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Toll and Contract Manufacturing

Meaning of Toll Manufacturing and Contract Manufacturing

Toll Manufacturing and Contract Manufacturing both are forms of outsourcing of production. In both the manufacturing arrangements, Companies get the production work done from a third-party company. It is done in order to reduce costs. Another reason might be to reap the benefits of technologically advanced machinery and workforce. Both arrangements are common in industries such as automobiles and ancillaries, pharmaceuticals, paints, inks, dyes and lubricants, textiles and garments, etc. Though both seem to be similar, there is a bit of difference between the two.

Difference

Toll Manufacturing is a process in which a company is responsible for the processing of raw materials or semi-finished products into finished products. Such companies may have specialized equipment for the same, or specialized know-how of the technicalities involved in the production process. They may even have specialized labor for the specific process. Such manufacturing is also called “Toll Processing”. The company does the production in return for a pre-determined fee or amount.

Contract Manufacturing is also similar to the above process. The difference between the two processes is the supply and usage of the raw materials used in the production process. In Toll Manufacturing, the source company that is getting the order made is responsible for the procurement and supply of raw materials to the manufacturing company. The manufacturer then processes these raw materials to produce the final product. It does not have control over vendor selection or procurement of raw materials. As a result, quality management and control in the hands of the manufacturer are only limited to the production process only.

On the other hand, a company outsources the entire production process to a contractor in contract manufacturing. The manufacturer himself selects the vendor for all supplies. It purchases all the materials for the production process and finally, produces the final product. A contract manufacturer quotes the final price at which he will supply the product, and the source company is concerned only with this price. Any variations in the prices of the raw materials are the concern of the manufacturer only.

Example

ABC Pvt. Ltd. is a multinational pharmaceutical company, manufacturing a wide variety of medicines. It decides to manufacture a new medicine for a specific ailment. Though it has done adequate Research and Development for the medicine and possesses the technical know-how, it does not have specialized machinery required for making this medicine.

ABC Pvt. Ltd. can buy the required machinery. It can also get this medicine made from another factory which possesses that specialized machinery. It decides to outsource the production of that medicine to another manufacturer XYZ Ltd. XYZ Ltd. agrees to make the medicine for ABC Pvt.Ltd. within the specified time period in return for a mutually decided fee.

ABC Pvt.Ltd. has two options. It can handover the entire production process to XYZ Ltd. from beginning to end and take delivery of the final medicine. ABC Pvt.Ltd. will not have to go for any vendor selection for materials, check for their price or even worry about price variations. It will just have to pay for the finished medicine at the pre-decided rate. This will be the case of Contract Manufacturing.

On the other hand, it may decide to supply raw materials for making the medicine to XYZ Ltd. This will help in keeping a check on the quality of the medicine. It will have to look for vendors of the materials, take quotes for the same, and absorb all the fluctuations in their rates during the course of the production. It may also have to arrange for transportation of the materials to the premises of XYZ Ltd. This will be the case of Toll Manufacturing.

Advantages of Toll Manufacturing over Contract Manufacturing

Due Control

The source company can completely control the vendors and therefore, the pricing and quality of raw materials used in the product.

Delegation of Sub-processes

The source company can sublet processes that are not its core competencies. It can also control product quality effectively.

Sole Focus on Production

The manufacturing company does not have to worry about lengthy vendor selection process. It need not bother about the price and quality of raw materials used. As a result, it can solely focus on its production and supply process.

Price Fluctuations

Fluctuations in input prices do not influence the costing of the manufacturer Company. In times of rising prices of raw materials, its profits will remain unaffected. This is so because it will keep getting a fee for its services as pre-decided.

Toll vs Contract Manufacturing

Advantages of Contract Manufacturing over Toll Manufacturing

No Pre-production Activities

The source company has no tension of vendor selection for raw materials, its pricing and quality. The manufacturer needs to bother for the same.

No Transportation Hassles

The source company need not worry about the transportation of raw materials and other essentials to the producer’s factory or workplace.

Economies of Scale

The manufacturing company enjoys economies of scale by integrating all the processes of production from end-to-end. These results in cost-saving and therefore, lower prices of the final product for the buyer.

Disadvantages of Toll Manufacturing over Contract Manufacturing

Delays and Interruptions

The source company has to provide the raw materials for production. Hence it can lead to delays and disruptions in the production chain. It is difficult to maintain an uninterrupted supply of materials at all times.

Disadvantages of Contract Manufacturing over Toll Manufacturing

No Control Over Quality

The source company cannot control the quality of the product. This is so because it cannot control the quality of raw materials going into production. It will have to rely on the manufacturers’ judgment of vendor and material selection for his product.

Conclusion

To conclude, it is difficult to determine which process is better of the two- Toll Manufacturing or Contract Manufacturing. The choice primarily depends upon the source company’s needs and capabilities.

In case the source company wants to maintain exclusive control and secrecy about the source of raw material or semi-finished product which is going into production, it should go for Toll Manufacturing.

The source company should also decide if the manufacturing company has the capability to handle vendors for the raw materials to be used. Also, it needs to assure that the manufacturing company has the proper process know-how. Adequate manpower to perform the entire product manufacturing activity is another criterion to check. If the manufacturer can do the above within the time deadlines, the source company can also go for Contract Manufacturing.1,2

1.
Toll Vs.Contract Manufacturing. cmcmilling.com. April 2020. [Source]
2.
Toll Vs.Contract Manufacturing. fluidenerygype.com. April 2020. [Source]
Last updated on : April 5th, 2020
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