Toll Manufacturing or Toll Processing is a process in which a company provides raw materials or semi-finished goods to a third-party servicing company. The third-party company is responsible for processing the inputs into finished goods. It may also be responsible for packaging and even shipping the final product. Toll manufacturing is done to make use of specialized equipment with the manufacturing company, specialized knowledge of technicalities of the manufacturing process, or maybe specialized labor of the producer. The manufacturer gets a fee for its services, which is usually pre-decided. In simple terms, toll manufacturing is the outsourcing of production.
The source company procures and supplies the raw materials or components to the manufacturer for production. The manufacturing company does not select or control the vendor, nor does it have control over its quality. As a result, it can control the quality of the product only to the extent of the process which it is performing.
- Advantages of Toll Manufacturing
- Disadvantages of Toll Manufacturing
The source company often allows the toll manufacturing company to use its licensed processes, know-how, and trade secrets for production. As a result, the source company has to share its proprietary secrets with the processing company. There is an element of risk as the producer company is from the same line of business and capable of setting up a competitive unit in the future. It may copy the processes to its advantage or might even divulge it to a third party in exchange for a hefty compensation.
A very common example of toll manufacturing is Supermarkets and Hypermarkets. Many of them get products made on a Toll- manufacturing basis. A supermarket may get items such as electrical appliances under such arrangement by a manufacturer who may already make similar products for other suppliers. It may supply the required raw materials and parts for producing those appliances. The manufacturer would then make those appliances, do the packaging and finally ship them to the Supermarket’s stores in return for a pre-decided fee.
The Supermarket would then sell the appliances under its own house brand name. This will help it create a market in that segment and enhance its brand value by using its own space. The idea is to cut the market share of other suppliers supplying those appliances and enjoy the profits themselves. Because of this, its sales volume would automatically increase without going into an expensive factory set-up.
Advantages of Toll Manufacturing
The advantages of toll manufacturing from the source company’s point of view are:
The source Company can completely control the vendors, and hence, it can control the price and quality of the raw materials used.
Benefit of Specialization
The source company can perform activities that are its core competencies. It can sublet the processes which some other companies may specialize in. Hence, it can use the expertise and experience of the toll manufacturer to its own advantage.
Avoid Heavy Investment
The source company can use specialized machinery and equipment, godown and production space, and even labor of the processing company to its own advantage. Because of this, it need not invest in expensive factory set-ups and still enjoy its benefits.
Highly Scalable Model
Toll manufacturing leads to higher production and sales volume because of which source companies can increase their customer base in geographical locations without being present there directly.
The advantages of Toll manufacturing from the manufacturer company’s point of view are:
Focus on Expertise
The manufacturing company is not responsible for vendor selection for raw materials. Also, the pricing and quality of raw materials used are not its concern. As a result, complete attention can be given just to the production and supply process.
Immunity from Price Fluctuation
The manufacturing company is unfazed by changes in prices of inputs as it is the concern of the source company. It will get its fee as per the pre-decided amount because of which its profits will not change even in times of rising input prices.
Improved Capacity Utilization
A company can use its spare capacity to good use by going for Toll manufacturing for some other Company. As a result, it can earn more profits.
Disadvantages of Toll Manufacturing
The disadvantages of Toll manufacturing from the source Company’s point of view are:
Risk of Losing Trade Secrets
This is the biggest disadvantage of toll manufacturing. The source company has to share its proprietary trade secrets with the manufacturing company to enable it to produce. As a result, the manufacturing company may use it to its own advantage in the future. It can stand up as a competitor itself later on after learning the complex processes of production. It can even help a third company to set up a competitive unit and produce for it at a higher fee.
The processing company might delay or postpone the source company’s order if its production facilities are occupied beforehand. It may face delays in set-up and production due to red-tape and bureaucratic delays. This may lead to delayed deliveries, because of which the source company may suffer losses.
The disadvantages of Toll manufacturing from the manufacturer company’s point of view are:
Complex and Low Margin Processes
The source company might keep with itself the higher margin and easier processes for making a product. It may sub-let the more complex and lower-margin processes to the toll manufacturer. As a result, lesser lucrative and cumbersome processes will be left with it, and this may not be advantageous to it.
Toll manufacturing is very common with companies that are situated in high-cost regions. They face the problems of expensive land and labor. Lower cost regions such as China, India, Thailand, Vietnam, Sri Lanka, and Bangladesh have played a major role in attracting Toll manufacturing contracts from across the globe. Cost of capital, set- up and land coupled with the skilled and inexpensive workforce has contributed to this shift in production processes.
These countries also attract a lot of red tapes and bureaucratic delays while setting up and functioning of manufacturing facilities. Therefore, companies should keep this in mind while giving Toll manufacturing contracts to these countries.
When used strategically, such arrangements can create a win-win situation for both the source company and the manufacturing Company.
We suggest reading the following to find out the differences between toll vs. contract manufacturing: Toll and Contract Manufacturing.