How Can You Acquire Sustainable Margins in Contract Manufacturing?

October 23, 2021

Margin erosion is all too common in contract manufacturing and comes from many sources outside of your control, including:

  • labor costs,
  • utility costs, and
  • material costs.

We’ve seen some crazy examples – particularly when raw material markets get out of control – and the financial consequences of a fixed price contract when your inputs are inflating can be devastating.  How do we protect the margins you’ve “won” when you won the job?  This is a long, complicated issue but at its highest level:

Negotiate

  • In your bid, and then in your supply agreement or statement of work, negotiate for the following:
      1. Material cost pass-thru provisions
      2. Price escalators if volumes are less than forecast in the RFQ (challenging for some because the customer may want price breaks at higher volumes – but due to overhead absorption you should be willing to make some of these concessions)
      3. Price increases if costs out of your control (electricity, minimum wage) escalate.
  • Ensure that your suppliers will provide you fixed pricing through the life of the contract, or won’t impose prices increases that you can’t pass through to your customer. You’ll likely need to agree that your supplier will have all of the volume under the contract (which is fine) if they can hold their prices constant.
  • If you’ve aggressively priced the job, ask the customer to agree that you’ll be included in future RFQ’s and/or have a right of first refusal on comparable work in the future. These sorts of provisions are less and less common, but will give you leverage in the future when you need to ask for a price increase (you priced the initial work on the expectation of more work to come).

Automate

    • Labor costs and labor availability can and will compress margins. The more you can reduce your dependence on labor – through robots, cobots, and other forms of automation – the more sustainable your margins become.
    • What most smaller businesses don’t know is that companies that supply automation will likely provide you extended terms (particularly if you plan on increasing your investment in automation over time). It’s not unheard of for automation suppliers to agree to net 180 day terms (or longer), giving you months to earn the money required to pay for the equipment.
    • Additionally, there are several banks that will finance your automation purchase, often at attractive interest rates. This means that you can buy and install the automation and pay only to lease it – and the lease rate is likely lower than the labor savings generated by the robot.

We can help you will all of these ideas – showing you how to negotiate with customers, suppliers and automation providers, installing the equipment, and securing financing,  And because all of these techniques help sustain or improve your profit margin, they make your business more valuable when you’re ready to sell it.