). The presence of contract manufacturers has enabled this trend, by freeing up businesses to invest resources in innovation, while the production (and sometimes sourcing and distribution) is outsourced to partners.

  1. Pressure from dynamic brands

Another trend is the rise of dynamic brands – by which we mean leading single-category brands. The reason Red Bull is a top pacesetter among convenience store brands is because of its innovative products. Reportedly, the production of its beverages is outsourced, which has enabled it to manufacture at scale (6.3 billion cans sold in 2017 alone). A similar approach is followed by Monster Beverage Corporation (famous for its energy drink). An outsourced strategy allows these nimble-footed companies to focus on enhancing their branding and innovating their product lines, while the contract manufacturers make, pack and distribute their products. This in turn has escalated demand for quality CMs.

  1. Evolving expectations of CPG companies

Ever rising compliance and regulatory policies, tighter control on IP, and the requirements of de-risking the manufacturing capacity are leading CPG players to hunt for more reliable and business-objective-aligned CMs. Suppliers need to meet the quality and compliance standards of their CPG clients, including pre-requisite certifications such as EC Marking and ISO levels, frequency of client audits and sustainability.

Capacity risk runs deep

shutterstock_191643074Use of contract manufacturing has become a very common practice for CPG players – both old and new, large and small. However, it remains a challenge for companies to find and engage with a supplier which meets all requirements, exacerbated by the fact that some CMs cater exclusively to one customer.

 Capacity among contract manufacturers in developed markets across Europe and the US is very tight. At the same time, there is a dearth of similar suppliers in emerging markets such as Asia. And with demand forever increasing, quality contract manufacturers are often low on availability and capacity.



Strategies for CPG companies to deal with this capacity risk

  1. Traditional supplier ID

Finding new CMs in the existing market is the first and most obvious course of action. Yet this process can be akin to the ‘needle in a haystack’ scenario! Finding new suppliers often requires information which is not easily accessible to category managers, and qualifying potential suppliers (for quality, equipment, capacity, capabilities etc) can be very time intensive, as well as requiring extensive experience in order to ask the right questions. So if CPG companies want to work with a quality contract manufacturer, they must start identifying, planning and negotiating well before the point of need.

At The Smart Cube we have supported many clients facing this challenge. For one F&B producer, we researched a comprehensive list of contract manufacturers for savoury puffed snack products, and assessed the companies against certification, capacity and capability criteria. The ready list of verified potential manufacturing partners put the category manager in a great position to quickly initiate negotiations when the need to outsource its savoury product manufacturing arose.

  1. Alternate suppliers in alternate geographies

Companies also have the option of looking at suppliers in alternate geographies. In this often-unchartered territory, setting the right quality criteria upfront becomes very important. Our research for new contract manufacturers on behalf of a large global CPG client, in countries including Indonesia and Thailand, found companies often did not have the necessary accreditations, some had no information on their ability to trace materials, and many didn’t do quality checks on inbound materials. In this case, 13 out of 18 suppliers assessed didn’t meet quality requirements. The five new options we identified provided good alternatives for the client in a market facing a capacity deficit.


Planning for the long-term


Emerging and dynamic companies have stamped their mark on the CPG industry and threaten to challenge the established CPG giants. In North America alone, $22 billion in industry sales shifted from large to smaller companies between 2011 and 2016, according to the Boston Consulting Group. The Davids may have a best practice or two to share around successfully using contract manufacturers for business benefits. But are the Goliaths listening?

In our next blog we will look at how strong supplier engagement and building closer relationships can help with driving innovation, delivering higher revenues and increasing margins.