Manufacturers are often faced with the decision of how to approach the production process efficiently and cost-effectively. Two common methods are turnkey manufacturing and toll manufacturing.

Each strategy has its advantages and disadvantages, which can significantly impact a manufacturer’s operations. Businesses should consider the pros, cons and implications of each approach to determine the best strategy.

TURNKEY MANUFACTURING: THE COMPLETE SOLUTION

Turnkey manufacturing involves comprehensive production services, from sourcing raw materials to producing and delivering the finished product.

Advantages of Turnkey Manufacturing:

• Complete Control: Offering turnkey services allows contract manufacturers to maintain control over the entire production process. This allows them to ensure consistency, quality and adherence to client specifications and production schedules.
• Logistics: Sourcing raw materials and managing scheduling and arrival helps turnkey manufacturers alleviate bottlenecks by synchronizing production schedules with the timely delivery of raw materials. This proactive approach helps mitigate the risks associated with customers delivering raw materials late and expecting immediate production, especially when the turnkey manufacturer is already committed to fulfilling orders for other clients.
• Cost Management: Assuming control over procurement in the production process allows turnkey manufacturers to identify cost-saving opportunities and implement strategies to maximize margins, provided that the contract with the customer permits and does not require passing the cost savings over through price reductions.
• Competitive Advantage: Offering turnkey services can be a competitive differentiator for contract manufacturers, especially in industries where clients value convenience, efficiency and reliability. By providing a comprehensive solution that meets all of a client's manufacturing needs, turnkey contract manufacturers can position themselves as trusted partners and preferred suppliers.

Disadvantages of Turnkey Manufacturing:

• Increased Risk: Assuming responsibility for the entire production process brings greater risk. The manufacturer must ensure that raw materials meet the agreed-upon quality standards and specifications.
• Complexity and Resource Intensiveness: Managing the entire production process requires significant investment in personnel, facilities, inventory management and quality control processes.
• Dependence on Suppliers in Sourcing Raw Materials: Managing supplier relationships, negotiating contracts and ensuring a reliable supply chain requires dedicated resources and coordination.
• Cash Flow Challenges: Payments to suppliers are often due before payments from the customer. Balancing outgoing payments with the timing of incoming customer payments can present additional cash flow challenges.

TOLL MANUFACTURING: COLLABORATIVE SOLUTIONS FOR FLEXIBILITY

Toll manufacturing involves taking responsibility over specific stages of the production process. The customer retains ownership of the raw materials and other components used by the manufacturer in the production process.

Advantages of Toll Manufacturing:

• Specialization: Specializing in the production stages or services where they have expertise or competitive advantages can lead to higher efficiency, better quality and lower costs compared to a turnkey model.
• Risk Mitigation: Focusing on specific production stages or services can mitigate the risks associated with sourcing raw materials.
• Reduced Inventory and Holding Costs: Processing client-owned raw materials or components reduces the need for manufacturers to maintain large volumes of materials or finished goods on hand. This helps minimize inventory holding costs and improves cash flow by freeing up working capital that would otherwise be tied up in inventory.
• Faster Revenue Recognition: Toll manufacturers fulfill their obligations to the customer throughout the production process. As a result, they can recognize revenue earlier, prior to pick up or delivery of the finished product to the customer. In some cases, the manufacturer may receive payment for each completed production stage, leading to quicker cash flow generation.

Disadvantages of Toll Manufacturing:

• Limited Control over Production: Manufacturers perform specific production stages or services according to the client's specifications, which may restrict the manufacturers' ability to optimize processes or differentiate their offerings and potentially limit their long-term competitiveness.
• Margin Compression: Toll manufacturing can be highly competitive. Manufacturers may experience margin compression, especially if they lack differentiation or face pressure to lower prices to win contracts.
• Complexity of Contracts: Toll agreements often involve complex contractual arrangements, with terms related to pricing, payment schedules, intellectual property rights and liability. Managing and negotiating these contracts effectively requires legal expertise and can be time-consuming.
• Dependency on Customers: Because customers are responsible for sourcing and delivering raw materials, customer failure to meet or adhere to the manufacturer’s production schedule will result in logistical challenges and bottlenecks.

STRIKING THE RIGHT BALANCE

Turnkey and toll manufacturing offer unique advantages and challenges. Manufacturers must carefully evaluate their priorities, risk tolerance and strategic objectives when considering these approaches.

By striking the right balance between control, cost, flexibility and risk, manufacturers can optimize their production processes and drive sustainable growth.

To learn more about this topic, contact GHJ’s Manufacturing and Distribution Practice.